Capital allocation that reaches deserving MSMEs will result in inclusive growth
Summary
- Capital without context could inflate a bubble while credit for worthy MSMEs is what we must aim for. The government, financial sector, various industry associations and sector-specific bodies must work together.
The numbers represent both an opportunity and a challenge: India has 63 million micro, small and medium enterprises (MSMEs), contributing almost a third of the country’s GDP and half of its exports, with an equal spread between rural and urban areas, that are mostly short of credit. Given the tailwinds behind India’s economy, the MSME sector will keep growing in size, especially as it is formalized. However, for the sector to reach its true potential, qualitative growth is important.
“I got 99 problems and money ain’t the only one"—these adapted lyrics from rapper Jay Z’s monster hit 99 Problems could well be the collective refrain of MSME entrepreneurs in India. Deficient funding reach and credit appetite aren’t the only obstacles in the growth path of small businesses. That’s why, along with the question of how to lend to MSMEs, we should also be asking: How to make MSMEs more credit worthy?
It’s useful to view MSME growth prospects through three lenses, as follows:
Customer base expansion: India’s economic rise is pegged to the promise of increased demand. In November 2022, a salary trends report by ECA International predicted that real wages would rise in India by 4.6%, more than Vietnam’s 4% and China’s 3.8%. In September 2023, BMI forecast that India would become the world’s third-largest consumer market by 2027, on the back of a 29% increase in real household spending. The question for MSMEs is how they will find these consumers, both on the wholesale and retail sides. A 34-year-old entrepreneur from Surat recently spoke to us about this challenge. His firm makes PET preforms, his primary clients are mineral water and soft drink producers. He has a high-quality product at a competitive price but still has trouble finding new markets and customers. The reason is information asymmetry. Some websites list ISI-compliant manufacturers, but these are scarcely updated. This field’s other issue is that a few big players capture the export market and smaller businesses get left behind for lack of information.
Business operation plans: In recent years, India’s infrastructure has seen a transformation. A Harvard Business Review article from September 2023 highlights an interesting data point: as a percentage of total government expenditure, capital spending in India has increased from 11% in 2010 to a projected 22% in 2023. Much of this build-up can ease logistical problems faced by MSMEs. Immense strides have been taken on the warehousing front, for example. The PM Gati Shakti programme and National Logistics Policy are top priorities for the government.
The benefits of these initiatives must trickle down to MSME operators who face manufacturing and production challenges. “Even if I want to become a B2C company, I can’t because I’m stuck with production issues," a Mumbai-based lighting manufacturer and interior project consultant told us, “There is no bandwidth to build a brand because scaling up is very difficult." Her bank and chartered accountant provide her with advice about private funding frequently and government schemes occasionally. But she’s looking for more.
Here again, information dissemination about sector-specific schemes like the government’s Production Linked Incentives (PLIs) will play a pivotal role.
Boosted employee productivity: In mid-2023, Goldman Sachs Research projected that India would become the world’s second-largest economy by 2075. The key to achieving that milestone will be to provide the right skills to this vast pool of human capital. The odds are stacked in India’s favour: over the next two decades, the country’s dependency ratio—the non-working age population that is dependent on the working age population—will be among the lowest among the world’s large economies.
It is imperative that this labour is upskilled and channelled productively. A conversation with a 63-year-old businessman from Nagpur reinforced our belief that upskilling is for everyone. He is a manufacturer of industrial and decorative paints and mostly operates in the business-to-business (B2B) space.
Ever resourceful and eager to learn, he has been regularly signing up for online upskilling sessions. In his view, industry associations should be taking a more proactive role on the employee training front. That could be a step towards stemming attrition and encouraging unskilled and semi-skilled labourers to think about their careers from a more long-term perspective.
Let’s unlock MSME growth: All these conversations have led us to believe that companies should look beyond their industry when it comes to MSMEs. “I’m a lender, so I’ll only do loans"—this attitude cannot take you very far if unlocking growth is the true objective. MSMEs need to be viewed as suppliers, customers and partners. Growth-oriented partnerships must go hand-in-hand with financing. India’s central and state governments recognize this. In recent years, administrations have launched a raft of schemes that go beyond subsidies and funding, and focus on skill development, digital transformation and marketing promotion.
The government, financial sector, various industry associations and sector-specific bodies need to come together to build and maintain a ‘capital-plus-plus’ environment that is imperative for India to reach its ambitious economic goals. Capital without context is a bubble; capital with context is inclusive growth.
