Home / Opinion / Views /  MSMEs need innovative solutions as inflation kicks in

Indian micro, small and medium enterprises (MSMEs) have a new challenge, with the high pass-through of the world’s ‘new normal’ inflation. Rates of inflation have been in excess of 5% in developed countries across the world. In January 2022, the year-on-year inflation rate for OECD countries rose to 7.2%, the highest since February 1991, while the rate for G-20 countries rose to 6.5%. Retail inflation in India has stayed above the psychological upper limit of 6% in calendar 2022 so far, while the wholesale price index (WPI) rate in February 2022, at 13.1%, has been more than double the retail inflation.

We carried out a survey of family-run MSMEs in March 2022 to study how inflation is affecting them, to what extent is such inflation driven by global factors, the methods used by these enterprises to cope with such inflation, and their inflationary expectations. More than 85% of the 170 respondents drawn from the manufacturing and services sectors from 65 cities across India attested to a significant rise in prices over three months from mid-December 2021 to mid-March 2022. The 19.55% average increase in operating costs experienced by these businesses was much larger than the current cost inflation suggested by the WPI. Thus, only 31% of the enterprises reported positive cost inflation less than or equal to 13%, while the majority experienced far greater cost increases, even exceeding 50% in some cases. Manufacturing enterprises seem to have been particularly badly hit, with 92% of these reporting an average operating-cost increase of 24%. This, as compared to the 14.4% average operating cost increase reported by 77% of service enterprises, suggests that policymakers would need to re-imagine their goal of a manufacturing-led industrial recovery in India.

Size seems to have mattered, albeit negatively, with mid-sized firms experiencing greater inflationary shocks than small or micro enterprises. Almost 90% of medium enterprises reported a positive average operating cost increase of 24%, as opposed to the 18% average operating cost increase experienced by 78% of micro enterprises.

The pass-through effect of raw-material inflation is significantly greater than that of fuel and energy costs, with 63.5% of these enterprises citing raw-material cost inflation as the No. 1 factor responsible for operating cost increases. However, this proportion was significantly greater for manufacturing firms: 79% of manufacturing enterprises cited raw material cost as the top factor for operating cost increases, compared to only 17.6% who stated energy, fuel prices and transportation costs and 1% who stated labour cost increases respectively as the No. 1 factor.

Policymakers will need to formulate strategies to cushion manufacturing MSMEs from experiencing the complete pass-through effect of such global factors (influenced by geo-political developments). Energy and fuel prices were more significant factors impacting operating costs of service firms, together with raw- material price increases. Financing costs were not ‘top of the mind’ as critical factors imposing a higher burden on the MSMEs surveyed. This may partly be on account of the accommodative monetary policy pursued by the Reserve Bank of India for the last two years in support of the economy during the covid pandemic crisis.

An overwhelming 83% of the MSMEs surveyed stated that they had gone in for price increases in response to higher operating costs. Some resorted to other measures such as improving their receivable collections and cash flows, scrapping old contracts and renegotiating contracts based on new input rates, besides borrowing from banks and other financial institutions. A very small proportion admitted to quality reductions and/or grammage reductions to counter rising costs. This may reflect a greater significance attached to social capital and network capital by family enterprises than non-family firms.

Some firms used rising costs to cut their own prices, so as to boost demand, dispose of inventories and/or to match competitor prices. There are others that have raised prices in anticipation of future operating cost increases, even without any increase in their own costs. We also found that MSMEs expect costs to continue rising over the next three to twelve months, with a majority of enterprises planning to increase their own prices over the next three months.

Medium/mid-sized enterprises account for a minuscule 0.5% of India’s 63.3 million MSMEs, and yet hold the most potential for growth, productivity and efficiency gains. They are capable of delivering superior and disproportionate returns on incentives and support. The government will need to focus on these mid-sized enterprises, especially those in the manufacturing sector, to get the biggest bang for the buck. This will also force enterprises to move from micro and small status to medium-sized enterprises. The government should also take up the need to partner with large enterprises, which by providing small businesses the required hard and soft skills, expertise and access, can help the latter build capacities and capabilities.

Our survey shows it is time to look beyond mere financial support for MSMEs. A host of non-financial advisory services that cover strategy advice, among other things, and help with branding and marketing, apart from general capability building and networking opportunities, will need to be provided by advocacy and interest groups. India’s aim should be to transform family business and entrepreneurial ecosystems to make them globally-oriented and competitive.

These are the author’s personal views.

Tulsi Jayakumar is professor of economics and executive director, Centre for Family Business & Entrepreneurship, Bhavan’s SPJIMR

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