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The Indian economy that was powering out of covid-induced doldrums is confronting dark clouds on the horizon. Raging inflation compounded by the war in Ukraine and aggressive rate hikes by the US Fed has put Indian policymakers on the backfoot, with the Reserve Bank of India (RBI) abandoning growth as top priority to battle inflation. As V. Anantha Nageswaran pointed out in Mint, RBI’s actions are perhaps driven as much by the intention to curtail demand and inflation as by the imperative to maintain broad macro stability. RBI’s shift in stance despite the fact that real rates in India are still higher than many developed economies and the real exchange rate is close to being fairly valued hints that with an expanding current account deficit (CAD), a retreating rupee and several successive months of portfolio outflows, RBI is concerned about a redux of the CAD crisis of 2013 and is willing to sacrifice growth for macro stability.

For RBI, ensuring that necessitates a monetary policy that is in lockstep with the Fed’s. In other words, India does not have full sovereignty over its monetary policy, and if it rains in Maiden Lane (street adjacent to the Federal Reserve Bank of New York), umbrellas must come out on Mint Street. This is merely a symptom of a structural gap in our economic model. We are dependent on the kindness of strangers (or foreign investors) to fund our consumption and bridge our CAD.

Instead of making a bold push for exports, successive governments have been content to tout India’s “unique" consumption led model of economic growth. The result is an economy which faces the spectre of a current account crisis every time risk aversion rises, oil prices surge and/or the US Fed tightens monetary policy.

Seemingly radical measures to boost exports, such as the SEZ Act have spluttered under the weight of their complications and while the Centre is trying to replace it with a Development of Enterprise and Service Hubs (DESH) Act, democratic frictions and the compulsion to make it World Trade Organization compliant cast a long shadow on the probability of its success.

While such measures are necessary for low-cost production at massive scale, it is not the only source of export competitiveness that a country can harness. There are other export levers that do not require the government to expend precious political capital.

In a fascinating book, Hidden Champions of the 21st Century, Hermann Simon outlines how the German Mittelstand made Germany into an export powerhouse despite cheap competition from China. The Mittelstand, a term often used to describe micro, small and medium enterprises (MSMEs) in Germany, account for 68% of German exports, 52% of its economic output and employ some 15.5 million workers, which helps the country keep its youth unemployment low (3.6%).

Several factors contribute to their dominance. Mittelstand companies are largely family owned with a long-term focus giving them stability and continuity of vision. They are financially conservative, with a preference for bank loans and equity funding, which makes them immune to cyclical downturns and makes them stable employers. They invest heavily in R&D at an average rate of 7.2% compared to 3.5% for larger corporations. But what really differentiates them is their business strategy. Instead of trying to gain scale through lower costs, they focus on niche markets ignored by large corporations and acquire scale by going global. They avoid capital-intensive sectors and dominate markets for critical components (with high cost of failure), which gives them pricing power. They are also deeply enmeshed with Germany’s technical apprentice system and employ 83% of its manufacturing trainees. This assures a steady supply of talent. The German government is very protective of the Mittelstand, offering them financial support, technical guidance and access to foreign markets.

Indian MSMEs are quite similar to Mittelstand firms. They are family owned, conservatively managed and avoid capital intensive sectors. What they lack is government championship of their cause through technical support, help with access to export markets and involving them in skill development. Instead of using their agility and low cost structure to exploit niche export markets, most Indian MSMEs spend resources on navigating a venal bureaucracy and extracting their dues from larger businesses, which according to a recent report have ballooned to 10.7 trillion. They also face an acute shortage of skilled labour. While the government makes grand claims about the success of its skilling programme, a cursory analysis shows that its ‘leading’ employers are skill providers that run training centres for it. So most youth ‘skilled’ this way end up being recruited by these very centres to train others in what looks like a labour market ponzi scheme.

Our government has launched a Make in India programme to facilitate investments in India by Mittelstand firms. It has set up a hotline for market assessment, consulting, tax support, government liaison, land allotment and growth financing—facilities that are unavailable to Indian MSMEs. Yet, despite this, they account for about 40% of our exports by dint of sheer entrepreneurial energy.

Our MSME sector can become an export powerhouse and a source of stable employment with minimal support and politically feasible reforms. With timely payments, a sympathetic bureaucracy, financial support, involvement in skill development and access to technology and foreign markets, we could have a Made in India Mittelstand.

Diva Jain is a director at Arrjavv and a ‘probabilist’ who researches and writes on behavioural finance and economics.Her Twitter handle is @DivaJain2

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