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SMEs as a Target as Trends in Industry Change

Posted in Finance Articles, Total Reads: 3480 , Published on November 09, 2014

The SME sector has been on the growth trajectory in India, especially in the last decade. SMEs have made a significant contribution to the economy and this can be seen from the impact they have made on the total GDP of the country. This is evident from the numbers below-

• SME sector in India contributes to over 40% of the country’s manufacturing output by value addition.

• It contributes to more than 35% of the total exports and circa 20% of the total imports.

• Excluding a few years, the SME sector exports have seen a double digit growth in the last 10 years.

• The industries with highest share and most rapidly growing exports include readymade garments (27%), engineering goods (14.5%), chemicals & pharmaceuticals (11%), electronics & computers (11%) and processed foods (11%).

• It provides employment to circa 70 million people in rural and urban sector.

• It accounts for over 90% of the industrial units’ production in the country by number.

• It is involved in production of over 8000 industrial items with products ranging from the traditional labor intensive technology based to the high technology products.

Image Courtesy: freedigitalphotos.net, Danilo Rizzuti

Hence, role of SME sector in India’s Growth Story cannot be neglected. Their role will become increasingly important in the nation building in terms of employment, revenue and growth.

Ever since globalization process in India started in 1990s, along with India the SME sector has been exposed to many global opportunities to do business in the world. When the industry Biggies were not able to fill in the demand gap completely and quickly, this opportunity was seized by the SMEs and this helped them grow to a large extent.

The following figure represents the place of this sector in the overall picture of the Indian economy.

Figure 1

Global Scenario-

The role of SMEs in the nation building can be seen in the more developed economies as well. The countries which are more advanced economically have a greater share of their overall growth coming from the SME sector. It helps not only in filling the demand- supply gap but also in redistributing wealth in the nation and achieving a more balanced growth.

First, significant variation exists among regions. Latin America has the highest percentage of MSMEs with access to finance (approximately 60 percent), followed by Central Asia and Eastern Europe (approximately 45 percent). By contrast, more than 85 percent of MSMEs in East Asia, South Asia, and Sub-Saharan Africa are unserved or underserved. In terms of the size of the credit gap, approximately 45 percent ($900 billion to $1.1 trillion) is in East Asia, more than six times that of Sub-Saharan Africa and more than five times that in Middle East and North Africa (MENA) countries.


Figure 2

Developing World-

In most of the developing world, SMEs are the only realistic employment opportunity for millions of impoverished communities. In Malaysia SME accounts for 21% of GDP. Even though their number is large their contribution to value added and value of fixed assets is far smaller than large enterprises,

Most OECD governments promote entrepreneurship and seek to support and develop SMEs through a variety of policies. These attempts to combat many of the common difficulties encountered by SMEs and offer solutions to problems in such areas like finance, technology, innovation, IT, management, internationalization etc.


Some of the world’s best-performing economies, such as Taiwan and Hong Kong are very heavily dependent on small enterprises. The majority of enterprises are in the service sector, specifically import and export, and wholesale & retail trade. In Japan, where SMEs are defined as establishments employing between 4 and 299 employees with a turnover of less than 100 million yen, they represented 99.7 % of all enterprises. Korea, recognizing the importance of SMEs has introduced many measures that include tax breaks and reduced interest loans for those starting new businesses in rural areas.

Problems Faced by SMEs-

As seen from the above numbers, the SME sector holds a vast potential. It is evident from their performance in many sectors. However, they have not been able to tap their full potential due to a number of reasons which can be broadly stated as-

• Cheap/ cost effective capital requirements

• Availability of credit as and when needed

• Technological upgradation

• Professional approach to the business

• Skills upgradation

• Sales and marketing/ access to the markets

• Resources management

• Regulatory compliance

Having said this, the main issue the SMEs face is the lack of awareness. The SMEs are generally managed by individuals or a small number of partners. Also, their budgets are low so they are not always capable of obtaining professionals, industry veterans and hands-on-experience like the big companies.

One of the ways to resolve these problems is by the help of external consultants. Consultants, which bring specialized industry experience to the table are able to fill in the problems faced by the SMEs quickly and at a lower cost.

Capital Requirements-

Most of the SME companies are not listed on the exchange and hence they do not have an option of raising capital through capital markets. One of the ways this can be overcome is by PE VC funding or Private Preferential Placement. In recent years, India has seen the highest number of PE VC fund coming in as compared to any of its global competitors. Most of this funding has gone to a few sectors like technology and IT. Hence, the hunger for capital by the SME companies was not really satisfied.

As a result, the only option left with many of the SMEs was debt, which is the costliest form of funding. The cost of capital is even higher for SMEs as most of these companies are not rated and the lenders do not rate them highly. This prevents them from scaling up their operations. As much as 60% of the SMEs in India do not have debt for expansion projects as compared to less than 20% in the developed world. This difference becomes evident when we look at the global picture.


Figure 5

Availability of Credit and Working Capital-

Many of the SMEs operate in the capital intensive sectors like engineered goods, textile and electronics. These sectors have a longer operating cycle and have many industry giants competing with the SME companies. To prove competitive with these companies and to maintain profitability these companies need to manage their working capital effectively.

As seen from the study by www.dcmsem.gov.in, almost 67% of the SME are facing working capital management problems. Their funds are blocked in lieu of payments of interest of the funds borrowed at higher costs. At the same time, their credit policies are such that it becomes difficult for SMEs to manage their creditors and debtors.

The Future of SME Sector-

It is clear that there are several factors that affect the Quality and Productivity. Particularly SMEs need to have a more educated work force, and provide formal structured training to their workers. They have to adopt greater automation and quality control in production, and improve on the human resource management and compensation practices that emphasize job stability and skill acquisition. This is an important step to move to a greater efficiency level in their operation. Efficient firms have better access to new technology through know-how licensing agreements, joint-ventures with foreign partners. Consequently, SMEs will provide an important source of growth and employment generation in the economy.

The government, banking system and the capital markets are increasingly understanding the importance of SMEs in the overall growth of the economy. As a result they have come with up many innovative ideas to support the growth of SMEs like-

• Ease in listing and equity capital raising by SMEs thorough the SME platform on BSE & NSE

• Easy of regulations to the sector by the government and regulator

• Special promotion policies and incentives for the SME companies

• Ease of credit lending procedures by the banks for lending to SMEs

• Setting up of different mechanism for credit rating and fund raising for the SMEs

As a result of these promotional policies, the SME sector may be able to solve many of the problems it is facing today. The SME companies are expected to grow at a CAGR of 18-25% in next 5 years. Looking at the current numbers, their contribution would be significant to the GDP of the country. According to the estimates of the study done by the McKinsey & Company, the share of SME sector in India’s GDP may increase by 1.5 times by the year 2016. The rise in the share of employment would be even more magnified.

In short, the SME sector would be the sector which will set the trends in the Indian growth story instead of playing only a minor role. It will bring about an inclusive growth which will propel India to achieve the status of a developed nation in the long run.

This article has been authored by Vaibhav Tyagi & Chinmay Ingole from NMIMS 


• The International Journal’s Research Journal of Economics and Business Studies

• Reserve Bank of India publications and public notices

• BSE SME Exchange-guidelines for launching the SME exchange in India

• Export Import Bank of India-SME & Agricultural Finance

• McKinsey and Company publications on SMEs in India (Fuelling the Indian Entreprenuer- Opportunities in SME)

• 2008 Asia Pacific SME Banking Report

• Serving Asian SMEs” KIP team

• www.dcmsem.gov.in

• Bombay Industries Association survey, 2011.

• International Journal of Engineering and Innovative Technology (IJEIT)

Volume 3, Issue 5, November 2013

• Twotrillion

Databases used-

• Prowess

• CapitalIQ

• Crisil

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