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MSME Sector –The Next Big Change

Posted in Finance Articles, Total Reads: 1683 , Published on November 24, 2015

With 45% contribution to industrial output and 40% employment opportunity, MSME is one of the most important sectors to drive growth. Existing government policy structure has ability to address problems but it’s not exhaustive enough to drive the next big change required. This is evident from the fact that there is demand supply gap as shown below. This article talks about various government initiatives to improve the financial inclusion in the MSME sector at the same time limitations of the same.

Image: pixabay

Source: MSME census, RBI, SIDBI, primary research, IFC

Existing Policies, Limitations and Recommendations

Government launched the scheme CGTMSE to offer collateral free loan to SMEs up to Rs 100 lacks. This is a profound step towards availing the collateral free loan which will help many SMEs which lack sufficient initial investment for collateralization. However there are some limitations of policy.


 Access to policy: Lack of knowledge about the policy to SMEs, SMEs registered with NSIC eligible to access the policy. But lack of awareness about NSIC and policies prove hindrance and defeat very purpose.

 No Control over borrower, putting banks and member institute on risk. Even though government (SIDBI) would be covering 75% to 80% of the loan, there is no streamlined process defined to recover the losses in case of default which adds to time delay in loan recovery and hence additional cost for banks

 Higher amount of one time guarantee fee and annual service fee are observed to be another big impediment owing to higher cost of borrowing


Implementation is the key

 Great need to disseminate awareness through training institute , EDIs , RUDSETI etc

 Define process in case of default to protect bankers and hence encourage them for further investment

 Define a minimum cap below which exempt from guarantee fee and annual service charge

Apart from CGTMSE, there are many other initiatives taken by GOI, but with certain limitations.

1. Government Incentive Dis-Incentivizing growth

Financial policies such as CGTMSE, Credit Linked Capital Subsidy Scheme for Technology Upgradation, MSE-CDP are applicable only for Micro and small enterprises. We would recommend extending these policies to Medium enterprises and till 1 year after becoming large. This way SMEs would attain sustainability.

2. Crucial Demand Management 

A/c to price purchase policy, 358 items are reserved for exclusive purchase from MSMEs with target purchase of 20% of annual value of goods. With 45% addition to gross industrial output it makes more sense to increase this limit to at least 30%. The direct impact will be increased revenue for MSMEs, increased profitability, better financial health. Also extend this policy to medium enterprises.

3. Inadequate policies for Micro-Finance

Except for Micro Finance programme, there is no policy in existence which can address issues such as

• labour management

• non-transparent pricing by MFIs

• Over-Indebtedness of borrower

• Limited financial literacy

In the following table we have provided existing MFI structure, their limitations and inefficient financing practises adopted by them.

Source: NABARD (Except Recommendations, provided by us

4. Making it more Bank and MSME friendly

5. Need For Cluster Financing Approach

6. Need of Strong Regulatory Authority

Even though RBI has set up guidelines regarding MSME credit lending, Banks are given autonomy in some respect. Delegation of more powers to branch managers to grant ad‐hoc limits, Freedom to banks to decide their own norms for assessment of credit requirements etc. The issue here is banks neglect the guidelines issued by RBI (like 20% YoY growth for MSMEs).

7. Need Efficient Rating System

Currently there are many rating agencies involved in MSME rating including SMERA. A/C to CRISIL post rating, interest rate reduction for its client was 0.5% to 1.25%. This depicts the importance of rating. Government provides subsidy to these agency for the first tie credit rating of the MSME depending upon its size. Problem lies in defining the rating criterion for the new MSMEs. Rating is awarded based on Industry risk analysis, project risk analysis and past data. Many of these MSMEs won’t have knowledge of book keeping and hence won’t capture their routine transactions. Also majority of the times above mentioned parameters act against entrepreneur. Hence there is need to alter the methodology of MSME rating. Also we recommend setting up external independent entity to make spread financial awareness to clients and also connect them to SMERA or similar rating agency.

8. Tax Structure and Impact of GST

With existing tax structure, MSMEs have to pay service tax, VAT , export duty. This is big concern for many poor financial health SMEs. This is a prime reason behind MSME does not register itself with NSIC hence fail to avail government policy advantages. With GST coming in picture, removing all indirect taxes, cost in terms of taxation will go down hence improving the situation.

However, clause 18 of GST suggests imposing 1% tax on Interstate movements of Goods which increases tax burden, thereby making small business uncompetitive.

9. Improving Ease of Doing Business

India ranks 142nd in ease of doing business according to World Bank report. One of India’s biggest concerns when it comes to the ease of doing business is that of clearing permits and getting contracts cleared. Although the introduction of e-governance platforms and single day window clearance mechanism have assisted in significantly lowering the gap and delay in the process a lot more has to be done to improve the process. Having more e-governance platforms would certainly make the process more transparent and open to the public but even transparency would not be significant. A tracking and monitoring system needs to be in place.(similar to that of an Enterprise Resource Planner ) This system is a deadline based alternative to each permit or contract. Every time the deadline is not meet a certain penalty can be levied on the individual responsible for the permit.

Another major concern is the cost incurred in starting a new business. Not only is this process time consuming it also requires a number of approvals. Hence, the process needs to be digitized to reduce time and single window clearance should be implemented at every point possible. Concerns of land acquisition also raise an alarm along the same lines. Hence, it is essential to have a centralized process of monitoring and clearing permits and approvals.

This article has been authored by Saurabh Dongare & Anshita Lalwani from NMIMS







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