Role of SME's in India's Economic Growth

Introduction to Indian SMEs

There is a silent revolution happening in India. In fact, if you look around the corner, you may just about get a glimpse of an India that is changing right before your eyes. This is the India powered by SMEs, more commonly known as Small & Medium Enterprises.

When we talk about companies that drive change, it is always the larger corporations that come to mind. Billion dollar businesses that are driven to change, and may be even disrupt the existing business models & practices. On the other hand, the SME sector with about 36 million units, each trying to push the envelope a little further. It seems as if a few million drops of water have joined together to form an ocean of change.

SMEs are defined differently in different parts of the world depending upon their net worth, assets, employee strength, shareholders, and funding structure, etc. In India, SMEs are classified into two main categories, based on the nature of business. These categories are:

• Manufacturing Enterprises: Which are engaged in the production of goods (pertaining to any industry), within this, the enterprises are classified based on their investment levels, such as:

  • Micro: Upto INR 25 Lacs

  • Small: Above INR 25 Lacs, but less than INR 5 Crores

  • Medium: Above INR 5 Crores, but less than INR 10 Crores

• Services enterprises: Which are engaged in rendering of services (in terms of investment in equipment). Within this, the enterprises are classified based on their investment levels such as:

  • Micro: Upto INR 10 Lacs

  • Small: Above INR 10 Lacs, but less than INR 2 Crores

  • Medium: Above INR 2 Crores, but less than INR 5 Crores

Role of SMEs in the Indian Economy

SMEs employ around 40% of India’s workforce, which is an estimated 80 million people, who are given an opportunity for livelihood and employment via low-skilled jobs. Around 1.3 million SMEs contribute 45% to India’s manufacturing output and 40% of India’s total export. In a way, they form the backbone of the Indian economy. At 48 million, India has the second largest number of SMEs in the world, edging close to China which has around 50 million SMEs.

There are around 6000 products manufactured by 31.7% SMEs while the remaining 68.2% are engaged in delivering various services. This sector, if extended the right support, has the potential to spread industrial growth throughout the country.

Despite employing 40% of India’s workforce, SMEs are also the bane of India’s economic problems. Though the volume numbers work in their favor, they currently contribute to about 17% of India’s GDP.

Challenges Faced by Indian SMEs

MAny SMEs are reluctant to grow, resulting in reduced productivity. Others cling firmly to the concept of staying small and comfortable – thereby avoiding regulatory and taxation related hurdles.

Those who choose to grow, have a different set of problems to deal with – starting with financing. In an earlier survey conducted with over 15000 listed and unlisted companies from diverse sectors such as textile, power, agriculture and IT&ITES, a common trend showed that SMEs’ exposure to bank credit was drastically falling due to the high interest rates.

Another reason to shun bank credit, originates due to repayment timelines. While most big companies who buy from SMEs get an interest-free repayment timeline of 120 days, SMEs get only 60 days to pay back their interest-loaded bank loans. Because of this, most SMEs have now chosen to reduce their exposure to bank credit.

In addition, individual sectors face their own challenges. Real estate, for example, saw a slowdown in the past few years after a decade of growth. Similarly, exports have also seen a quarter-on-quarter reduction as demand has been slowing in European countries, and disturbances in West Asian countries have caused the tables to turn unfavorably for SMEs.

Because these companies are not market leaders in their segments, they are unable to hold a bargaining power in the price battle. They struggle to maintain quality while coping with reducing profit margins. Supply chain inefficiencies, global and local competition and insufficient skilled manpower can choke out SMEs that aren’t ready to take the bull by the horns and create their own path for growth.

Exploring Financing Opportunities for SMEs

One of the key ways to ensure the survival of SMEs is to make sure they don’t run out of financing options. Let’s look at a few new/ alternative funding options for SMEs:

• Foreign Banks: A healthy competition can be a win-win for most people, especially customers. In this case, bringing down restrictions on foreign banks on extending their number of branches can work in favor of SMEs, who may then see an influx of local banks clamoring for attention. Foreign banks are currently allowed to open only 12 branches a year. Change this to a 100 and see the magic work in favor of SMEs.
• Equity Funding: This type of funding has been a great success with startups, and it works well especially if you plan to bring in senior management who can help in significantly improving revenue & market share over a relatively short period of time.
• Debt Funding: Stepping away from known banks and exploring other debt funding options may work well for SMEs. Depending on business size, age, etc. the government has formulated schemes like collateral free loans up to INR 1 Cr.
• Mezzanine Debt Funding: This is a mix of equity and debt funding now offered by domestic as well as foreign investors
• LIBOR for Exports: Pre-shipment and post-shipment credits for exporters are available in LIBOR based regimes that offer highly competitive interest rates.
• NBFC Loans: There are a few NBFCs which currently offer debt-backed PE funding for SMEs
• Grants: India has developed bilateral trade ties with other countries where the trade/ finance associations offer grants to proven sectors, to gain an advantage from their growth. (Example: Renewable & Clean Energy, etc.)

SMEs & Technology

SMEs have been accused of living in an obsolete era in terms of technology. Access to internet, resources, virtual skilled workers and client opportunities can help them grow by leaps and bounds. They are now waking up to the fact that technology and culture of innovation can be high potential growth drivers. In a recent global study with Oxford Economics over 2300 SME executives, over 60% agreed that tech can be a key differentiator for their SME and over one third agreed that creating a culture of innovation is a top priority in their strategic growth plan.

Tech can be used in multiple spheres. It can make SMEs agile, improve innovation, fortify customer relationships and help explore new markets while reducing the cost of expansion. Specifically speaking, Big Data Analytics and MobiTech were named as the two biggest drivers of change.

• MobiTech: World over, as businesses move from being product-centric to customer-centric, it has become increasingly important for SMEs to focus on enterprise mobility as a key driver of innovation. Using mobile tech efficiently, helps to drive better customer experiences, especially for B2C SMEs in retail. For example, mobile apps can change the way SMEs do business. They can enable streamlining order flow, forecasting warehouse inventory & allow for better communication processes.
• Cloud Computing: Using the Cloud to handle a substantial chunk of their IT related aspects can be a great way for SMEs to save on IT costs, and instead use these savings to drive product innovation. This would allow SMEs to scale and gain expertise from any part in the world without having to invest in infrastructure and offices. It helps streamlining sales, inventory and financials especially for SMEs without huge capital reserves.
• Big Data & SMEs: Analytics can be a great way to know more about your customers, and will allow you to gain insights on what your customers are buying, how they’re buying it (or not) and where exactly in the sales funnel are they dropping off. All this information can help in creating a better customer experiences and nurture leads to close sales.
• Exclusive Telecom for SMEs: In recent years, many telecom technologies like VoIP, WiFi and other Compression Technologies have become affordable for SMEs. Telecom companies did take a bit of time understand the price-sensitive SME market, and have started offering technology which can implemented relatively quickly and can be upgraded on demand. One such example is a network service between branch offices which will enable SMEs to save on call costs.
• Tech Improvements for the SME Support Systems: It's not just SMEs that need a boost in technology, but also those who offer their services to them. Banks, for example, charge lesser for electronic/ branchless transactions vs. those transactions which are conducted within branch premises.

Government’s Role in Promoting SMEs

A few of the recent initiatives by Government of India have a given a boost to SMEs. In a direct move to increase the GDP share of SMEs, the Government has allocated 20,000 Cr to this sector through the Micro Units Development Refinance Agency Bank (MUDRA).

Similarly, in a move to promote ‘Zero-Defect’ manufacturing that has ‘Zero-Effect’ on the environment, the Government has set up the performance and credit rating system for SMEs called the ZED rating. SMEs will be classified into bronze, silver, gold, diamond and platinum categories. The idea is to help SMEs grow bigger, gain economies of scale and improve the quality of their products. Here are some of the other popular schemes for SMEs in India.

• Credit Guarantee Fund Scheme: Applicable to both existing and new enterprises, this scheme provides collateral-free credit to Indian MSMEs. The ministry in association with SIDBI established the trust that facilitates a working capital loan of up to Rs. 100 Lakh per borrowing unit
• Credit Linked Capital Subsidy Scheme for Technology Upgradation (CLCSS): The Ministry of Small Scale Industries (MSSI) created the CLCSS which provides upfront capital subsidy of 15% (max 15 Lakh) to SSI units which can be used for plant & machinery modernization.
• Financial Assistance on International Participation: This scheme offers funding to SMEs for participate at international trade fairs, exhibitions and also promotes sector specific market studies by industry associations. It also offers reimbursement of 75% on one-time registration fee and 75% on annual fees (recurring) paid to GSI by SMEs for the first three years for barcode. It also facilitates tech upgradation, creation of joint ventures and foreign collaborations.
• Technology & Quality Upgradation Support to SMEs: This scheme helps SMEs gain benefit from energy efficient technologies and manufacturing processes to reduce their carbon footprint. It provides them with 75% expenditure to buy such technologies.
• Mini Tools Room & Training Center Scheme: The govt. provides grant / aid that equals to the cost of the machinery/ equipment (max 9 Cr.) to create a new mini tool room and 75% of the cost if an existing room has to be upgraded. The scheme aims to create a skilled workforce which would also benefit the region in the long run.

With low investment requirements, operational flexibility and the capacity to develop appropriate indigenous technology, SMEs have the power to propel India to new heights. Imagine an India that has empowered SMEs to maximize their growth propulsion, resulting in a significant boost to the growth of India as a whole. Looking at the current trends, it’s seems as if India may one day overtake China in its SME volume. However, it’s crucial for India’s SMEs to ramp up the quality of their product offering and transfer benefits to the end consumer.

Starting a business today is a lot simpler than before. There are accelerators, incubators, investors and mentors available to handhold a business to ensure they see the light of day. The ever-growing internet/ mobile penetration have opened up both the international and rural markets like never before. While the atmosphere is rife with challenges it’s also ripe with opportunities. The time is right for us as a nation to sow the seeds, and build a support system, which would allow our SMEs to achieve their full potential.