New Law for Micro and Small Enterprises suggested

New Law for Micro and Small Enterprises suggested B. Yerram Raju* Abstract Micro and Small Enterprises (MSEs), the second largest employers and the strongest link in the supply chain, are the seedbeds of innovation and entrepreneurship. The drivers of growth thus rest on entrepreneurship, and enterprise creation. Legal, and regulatory facilitation fall short of the requirement because these units – both in manufacturing and services -- are regulated under the 15-year-old Micro, Small and Medium Enterprise (MSME) Development Act, 2006, The Act benefitted the large SMEs bypassing the micro and small. The Act was amended amidst the pandemic providing for classification under the twin criteria of investment and turnover from the earlier single criterion - investment. This paper argues that MSEs require a separate law and supporting dedicated institutions at the federal level. This is imperative in the interest of financial inclusion agenda, and for the success of the ambitious ‘Make in India.’ Key Words: Micro, Small, and Medium Enterprises; Employment; Growth; Equity; Law; Regulation; Financial Inclusion, Digitisation.  Introduction  With more than a billion vaccine doses administered in the country and with quite a few lagging sectors like aviation, tourism and services looking northwards, growth projections of the Indian economy are attracting global attention. World Bank, IMF, global rating agencies to NITI Aayog, estimate that India would reach 9.5% growth by March 2022. The raging debate has, however, been on the rising energy prices, global disconnect in post-pandemic growth transmission and unemployment. Fiscal 2021-22 has been witnessing a vast expansion of industries and services, both online and offline, particularly in rural and semi-urban areas or second and third tier towns and cities. The Reserve Bank of India (RBI) in its September 2021 monthly bulletin highlighted the top concerns of the economy – growth and inflation against the backdrop of an unstable consumer confidence index.  Census of MSMEs Required There have been positive announcements by the Government influencing such prospects during the last few years relating to infrastructure, agriculture, commercial coal mining, defence, insurance, creation of a bad bank, redefining MSMEs and Gati Shakti. Digitisation has been a major driver in formalising the economy. These are all necessary but not sufficient conditions for ensuring that the bottom of the pyramid comes out of the pangs of poverty. They still reel under the lagging productivity and failing jobs. Overall, Micro, Small and Medium Enterprises (MSMEs) employ about twelve crore skilled and semi-skilled workers. If the unskilled are considered in the total employment of enterprises, they should be providing employment to about twenty crore people. If the unorganised micro and small enterprises (MSEs) are included in the muster roll, the employment generated is much higher. It is worth noting that there is no record of mortality of the MSMEs during the last decade-and-a-half, which calls for a full-scale Census of the sector sooner than later. The drivers of growth, however, rest on entrepreneurship, enterprise creation at the micro level – the strongest link in the supply chain, particularly linked to agriculture and allied activities. The industrial growth model of the developed economies fell short of equity or poverty-reduction growth since it bypassed most workers, especially the least educated. It also failed to promote higher productivity activities. This is the area that India should focus on while strategizing through Make in India.  Micro and Small Enterprises Cry for Separate Dispensation MSEs, the second largest employers after agriculture, are the seedbeds of innovation and entrepreneurship and yet unorganised. Legal and regulatory facilitation falls short of the requirement because these units – both in manufacturing and services -- are regulated under the 15-year-old Micro, Small and Medium Enterprise (MSME) Development Act, 2006 on a single criterion – investment, which enabled more inspections than interactions with the entrepreneurs. All the legal and regulatory provisions benefited the large SMEs sidestepping the micro and small. Long-term economic gains would be possible when investment in human capital, infrastructure and better institutions reaches those at the bottom of the pyramid. This paper, therefore, argues that micro and small enterprises, even after the amendment to their definition in 2020, require a separate law, rules and regulations and supporting dedicated institutions at the federal level. India’s overreliance on the services sector for growth has raised certain doubts about sustainability. This service orientation of public policy has percolated to the policy on MSMEs. Globally, manufacturing activity dominates the sector.  Pandemic impact and Jobs lost Often, delays in payment of receivables and labour attrition, payment of wages/salaries (especially during the lockdown), depletion in inventory with the continuation of the lockdown, payment of minimum power bill notwithstanding usage, machinery maintenance due to non-operation etc., plague the sector. Added to these, the dependence on other industries for materials forces the entrepreneurs to borrow from unsecured creditors to pay suppliers on time. Thus, the enterprises are locked out from both ends where there is no cash inflow but only cash outflow. Bearing the fixed expenses in times of low or no cash flows can prove expensive to small firms. Usually, these firms consider these as out-of-pocket expenses, which, in turn, can lead to blockage of the funds. One research estimate puts the job loss on account of Covid-19 lockdowns at 15lakhs. Even after the lockdown was lifted in several industrial States, migrant labour did not return to their parent firms. “MSEs are faced with issues of labour shortages and escalating business uncertainty with a large set of them expecting business performance to worsen.”[i] The most affected are the MSEs in manufacturing, particularly in the areas of fabrication, leather, artisans, handlooms and handicrafts, apparels and garments, restaurants and wayside eateries, private taxi operators, building accessories, tools and implements and auto components. The ferocity of the pandemic’s second wave has “overwhelmed India and the world”, the RBI stated, adding that “war efforts” have been mounted to stop the second surge in its tracks.[ii] While the Government of India (GoI) announced the Atma Nirbhar Abhiyan package for the MSMEs, the larger among the SMEs received the benefits of the package but almost none in the micro and smaller among small, in manufacturing sector.  Global Perspective A recall of Dani Rodrik, the Harvard economist, in this context would be apt. He points out that “global value chains turned out to be at best weak vehicle for transmission of jobs because they are a transmission for skill-and-capital-intensive technologies and because their business model is based on imported inputs and a relative lack of integration with the local economy.”[iii]  “Traditionally, East Asian-style industrial policies target larger productive manufacturers most likely to become exporters. Future “industrial policies" will have to focus instead mostly on smaller services firms, most of which are unlikely to be exporters. This new generation of industrial policies targeting lower-productivity segments can both enhance the livelihoods of the urban poor and boost productivity in the labour-absorbing sectors of the economy.”[iv] Italy, South Korea, Malaysia, the Philippines, Taiwan, Chinese Town, and Village Enterprises have models in the micro enterprise sector as growth engines of high productivity and employment. Hence, separating this sector from the other medium enterprises would make good sense for India both in law and economics. “Informality is high among micro and small enterprises. Many micro and small enterprises employ family members and often work from their homes. Salaries are low and conditions are far from stable and safe. While micro and small enterprises provide employment for many who would otherwise be unemployed, this falls well short of Decent Work.”[v] The product range, spreading from artefacts, nuts, bolts and screws, caps to auto-components, of around 8,000, should go through many regulations in addition to financial covenants. Manufacturing MSEs dominate in electronics, electricals, food products, leather and footwear, garments and apparels, machine tools, fabrication, paper products, handlooms, and power looms. Here, the growth is uneven across geographical spaces and sectors. Quality matters the most. Aggregation provides scope for branding and a strong supply chain link at the bottom of the pyramid in the sector. In India, agro-based industries, food processing organisations, micro enterprises promoted by self-help groups of women and logistic firms – all in the micro enterprise sector – have started looking up since the beginning of the third quarter 2021-22. Packing, packaging, and small transport in service-related micro enterprises have also picked up traction. Reverse migration has also started. Several NRIs have returned to their villages with investment in greenfield sectors. Mobile applications and equity investments have improved.  Having experienced the low-risk appetite of banks, fintech’s, start-ups, and NBFCs saw an opportunity in meeting the structural gap in access to finance for the MSMEs. Now is the time to look at the institutions, structures, legal and regulatory that would take such transition to the next level – where micro enterprises would move to the profitable ways of doing business and not just as a way of life.  The unorganised part of the sector is the micro enterprises. Competition is severe and pricing is at the mercy of the market. Many a time, production costs also are not realisable and yet the entrepreneur remains in the business. Business environment, advocacy, regulatory, incentive environment and supporting institutional environment are mostly hostile and expensive. The correction can happen if such enterprises have exclusive dispensation through a separate Act. Need to relook at MSEs’ definition  When there was no law governing the small-scale industry for decades, repeated attempts by the industry resulted in the formulation of the Micro, Small and Medium Enterprise Development Act, 2006, when services also formed part of the Act. The Act gave the broad brush to all institutions and the financial sector to swear by its provisions. Investment in plant and machinery was the sole criterion by which the subjects of the Act were defined till it was amended amidst the pandemic providing for classification under the twin criteria of investment and turnover. This revised definition may seek to correct imbalances in the treatment of the sector that led to unnecessary inspections of the units but cannot address issues comprehensively because the proportion between the investment and turnover has been uniformly kept at 1:5, across sectors. ‘One-size-fits-all’ approach would not do justice to the less endowed MSEs. “Definitions vary across the multilateral institutions like the World Bank, UNIDO, and OECD. World Bank defined SMEs based on Employment and Assets. Out of 18 countries in Asia, Caribbean, East Africa, West Africa, South Africa, Latin America, North America, Brazil, and Eastern Europe, six countries defined in terms of Assets, Employment and Turnover. Nine countries defined in terms of two of the three criteria – either assets and employment or employment and turnover. Only four countries including India defined in terms of a single criterion – investment in plant and machinery till recently. Philippines, Thailand Bolivia, Mozambique, and Rwanda defined in terms of employment as single criterion.”[vi] This single criterion is also not perfect.  Employment as a criterion to define the sector has widely been prevailing in many countries. Digitisation proved its value after the Goods and Services Tax (GST) came into being and supply chains moved to the realm of value chains. The criterion of turnover in the definition is verifiable by the institutions that support the MSMEs – both in credit and non-credit areas. A definitional correction would seem necessary as far as micro and small enterprises are concerned because the regulatory institutions tend to support them in finance and trade more by the way they are defined in the policy. Experience of the shift to the twin criteria of investment and turnover did not benefit the manufacturing MSEs as much as their service sector counterparts. Even if the twin criterion is retained, the principle of proportionality demands that the turnover to investment needs modification for the micro enterprise sector. Further, all the incentives – whether fiscal or monetary -- could be related to the criterion of employment. A few States like Telangana have already announced such a package.  Problems of manufacturing MSEs India’s manufacturing sector contributes about 16% to the GDP with its share in the world manufacturing at just 1.8%. According to evidence, a large chunk of the growing workforce has been absorbed by the unorganised sector, and the growth of the organised sector has failed to make any dent in this sector. If the organised sector required a crore of rupees to employ on average two persons, the unorganised sector, particularly the MSEs, employ on average four people, according to the 4th MSME Census, 2007. But that did not anyway mean that the sector could stand on its legs. It survived and grew where there were anchor and large industries, and the domestic markets supported their existence. They also thrived in industrial parks, clusters, and clustered industrial areas due to crossholding of risks in terms of interlocked backward and forward linkages.  These enterprises are heavily dependent on debt capital, suffer delayed payments, pay higher interest than the medium and large, lack collaterals, follow self-defeating policies in maintenance of accounting books and muster rolls, fail to get counselling and mentoring at affordable cost and do not have the lobby to influence policy. Inadequate access to finance Bankers allege that information asymmetry and moral hazard continue to discourage responsible lending to the MSEs, and that they are neither equipped nor prepared to invest in correcting the traditional malaise. Trading and services are always the preferred sectors for financial institutions because the players know the ways in which benefits can be cornered by them. While these will be supporting the manufacturing sector as an essential link in the supply chain management, they tend to be exploitative.  The solution for delayed payments of the micro enterprises as sub-contractors remained at the mercy of the vendees. Principle of proportionality in regulation weighted against their interests. Though factoring and TReDs (Trade Receivables Discounting System) proved worthy interventions for some higher-end SMEs in realising their bills fast, micro enterprises least benefited as they could not fit the threshold. Similarly, financial institutions lent to the micro enterprises through priority sector targets, MUDRA loans or loans for women enterprises etc, as a compulsive agenda and project that financing them is the riskiest of the jobs. The very definition that should benefit them has become self-defeating in the process. On the other hand, lending to the SMEs, however, is viewed as part of their mid-corporate and corporate credit portfolio. The approach can change when banks and FIs view lending to micro enterprise as a business proposition. MSEs mostly rely on debt -private and institutional- as their primary source of business but usually fail to conform to the terms and conditions governing it. When a lender invests in a micro manufacturing enterprise, he has the additional responsibility of advocacy, counselling, mentoring, and putting the needed efforts to recover the loan. Banks and NBFCs with their limited human resources feel that they can ill-afford the mentoring, monitoring, and supervision of the micro manufacturing. This explains the negative 3.1-3.8% year-on-year growth in finances that we find in the RBI Monthly Bulletins of 2019,2020. Banks that are ordained to reach 40% of the total lending under the priority sector of which MSMEs are just a part, prefer to unchallenging ride on the corporate sector where the rest 60% of their lending portfolio lies. Between the micro and small, again, the preference is for the small sector, where collateral security is available on demand.  Many ‘intelligent’ banks enticed the non-collateral MSEs to borrow, for a housing loan or a vehicle loan, and bring those assets within the ambit of the collateral security for the manufacturing loan. Since any one of the loan accounts becoming non-performing would make all the loans transit to the NPA bracket, they do not bat an eyelid to proceed against the collateral they could rope them in. Many functioning MSEs, in the process, are forced either for outside borrowing or shut shop.  Financial inclusion of MSEs – A long way to go The National Strategy for Financial Inclusion (NSFI) 2019-2024 has set forth the vision and key objectives of the financial inclusion policies in India.  “To improve credit flow to the MSMEs, a special capacity building programme named ‘National Mission for Capacity Building of Bankers for financing MSME Sector’ (NAMCABS) was put in place to familiarise bankers with the entire gamut of credit related issues of the MSME sector. Enterprise level interventions have been many but mostly reached the large among small and medium enterprises.”[vii] Web portals like the ‘Udyami Mitra’ and ‘psbloanin59minutes’ Pradhan Mantri Mudra Yojana (PMMY), a scheme to finance small business enterprises, interest subvention scheme for MSMEs to reduce cost of borrowings, ‘Challenge’, as a grievance redress mechanism, have not reflected in credit uptake for the sector. “An inclusive financial system supports stability, integrity, and equitable growth. Therefore, financial exclusion because of several barriers like physical, socio-cultural, and psychological, warrants attention from the policy makers.”[viii]  To bring about an attitudinal change in the mindset of the bankers while dealing with entrepreneurs from the MSME sector, a special capacity building programme named National Mission for Capacity Building of Bankers for financing MSME Sector (NAMCABS) was put in place to familiarise bankers with the entire gamut of credit-related issues of the sector. Similarly, a Certified Credit Counsellors’ Scheme has been launched through the Small Industries Development Bank of India (SIDBI), but the effect is invisible on the ground as most bankers at the field level do not exhibit even a basic understanding of the manufacturing MSEs. Even due diligence has been a casualty resulting in their poor credit risk management.  The NSFI also pleaded for “a strong regulatory and legal framework aimed at protecting the interests of the customers, promoting fair practices and curbing market manipulations. Further, the regulations should have adequate space to allow flexibility and openness for innovations. This calls for incorporating a Test and Learn Approach in the form of Regulatory Sandboxes along with encouraging Pilot projects to reach long term viability and mitigate losses.”[ix] Existing MSME Development Act does not provide a window of opportunity to achieve these expectations. Make in India and MSEs as growth engines  When Make in India, Start-up India and Stand-up India campaigns were instituted, it was expected that the share of manufacturing in the GDP would scale up to 25% from the now 16%. The contrarian static position is on account of the overarching emphasis on the services sector as the engine of growth since the first-generation reforms (1990s) and the continuing indifference in policy execution as far as the manufacturing MSEs are concerned. Defence, pharmaceuticals, space, textiles, and paper products predominate the Make in India’s success.   Few start-ups have come up in manufacturing MSEs. The reasons are not far to seek and at least a few areas stand out: lack of equity support; poor access to infrastructure and excessive cost of power; delayed/lack of incentives from the state governments; inadequate and untimely access to credit from the lending institutions, notwithstanding the repeated emphasis by the RBI to banks to increase their risk appetite and delayed payments. Since they are at the beginning of the supply chains, any small disruption in the link would derail production. Medium and large enterprises that source materials from the MSEs did not devote enough attention to strengthening the latter, the weakest link in the supply chain. The capacity of the MSEs to manage the demand-side is weak because of a lack of knowledge and skills.  “The pressure to produce results is great, given the volatility of the start-up environment and stakeholder impatience. Thus, start-up delivery units’ risk over-promising and underachieving. To minimize this possibility, initiatives should be based on estimated impact on start-up activity (usually measured by how much activity can be enhanced along the funnel from start-up creation to growth and maturity) and the feasibility of implementation (a more qualitative internal assessment).” [x] Start-ups should, therefore, have entrepreneurship guidance upfront for a month after registration – general and product regulatory compliances to be part of the guidance –Content development: Who, How, and Where, Costs of regulation, and the source of funding. Fiscal incentives are always a preferred mode to financial incentives while the entrepreneurs initially chose the latter. It is better that a portion of the revenue earned by the enterprises is channelled to equity of the firm. Greasing Innovation Ecosystem The ecosystem of innovation and innovation that takes place mostly at the micro level, and even at the individual level, require certain essentialities to be in place: a strong scientific and technological base; investment from both public and private sectors and regulatory support. While cost arbitrage has formed the lynchpin of outsourcing in this area for a long time, it is time for change in thinking to ‘strategic innovation’ where talent development takes the front seat.  Innovation inevitably carries with it the risk, that not every creative idea will be commercially viable, and, therefore, incentivisation through fiscal relief is required as is being done in China, South Korea, Germany, and Japan. Depending on the nature of the product, global competitiveness index and the capacities of the industry, tax breaks, tax holidays and tax reliefs can be attempted in the ensuing Budget by the finance minister. An incentive system should provide for vertical and not horizontal growth. In the interest of financial inclusion agenda, viewing the MSE environment as a major driver of growth, both for domestic and global value chains, government would do well to provide separate legal dispensation to them for greater facilitation. While the States continue to be the key drivers of the policy, legal support from the Union government would help them frame appropriate rules and allocate necessary budgets to provide an overarching environment for the MSEs to gain competitive advantage both domestically and globally.  The Way Forward Credit Access Needs Correction: The Report of the RBI Working Group on Flow of Credit to SSI sector, 2004 suggested adoption of the “4-C approach: Customer focus, Cost control, Cross-sell and Contain risk. In the context of increasing pressure on banks to lend responsibly and adequately as also in time, banks would do well to extend credit in clusters and industrial estates/industrial parks and Special Economic Zones (SEZs), that would reduce information asymmetry, provide better inter-firm comparison, and render cost-effective monitoring of the credit.”[xi] The moratorium for term loans should be a minimum of 18 months and a maximum of 24 months or at least 6 months after commencing commercial production. Public sector banks in India opening working capital accounts ahead of the units commencing commercial production, debited quarterly interest on term loan to the working capital account making the account irregular even before those enterprises became productive. Banks should be, therefore, mandated to operate the working capital only after the trial production starts and not before. Interest charged on the term loans before commencement of commercial production turned the accounts as non-performing assets (NPAs). Cash-flow-based lending for working capital as recommended by the UK Sinha Committee in 2019 would be the best option for banks and this requires that banks should move their technologies and appraisals in this direction.  Why Separate Law Enactment of a separate law with a bias to manufacturing would help realise the broader goal of financial inclusion as part of national strategy, promote innovation in manufacturing, and help employment generation. Focus on agro-industries and agribusinesses that would provide value addition at the farmgate level to the farmer and the resultant impetus to the MSEs in rural and semi-urban areas; separate budget allocation for the MSE sector would be possible if they have a focused law. Incentives can be redirected to MSEs that have focus on local employment generation. Emphasis on skilling, re-skilling and upskilling in the manufacturing sector would generate employment of welders, mechanics, architects, carpenters etc. The proposed law that has employment as one of the criteria to define them would prevent labour from migrating to urban and metro areas.  The doctrine of proportionality in legal dispensation is imperative in this land of diversity both in demographics and geography.  District Industrial Centres (DICs) as delivery channels need redirection, restructuring and resources. They should give a welcoming ambience for the investors irrespective of the size and nature. They should have e-library access to update their knowledge in technologies and regulations. The DICs that have vacant space after leaving for green shoots should be enabled to monetise the asset. Newly set up DICs should be in specific production zones and their layout investor friendly. Make labour participate from inception in the industrial parks and estates – creches, schools, playgrounds, retail complexes and housing -- to ensure their optimum use. Most MSEs cannot build their own brand image as it is expensive and eats into the cost of the product. Several MSEs do not also know how to price the product and, therefore, pricing of a product to enhance competitiveness should be part of structured training programmes. Several manufacturing micro enterprises tend to cut costs at the expense of regulatory compliance – labour laws. If the medium and large enterprises are enabled to invest in micro and small, a portion of their CSR towards the compliance costs - the sector has the potential to be globally competitive. Growth with equity would help the bottom of the pyramid in industry secure the intended benefits and become competitive.  This proposed law can seek disclosures that are essential for the sector overriding all the other enactments covering environment, minimum wages, insurance, and social protection. A single Law should regulate the MSEs and not many as obtaining now. This law can also facilitate collateral-free lending and revival and restructuring of every functioning manufacturing MSE within the regulatory oversight of the state governments.  Each state should enact Industrial Facilitation Act in the first six months after the new MSE Law becomes effective and this law should have Regulatory Impact Assessment as a key chapter with the proviso that the Minister concerned, both at the Centre/state, should present the status report relating to the impact of the Act on its subjects. Dani Rodrik rightly emphasises that next-generation growth policies would have to target the MSEs and find ways to increase their productivity. “The reality is that a few firms will grow to become national champions. But by offering a range of public services – help with technology, business plans, regulations, training for specific skills- governments can unlock the growth potential of the more entrepreneurial among them. The provision of such services can be conditioned by the government monitoring and soft-employment targets.”[xii] One implication is that growth policy and social policy will overlap enabling poverty reduction and enhanced economic security.  *The views are personal. The writer is author of ‘The Story of Indian MSMEs: Despair to Dawn of Hope.’ References and Notes: Notes: Change in Definition: The new definition that became effective from July 1, 2020, three months after the Covid-19 hit the economy, the Ministry of MSME revised the MSME definition on the twin criteria of investment and turnover. Micro enterprises accordingly are at the threshold of investment of Rs 1 crore and turnover of Rs 5 crore; small are with investment above Rs 1crore but below Rs 10 crore with a turnover of Rs 50 crore, and medium are with an investment of Rs 50 crore and turnover of Rs 250 crore. References: Impact of ongoing lockdowns (May 2021), Report of the Care Ratings Money Control News, May 17, 2021 Dani Rodrik (2021), https://www.livemint.com/opinion/columns/the-metamorphosis-of-growth-policy-as-circumstances-change-11634056159291.html https://www.livemint.com/opinion/columns/the-metamorphosis-of-growth-policy-as-circumstances-change-11634056159291.html Hazem Kawasmi and Simon White (2010), Towards a Policy Framework for the Development of Micro, Small and Medium-sized Enterprises in the Occupied Palestine Territory: First Draft Assessment Report, Ministry of National Economy, International Labour Organisation Yerram Raju, M Sitarama Murthy, & Subbaiah Singala (2015), India’s Growth Resurgence – Sectoral Issues and Governance Issues, BS Publications, Hyderabad, p.150 Report on the ‘National Strategy for Financial Inclusion (2019-24)’, RBI 2019 Report on the ‘National Strategy for Financial Inclusion (2019-24)’, RBI 2019 Report on the ‘National Strategy for Financial Inclusion (2019-24)’, RBI 2019 para 11.1 Kirchherr, Scherf and Suder, 2014, Startups and the City - cluster creation – LinkedIn https://www.linkedin.com › pulse › 20140724112436-34... Yerram Raju, B (2019), The Story of Indian MSMEs, Konark Publishers Pvt Ltd., New Delhi p.37 Dani Rodrik (2021), https://www.livemint.com/opinion/columns/the-metamorphosis-of-growth-policy-as-circumstances-change-11634056159291.html 11