It is almost 60 years since Dhar & Lall first identified the problem of “missing middle” in India in 1961. During these 60 years, the world has seen the waxing and waning of a number of manufacturing bases. The decade has begun on a fascinating note presenting a plethora of opportunities for India. China’s predominance in the Global Value chains is gradually declining, presenting new opportunities for India to up its market share. However, the fast emergence of new manufacturing hubs like Vietnam, Bangladesh & Africa can impact India’s calculation in a changing market. Driven by market access and policy support given by their respective governments to empower the manufacturing chain, the gradient of growth in these economies is almost three times that shown by India even during the times of peak growth. Cue back to just before the nation went into lockdown, RBI governor Shaktikanta Das, in the Annual banking summit hosted by ASSOCHAM, highlighted the same problem of “missing middle” and its ever-increasing significance for India in the new world order. In this article, we discuss the missing middle problem in India, which focuses on the reasons why India’s micro sector cannot blossom into medium and large enterprises.
The Grim Picture:
The MSME sector contributes in a significant way to the growth of the Indian economy with a vast network of about 6.3 crore units and a share of around 30 percent in nominal GDP in 2016–17. The share of the sector in total manufacturing output was even higher at 45 percent. As per the 73rd round of National Sample Survey (NSS) conducted during the period 2015–16, the estimated employment in the MSME sector was around 11 crores. Around 50 percent of the total MSMEs operate in rural areas and account for roughly 45 percent of the total employment generated in the country. Interestingly, the micro-enterprises account for 97 percent of total employment in the MSME sector. This brings to fore the problem at hand: the problem of “missing middle”. We break our analysis of the problem into 3 parts and using both empirical and anecdotal evidence, elucidate what we think is broken and what can be done for it to be fixed.
1. Cost of Credit Suffocates Indian Competitiveness
Fresh and cheap capital is a vital lifeline for the struggling MSME industry. The problem here is not the availability of credit per se, but the availability of “cost-efficient” credit. To estimate the cost of credit both we collected data from 20 small and mid-sized enterprises and compared them to publicly available data for similar Chinese enterprises. The base rate at which big banks lend to NBFCs is 9.18% which is roughly 200 basis points higher than rates offered to similar Chinese businesses. As an extension of this argument, the macro-level data provided by World Bank shows that real interest rates in India went up to 6.2% in 2017 from 2.5% in 2012, while real rates fell in many other Asian countries, including China. And herein lies the crux of the problem: essentially Indian business paid roughly around 12–14% as the cost of borrowing with the net rate (with government subsidies) being in the range of 9–11%, where that for their comparable global peers are substantially lower. The outcome of this can be seen in the declining credit growth in India with Micro & Small segments borrowing the least.
· The Year-On-Year (YOY) commercial credit growth was at 8.1% in the quarter ending in Sep’19. However, the growth rate for the period Dec’17 to Dec’18 was 16.2%, Mar’18 to Mar’19 was 12.6% and Jun’18 to Jun’19 was 14.8%.
· On a QoQ comparison, Sep’19 quarter ending exposure levels are higher than Mar’19 and Jun’19 quarter ending exposure.
· YoY growth in Sep’19 has been lowest across all segments when compared with annual credit growth of other quarters. NBFCs’ share in the small and medium-sized enterprises’ lending segment is higher compared to the smaller and less formal MSME. NBFC and PSB’s hold around 45% market share each in the MSME segment with the Micro and low ticket size lending dominated by NBFC.
What all this essentially means is that volume adjusted cost of borrowing for MSME will be almost double that of large corporations and almost thrice that of our APAC counterparts. Naturally, the cost of production shoots up, profitability declines, reinvestment in R&D and project expansion initiatives are delayed. All of these contribute to exacerbating the missing middle problem in India.
2. The Subsidy Oasis:
Capital subsidies and interest waivers are the two broad segments of subsidies for MSME in India. There are roughly around 15–18 flagship subsidy programs covered under DCMSME (development commissioner MSME) aimed at providing credit support, capital subsidies, interest subventions, and industrial park developments. Among them, CLCSS (credit linked capital subsidy scheme) for technology up-gradation is the oldest and the most used scheme. The scheme aims at providing 15% capital subsidy for all loans taken for technology up-gradation of manufacturing units up to 1 crore. This implies that the maximum subsidy outcome is of 15 lakhs. Operational challenges, complex process, and further red tape ensure that the best-case disbursal of a subsidy is 9 months. Now let us run the math on this: for a loan of 1 crore at 12% the interest outlay is 12 lakhs annually. The commission to be paid for claiming the benefits is 7–10% which translates to 1.2 lakhs. Therefore, the net benefit of subsidy at the end of 9 months is 4.8 lakhs. That too if all goes according to plan. The reactive subsidy schemes hardly have any tangible benefits for the micro and small segments. The irony of it is that the government calls them “upfront” capital assistance programs.
The interest subvention schemes fare no better. The government of India launched the interest subvention scheme of 2.5% for all GST & UAN holding business units. But the scheme was restricted only to scheduled commercial banks, leaving out NBFC and cooperative banks from its ambit. Considering the credit exposure to these sectors being 2 lakh crores and assuming 12% rate of interest average, this comes out to be 5000 crores annually to be borne entirely by the Micro and Small enterprises. For the MSME sector facing the double whammy of slowing economy and the GST-demonetisation shock, the amount can be a make or break thing. For all the talk around digitization and efficient subsidy delivery mechanism the outcome is nothing more than an illusion of government support. However, the delivery has significantly improved during the tenure of this government the tangible benefits are hardly visible.
3. Poor quality control & oversight
As per data from the RBI, the current amount outstanding to the MSME sector was approximately ₹16.6 lakh crore as at end of September 2019. Scheduled commercial banks account for 90 percent of the share of total credit outstanding. However, according to SIDBI data MSME Segment with aggregate credit exposure of up to Rs. 50 Crores constitute Rs. 18.3 Lakh Crores outstanding (~28% of commercial credit outstanding). Large corporates with aggregated credit exposure of more than Rs. 50 Crores account for Rs. 46.7 Lakh Crores (~72% of commercial credit outstanding). There is roughly a 2.3 lakh crore discrepancy in the data compiled by two premier institutions in India lending credence to some of the structural problems in the sector.
Case in point
Let us take the textile industry as an example. Not too long back, we used to be one of the most dominant players in the industry worldwide. Now, however, China, Vietnam, and Bangladesh are able to beat us fair and square in the game where we were the grandmasters.
India has the ecosystem from fiber to fashion, both in cotton and synthetics, an abundant and young labor force, a vibrant domestic market and a good starting point in export. With our imports restricted purely to technical textiles one would argue that the government’s focus on technical textiles is commendable. But the problem here lies in the offtake of the scheme. For a garment factory of 350 machines which can be set-up with capital investment of Rs. 12 crores can provide jobs to more than 500 people and can generate revenue of more than Rs. 50 crores. The value can be much higher for technical textile industry. It all seems fine till now but the problem is market. In the current low margins textile business, to produce a turnover of Rs. 50 crores the volume required in the textile industry is enormous. Given the economic scenario, the flawed subsidy frameworks, and low investments in R&D the notion of achieving this target is a pipe dream at best. For a factory in Bangladesh or Vietnam whose average size is almost five times that of India it is easier to attract key global brands and keep developing new products. Among other problems poor scale, fragmented clusters, restrictive labour laws, unpredictable wage increases, disadvantaged operating cost positions (especially in synthetics), unfavourable market access in key markets like EU, US, high costs of working capital, poor brand perception, limited innovation and slow progress in improving key enablers like infrastructure prevent India from achieving its potential for breakout growth. This is where the role of government becomes critical.
Unfortunately, the amount of investment and the willingness that the government should showcase in ensuring key technical textile products become commodities is not to be seen. The TUF scheme was a principal driver of the power-loom revolution in India, but apart from that the massive corruption of the UPA era ensured that the businessmen had to worry simply about revenues and nothing else. While it seems very lucrative to promote formalization of businesses; it has to be backed by a solid infrastructure to support and promote investments, frankly speaking, it is simply not there at present.
The next five years will determine the winners and the stakes are very high. Moving an entire industry and creating millions of jobs is not easy. But it can be done, with bold ambition, will, and perseverance. Important steps have been taken but let us ensure there is no let-up. 110 million jobs are at stake.
Data Courtesy: SIDBI, RBI, BCG, Wazir Advisor & Finetics independent research
