India’s MSMEs: Why COVID-Battered Businesses are Still Struggling to Survive

Many micro and small firms are going out of business, which has spillover effects on the jobs crisis.

Photo for representation.

(Photo: iStock)

The United Nations General Assembly has designated 27 June as “Micro, Small, and Medium-Sized Enterprises Day” to raise awareness about the contributions of MSMEs towards achieving the United National Sustainable Development Goals (SDGs).

Globally, MSMEs roughly account for 90% of businesses, 60-70% of employment and 50% of GDP. As the backbone of societies everywhere, they contribute to local and national economies and sustain livelihoods, particularly amongst the working poor, women, youth, and groups in ‘vulnerable’ situations.

(Source: Assocham Study)

45% of MSME Workforce Is From Rural Areas

In a labour-surplus, highly unorganised employment landscape like India (see Figure above), the importance of MSMEs cannot be overemphasised. For a definition, one can categorise them as “entities with revenue of less than Rs 250 crore” (the existing definition is based on plant and machinery investment).

Source: Annual Report on MSME Performance (2022)

The MSME sector in India comprises 630 lakh units and is estimated to employ an 11.10-crore large workforce. As much as 45% of the total employed workforce in MSMEs is from rural areas, while 55% is from urban areas. The sector accounts for roughly 30% of India’s GDP (in manufacturing) and adds up to almost 48% of India’s overall exports.

Source: Assocham Study

As per the data provided by the 4th Census of MSMEs, almost 86% of the manufacturing MSMEs operating in the country are ‘unregistered’. The output data for unregistered manufacturing from the National Account Statistics (NAS) reveal a notable trend in terms of change in output composition of unregistered manufacturing MSMEs in recent years.

The share of sectors with above-average capital intensity in the total output of unregistered manufacturing has steadily risen from 23% in 1991 to close to 33% in 2013, with a commensurate fall in the share of more labour-intensive sectors (see Figure below). The same trend emerges if we look at the relative share of sectors as per use-based classification: the share of capital goods has steadily increased from 12% in 1971 to 25% in 2013.

Output composition of unregistered manufacturing MSMEs.

Source: Ganguly (2017)

The Current State of MSMEs

However, as a recent statement by the Union Minister for MSME sector reflected, the sector is currently “battling for its survival”, and so is the fate of India’s manufacturing base. This is because the vitality of Indian manufacturing, in both urban and rural areas, is closely linked to the performance of its micro, small and medium-sized enterprises.

Weak consumption demand and low production-capacity utilisation combined with the shock effects of the COVID-19 pandemic-induced restrictions have brought the MSME sector down to its knees, plunging it neck-deep in debt. A recent survey of 5,000 MSMEs found that 71% of them could not pay salaries to their workers in March 2020 due to the COVID-19 lockdown in India.

Rising NPAs (see illustration below) have made institutional lenders warier of extending credit to the sector, even though macro-lending to MSMEs has been growing at high single/double digits over the last decade (particularly via NBFCs-Non Banking Financial Corporations).

Rising gross NPAs of a large bank in MSME lending

Source: Listed Players MSME lending book accounting for 12-15% of MSME lending in India based on Assocham Study

MSMEs mostly borrow to meet their working capital needs. Given demand-side pressures, the working capital requirement has further stretched, for example, in segments such as textiles, gems and jewellery. Moreover, MSMEs face a high cost of debt with a large portion coming from informal sources.

Fall in Production and Estimated Losses

In a recent study undertaken by Khanna and Rathore (2020), which involved interviews with over 360 enterprises, primarily from Uttar Pradesh, Rajasthan, Haryana, and NCR (National Capital Region), MSMEs noted high levels of distress in the sector, with micro-enterprises facing the worst.

On the demand side, there were significant signs of a slowdown much before COVID-19 hit. On the supply side, a Reserve Bank of India (RBI) study found that both the GST roll-out and demonetisation had adverse effects on the MSME sector, which were further exacerbated by the NBFC (non-banking financial companies) crisis.

Data also show that firms were, on an average, operating at 75% of their capacity before the lockdown.

Production as % of capacity, before and after the lockdown

Source: Khanna and Rathore (2020)

After the lockdown, firms were operating at an average of only 11% of capacity, with 56% producing nothing at all. These numbers indicate the severity of the lockdown, which has been documented to be the strictest worldwide. In terms of losses, it was reported to be 17% or more of their annual sales, which suggests that about two months of revenue has already been wiped out.

It is worth noting how the smallest firms experienced the biggest losses. Firms with less than eight employees lost 24% of their annual sales, whereas those with over 45 employees lost about 10%, which is significantly lower. As the lockdown was extended, the situation worsened.

Borrowings During the COVID-19 Crisis

Based on Khanna and Rathore’s study, “45% of the enterprises reported own capital (31%) and informal channels (14%) as their primary source of finance. The share of micro-enterprises reporting reliance on these sources was even higher at 57%... during the crisis, borrowing is more expensive overall, and while firms typically used to pay around 12% interest annually, they are now paying 14% interest.”

Interest rates on borrowing during the crisis.

Source: Khanna and Rathore (2020)

During the crisis, most firms were able to retain less than 50% of employees on average. The figure below shows the share of employees retained for different firm sizes. Firms in the first quartile (with nine or fewer employees) have only been able to retain 35% of their employees, whereas firms in the top quartile (45 workers or more) have retained 53% of their workforce.

Share of workers retained (%), by firm size.

Source: Khanna and Rathore (2020)

Did Govt Intervention During COVID-19 Help?

The government of India announced a series of stimulus packages focused on the MSME sector . It was important, however, that such a package focused not just on providing temporary relief through short-term liquidity infusions, but went beyond, addressing medium- and long-term issues that will test their resilience.

Monetary and Fiscal interventions during COVID-19 included business continuity measures announced by the Reserve Bank of India (RBI), emergency credit lines introduced by Public Sector Banks (PSBs), a concessional interest rate loan announced by the Small Industries Development Bank of India (SIDBI) specifically for MSMEs engaged in manufacturing goods or providing services related to COVID-19, and deferring GST (goods and services tax) payments until June 2020.

Governments across the world went further to introduce a range of measures while infusing more confidence and credit into their small business lines. These measures included short-term liquidity, as were offered in India, but also involved wage support/subsidy (capped) for a period of three to six months, direct subsidies to one-person businesses and micro-units, deferral of rent and utility payments, compensation for a decrease in turnover during lockdown periods, etc.

While India’s fiscal space was weak, given its own deficit considerations, it should have nevertheless considered introducing such financial and safety net measures (similar to other MSME-dependent nations).

Another issue for the government is how – and to whom – should the ‘help’ be provided.

‘Identifying’ Those Who Really Need Support

The real challenge for any form or degree of government intervention in India during crisis periods (or even post-crisis periods) lie in identifying these 63.4 million unincorporated MSMEs, of which 99% are micro-enterprises that remain largely informal.

As Pandey and Pillai (2020) in a comprehensive analysis on MSMEs during Covid argue:

“Informality in the MSME sector exists in both the nature of businesses and the relationships that businesses and workers share. The number of enterprises in the unorganised sector (unregistered) is estimated to be 99.7% of all unincorporated non-agricultural enterprises (excluding construction). What is also pertinent to note is that 84.17% of this universe of unincorporated businesses are the owner-managed/self-employed firms (with characteristic features of household enterprises), and the next highest share is of units that employ up to five workers (micro-units). These two categories thus together form 97.4% of informal businesses in this country. Various government sources cite different levels of informal employment – what is agreed on however is that it has persistently hovered well past the 90% mark.”

The lack of a comprehensive dataset on MSME units and their employment profiles further exacerbates issues of targeted relief delivery in such crisis situations. Absent a dedicated census for this sector in the last 13 years – the fourth and last census on Indian MSMEs was conducted as far back as 2006-07 – information regarding these enterprises is presently known to be scattered across datasets such as the Udyog Aadhaar Memorandum (UAM), MSME Databank, and the Goods and Services Tax Network (GSTN).

Pandey and Pillai in their study add: “The first two datasets contain self-certified, voluntary information provided by businesses that wish to register on these portals, while the GSTN has a statutory requirement that only businesses with a turnover of more than Rs. 4 million need to be registered on it. An RBI Expert Committee on MSMEs, in June 2019, has also noted the absence of reliable (and updated) information on this key sector of the economy.”

MSMEs are at a Breaking Point

In the event that the government decides to directly aid workers in micro-businesses or provide a separate set of relief measures for, say, self-employed/owner-managed enterprises, it will have to first figure out a way to ensure that the relief reaches its target. So far, the government’s efforts in this regard have yielded less consequential success.

What this has done is taken the MSMEs, especially the smaller firms, to their breaking point. Being unable to survive the crisis is leading more micro and small firms to go out of business, which has spillover effects on employment, rendering thousands of workers jobless overnight.

It is critical to note that while tax cuts may be necessary for larger businesses, which help them expand profitability (if not wages), such fiscal measures tend to exclude the ‘informal’ MSME sector where employment and turnover will not meet the minimum thresholds required to pay income tax or to be registered under the GST.

Relief for unorganised MSMEs occupying informal workers, plus tiny micro-enterprises with five to 10 workers, will need to be targeted such that it reaches them in time to save their lives and livelihoods.

In this case, the role that trade unions and other labour market institutions in India can play in identifying these businesses and workers should also be encouraged. I have argued before how unionisation is key to not just secured worker contracts but also business survival.

The Union government will need to collaborate with manufacturing and retail trade associations, in all its size and forms, while diverging from the big capital-state nexus that has been shaping the macro-business, finance and capital market base in India for some time now. Lessons from the poor implementation of existing government schemes and the incompetence reflected in not being able to ‘identify’ or ‘help’ firms in desperate need of cash during crises must enable permanent structures that support the unorganised MSME, the lifeline of India’s manufacturing and employment landscape.

(Deepanshu Mohan is Associate Professor and Director, Centre for New Economics Studies, Jindal School of Liberal Arts and Humanities, OP Jindal Global University. He is Visiting Professor of Economics to Department of Economics, Carleton University, Ottawa, Canada. This is an opinion piece and the views expressed are the author's own. The Quint neither endorses nor is responsible for them.)