MSMEs need liberal investment limits

The Centre recently enlarged the definition of what constitutes a startup venture from five to seven years old. The Government has also eased norms for companies to avail themselves of income tax benefits under the Startup India programme. While these initiatives have been welcomed, the traditional sector which largely comes under the purview of micro, small and medium enterprises (MSMEs) is yet to be rescued from a decade-old definition which is stunting its growth.

The importance of MSMEs is well documented. In 2016, there were more than 36 million such units providing employment to over 80 million persons, whilst contributing about 8 per cent to GDP, 45 per cent to the total manufacturing output, and 40 per cent to the exports from the country.

The MSME sector in India, with some exceptions, is characterised by low technology levels, which act as a handicap in the emerging global market. Although the sector plays an important role in India’s economic growth, not many units have the ability to access technological expertise or mobilise resources for in-house innovation.

MSMEs in India are defined on the basis of the investments made in plant and machinery, according to the MSME Development Act of 2006. What is of concern is that the limits identified in 2006 have gone out of sync in the last ten years.

An analysis using the annual GDP deflator as the moderator to calculate both real and ideal investment levels required to be classified as an MSME in 2016, against the prescribed definition circa 2006, is presented here. GDP deflator, for inflation, shows the rate of price change in the economy. The GDP deflator measures the ratio of nominal GDP to the real measure of GDP, and could be considered as the most accurate indicator of the underlying inflationary tendency, as it covers all goods and services produced in the economy, unlike CPI and WPI which are derived from price quotations for select commodity baskets.

In the manufacturing sector (Table 1), micro enterprises are classified as those with investment in plant and machinery not exceeding ₹25 lakh; after adjusting with the GDP deflator, the real investment limits work out to just ₹13 lakh. For a small enterprise, the investment limit has been prescribed at ₹5 crore; but the real investment limit, after adjusting with the GDP deflator, works out to just ₹2.56 crore. For a medium enterprise, the real investment limits after adjusting with the GDP deflator comes down to ₹5.13 crore from the ceiling of ₹10 crore set in 2006.

In fact, factoring the inflation since 2006, the ideal investment limits for micro enterprises should stand at ₹43 lakh; for small enterprises the upper limit should be ₹8.75 crore; whereas for medium enterprises it should be around ₹17.51 crore. The estimated difference between the prescribed investment limit and ideal investment on an average across all the three segments of MSMEs stands at 85 per cent.

The MSMEs in the services sector (Table 2) have also been experiencing a similar fate. Comparison in the services sector between the real investment limits using GDP deflator and the existing prescribed limits, across all three segments, micro, small, and medium enterprises, shows a phenomenal gap of around 91 per cent, thereby stunting their opportunity to grow. Upper investment limits after factoring the inflation since 2006 should be ₹17 lakh instead of ₹10 lakh for micro, ₹3.51 crore instead of ₹2 crore for small, and ₹9.31 crore instead of ₹5 crore for medium enterprises.

Globally, medium-size enterprises in the manufacturing industry differ by definition. In China it is defined as those having investment ceiling of 300 million yuan (at the current price level $44 million); in Thailand it is with a ceiling on investment capital of up to 200 million Thai bahts ($6 million); and EU defines medium enterprises as those of having turnover of €50 million, which is approximately $58 million.

In comparison, the investment limits for medium enterprises in the manufacturing sector in India as defined in 2006 was ₹10 crore, which was equivalent to $2.3 million then. Factoring for inflation, this figure stood at just ₹5.28 crore in 2016, or $0.8 million at the current exchange rate.

Ideally, the figure currently, taking into account inflation, should have been around ₹18.63 crore or $2.9 million, which is a significant difference of ₹13.35 crore or $1.5 million.

This anomaly is a huge deterrent for enterprises in this sector to grow and participate in the value chain. With such a low investment ceiling, Indian MSMEs are either expanding laterally or engaging themselves at the lower end of the value chain.

The Government could enhance the spread of the investment limits of MSMEs to accommodate the technological needs of the sector.

This would allow the enterprises to continue as MSMEs while also enabling them to grow. Some regions (such as EU and China) have kept the ceiling on investment for medium enterprises at high levels, encouraging capital infusion, technology upgradation, quality improvement, export orientation and employment generation.

It is important to review the investment limits every three to four years, factoring inflation. Since manufacturing operations are generally capital intensive, investment ceiling for SMEs should be reviewed periodically.

There should be a broad demarcation within the two broad categories — manufacturing and services, while defining MSMEs. Within these broad categories , each sector would require a different level and size of investments.

The need of the hour is to have a definition which would consider not only the capital employed, but also factors such as turnover and number of people employed.

With this, the probability of someone tweaking their investments to take benefits of being an MSME would be minimised. Many manufacturing units are becoming more asset-light due to the trend of leaseback on equipment and buildings, and therefore basing a definition on asset investment may appear futile.

The writer is an economist with Exim Bank, India. The views are personal