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Small and Medium Enterprise in India - Overcoming Policy Constraints to Achieving Rapid Growth in a Globalizing Economy

Sebastian Morris () and Rakesh Basant

No WP2006-07-03, IIMA Working Papers from Indian Institute of Management Ahmedabad, Research and Publication Department

Abstract: Sustained very high rate of growth (above 8% in the context today in India) would be able to achieve (since a labour productivity growth of 4 to 4.5 % is to be factored in) a labour absorption rate of 3.5 to 4% which is about a percent above the growth in the rate of the workforce. But slower growth of around 6% which is what India seems to be achieving in the 90s on an average would keep disguised unemployment alive for long. Similarly, the transformation of firms and especially SMEs which have little autonomous capacity is itself a function of growth oriented policies. In the nineties labour has been sufficiently flexible to allow rapid growth whenever demand was high. In any case the unorganised workers, did not have the ability to resist hire and fire. Demand has been lower than possible otherwise since the rupee especially in comparison to the East Asian currencies has not been aggressively priced. Lacking a very rapid growth in the market sufficient to overcome disguised unemployment, the transformation of these industries has itself been affected. Similarly the continuation of tariff inversion, high and uncompensated energy taxes hurt manufacturing and especially the small and medium sector whose dependence on relative factor cost is higher. The slow movement towards de-reservation has further attenuated the process. The dynamic inefficiencies and distortions are far more significant than the static efficiency penalty that the economy pays in the continuation of reservation. Without these corrections the move to have “free-trade” agreements with the ASEAN countries would hurt manufacturing in India and especially the SMEs. Many of the traditional small firms are in clusters, and a cluster oriented approach would be important for their success. A strategy based on leveraging trade names /brand names, many of which could be argued to be "geographic indicators", with much equity world wide, would require immediate changes in our intellectual property rights regime. Costs of excise registration and dealing with excise authorities are too large, and there is a fixed component to this cost which cannot be spread over a large value of turnover. Only significantly lower excise rates for small firms could compensate them sufficiently. The criteria of "with and without the use of power" in the Factories Act, be entirely dispensed with. All units with more than 50 employees including the entrepreneur and family labour, be brought /retained under (all) the provisions of the Factories Act. And all other units be entirely exempt from its provisions. Credit is the single most important constraint for small firms. Incentivisation of priority sector targets is the solution. The policy of directed lending to small firms (the targets for priority sector lending) ought to shift from targets or quotas to incentives to banks for lending to small firms. Responsible risk taking in lending would have to re-emerge. Tax based incentives for banks and financial intermediaries are possible. Statutory Reserves based incentives for banks too are possible. Concessions on interest rates are dysfunctional, though the margin above PLR rates ought to be subject to a ceiling. State Finance Corporations which could play a crucial role in financing of SMEs would have to go through quick restructuring and refocus on promotion of new enterprises typically where vast positive external effects are anticipated, such as in technology based small firms, promising industries, nodal industries, industrial estate corporations, in exchanging specific infrastructural support to existing clusters of small firms, etc. Investments in infrastructure especially general roads, power, railways, and water supply would help to improve the performance of small firms significantly. For all small firms power and water continue to remain constraints shamefully after nearly 10 years of reform. These can easily come down at least for export industries if the taxes and cross subsidies on them are made vattable. Despite the Electricity Act 2003, it is shameful that open-access has not been extended to SMEs. Technology based and skill labour using industries such as IT, BT, pharmaceuticals and auto oriented industries, also need to be exploited. In automobiles taxes are still very large and the inverted tariffs / high cost of materials and energy that are uncompensated hurt the prospects of India emerging as a base for manufactures. In IT, Biotechnology, pharmaceutical industries and other related offshoring activities the challenges lie in bringing about better IPR regimes that reduces the risk faced by foreign firms in their operations in India. IPR regimes requiring much insight would have to be worked work out that is able to balance the interest of Indian firms and yet lead to much industrial relocation. The addition of a petty patent register could considerably enhance the extraction of value from the many innovations that take place in the SME sector. Municipal infrastructure is inadequate and its correction in at least a few cities is of crucial importance to the growth of the off-shoring activities and growth in these industries. Financial institutions could usefully develop strong venture capital arms to finance innovative small firms that have a good potential to emerge in the near future in many industries. Problems with government procurement which are designed to fail keeps alive a very large market for shoddy goods among SMEs. Merging of the umpteen laws and regulations into one wherever feasible can reduce the currently large costs of SMEs in dealing with government.

Date: 2006-07-03
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