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The Prime Minister on Tuesday tweeted a message announcing the government’s latest efforts to strengthen the MSMEs by revamping the Credit Guarantee Scheme to increase the flow of credit to this sector. The biggest problem that the small entrepreneur faces is the non-availability of timely and adequate credit at reasonable interest rates. And a major cause of this is the low availability of bank finance on account of the high-risk perception of lending to this sector.
There are approximately 64 million such enterprises
Every effort must be made to strengthen this sector as the importance of small and medium enterprises for the economy cannot be overemphasised. In the industrial sector, these enterprises contribute to roughly half the output, employment and even exports. There are approximately 64 million such enterprises, not just in industry and manufacturing, but in services including single person services such as cobblers, paan shops or hair cutting salons. In manufacturing alone there are an estimated 1.2 million units. These economic units are collectively referred to as MSMEs (micro, small and medium enterprises).
The problems and challenges plaguing the MSMEs are a lack of adequate credit, marketing and technology, lack of financial literacy, over dependence on a single or a few customers, or getting the right talent
There is also an MSME ministry at the Centre which was established in 2007. One year before that, the Parliament passed the MSME Act. The purpose of the Act was promotion and development of the MSME’s and also enhancement of their competitiveness. They have been given special preference when it comes to procurement of goods and services by Central, State and local governments. There are special provisions to ensure that they get formal credit from banks and non-banks. The loans to MSME’s are counted toward the bank’s obligation to fulfil priority sector lending.
In 2020, after fourteen years of enacting the MSME Act, the government recognised that the definition of an MSME needs to be changed and updated. So now the definition is in terms of investment or turnover. For micro units it is up to a one crore investment or a five-crore turnover, for small enterprises it is a ten-crore investment or 50 crore turnover, and for medium units and services it is up to 50 crore and 250 crore respectively.
Most MSME’s have only one large buyer. So they cannot afford to name and shame that customer
Over the years there have been several policy initiatives by the Centre and also various States to provide a fillip to the businesses in the MSME sector. The problems and challenges plaguing the MSMEs are a lack of adequate credit, marketing and technology, lack of financial literacy, over dependence on a single or a few customers, or getting the right talent. Giving support to MSME’s and ensuring that they survive and thrive is in the spirit of inclusive growth. That is because they provide a livelihood to millions of households, and also their success gives them the confidence and dignity of participating in the economy on their own steam.
A report says that estimated delayed payments across all MSME’s is about 10 lakh crores. The annual interest cost alone on this staggering amount is 1 lakh crore
One of the most pressing issues that the MSME’s face collectively is that of delayed payments. Since they face a large customer, with great clout, they have limited bargaining powers. Often the last part of the payment of the present order, is clubbed with the next repeat order. So it is possible that the customer always holds back ten or twenty percent of the payment that is due. This is like a portion of the working capital of the MSME’s that is permanently locked and lying with the customer. Most MSME’s have only one large buyer. So they cannot afford to name and shame that customer. Nor can they drag that customer to court or to the Insolvency and Bankruptcy process for want of a payment delayed beyond six months. Because if the small vendor does that to his big client, then that vendor will get permanently black listed and lose all business. Incidentally this applies to large companies both from the public or private sector.
Some large companies will simply drop MSME purchases, fearing penal action from income tax authorities
The railways for example probably have a million small vendors, and for each of them they have only one customer. Even though the 2006 Act explicitly prohibits any delay beyond 45 days, this Act is observed more in the breach. A Dun and Bradstreet report says that estimated delayed payments across all MSME’s is about 10 lakh crores. The annual interest cost alone on this staggering amount is 1 lakh crore. If the delayed payments are cleared as per the provision of the 2006 Act it would be like releasing a subsidy of 1 lakh crore to the MSME’s.
In the recently passed Union Budget there is an amendment to the Income Tax Act Section 43 B. In short the amendment says, that if a company does not pay their MSME vendor within 45 days, then that expense will not be allowed as tax deductible, and will be counted as income to be taxed. The amendment is well intended. But the effect of this will regrettably be perverse. Firstly, some large companies will simply drop MSME purchases, fearing penal action from income tax authorities.
Since every purchase is logged into the GST network, and an MSME is identified by the Udyam registration number, the large buyer company should not be allowed to file their GST returns for the next month (or beyond the 45-day cycle) unless it has cleared all MSME payments
Since non-MSME purchases do not attract this penalty, that is a safe route. It is somewhat like the unintended impact of the maternity leave law of 2016 which was supposed to help women, but unfortunately ended up reducing their employment chances! A second more serious problem with amendment to 43 B is that it needs an auditor to certify by March 31 of the financial year. So if a buyer delays payment until the very last day, say till March 30, and then pays off, no penalty will apply. So this is a loophole. Or else if there is delayed payment and the prospect of not getting tax deduction this year, the large buyer will simply postpone payment to the next year and claim a full tax deduction next year. This effectively nullifies any penalty effect, since what you lose this year, you gain in the next year. Even the journal of the Institute of Chartered Accountants of India has pointed out this unintended consequence of the amendment.
However, a truly effective measure would be to cut off the oxygen of GST filing to the large buyer. Since every purchase is logged into the GST network, and an MSME is identified by the Udyam registration number, the large buyer company should not be allowed to file their GST returns for the next month (or beyond the 45-day cycle) unless it has cleared all MSME payments. This confirmation that the MSME payment has been made is done by the large buyer posting the transaction on the Trade Receivables portal of the Reserve Bank of India. All this being systems driven removes any discretionary delays or informal extortionary behaviour. It also will not put the MSME’s in mortal fear of displeasing their “maai baap” client and customer. This would go a long way in improving the ease of doing business for the MSME’s. The government must push this reform even though large corporations will resist it, for this step forces them to clear their dues within 45 days.
Meanwhile, though the latest government effort to strengthen the MSME is heartening. Much more is needed to help this all-important sector of the Indian economy.
(Dr. Ajit Ranade is a noted economist)