Opinion

Integrating MSMEs into global value chains

Ketan Reddy |Badri Narayanan Gopalakrishnan | Updated on: May 01, 2022
Resolving the credit issues of the MSME sector is critical

Resolving the credit issues of the MSME sector is critical | Photo Credit: PICHUMANI K

A bigger push towards digitalisation will give this crucial sector greater access to formal sources of credit 

Micro, Small and Medium Enterprises (MSMEs) play a fundamental role in India’s economic growth, contributing 30 per cent to its GDP and nearly 50 per cent to its exports. The sector encompasses over 63 million enterprises and provides a livelihood to over 111 million workers.

With the manufacturing sector’s contribution to GDP hovering around the 15 per cent mark over the past two decades, MSMEs are seen as a way of re-energising the sector that will push its contribution to 25 per cent of GDP.

The potential of MSMEs is well recognised by industry bodies, academics, and policymakers. In a recently concluded MSME conclave, BB Swain, Secretary, Ministry of MSME, highlighted MSMEs’ potential in building a complete supply chain, enhancing their global competitiveness.

Along similar lines, the Economic Survey also underlines the significant benefits that can be reaped by participation in GVCs (Global Value Chains) for Indian manufacturing by creating four million jobs by 2025 and contributing one-fourth in value-added terms towards the $5 trillion economy.

Impediments to GVC Integration

Integration into GVCs can not only support economic growth but might also be a crucial strategy in the post-pandemic recovery. GVCs enable firms to participate in international markets more flexibly, as they might contribute only a small component of an overall supply chain rather than a product in its entirety.

In this regard, manufacturing MSMEs can use lower costs and flexibility to their advantage. Innovation is yet another component of competitiveness, and MSMEs can test advanced technologies in a pilot mode.

MSMEs’ integration into GVCs, however, depends crucially on access to finance, as rightly recognised by the government. For example, NITI Aayog’s Export Preparedness Index (2021), released in March, covers access to finance as an important sub-pillar of export preparedness, in which the coastal States have performed better than others.

Nevertheless, despite its importance and potential, the MSME sector is often plagued by a lack of working capital, affecting its day-to-day operations and even survival during the Covid period. Given that 95 per cent of the MSMEs in India are in the informal sector, access to formal finance remains a significant constraint, with studies highlighting that MSMEs as a whole receive less than 6 per cent of bank credit.

Yet another area of significant concern is delayed payments. The number of applications filed by MSMEs on the delayed payment monitoring system MSME Samadhaan has crossed the 1-lakh mark, amounting to over ₹26,000 crore.

The large extent of informality and the alarming rise in delayed payments coupled with the slowdown imposed by the three waves of Covid-19 are threatening the competitiveness and even survival of small firms. Without improved access to finance, the goal of integrating MSMEs into supply chains will remain a challenge.

In this regard, the Union Budget has rightly extended the ECLGS till March 2023 and increased its cover from ₹50,000 crore to ₹5 lakh crore to help MSMEs. Nevertheless, the issue of delayed payments remains a major hurdle for MSMEs which needs to be tackled urgently.

Digitalisation: way forward?

Although the onset of the pandemic clearly hampered economic activity and left the already distressed MSME sector struggling for survival, it has also pushed it towards greater digitalisation, which offers a promising way forward. Many aspects of B2B (business to business) and B2C (business to consumer) interactions are moving to the digital sphere.

A recent MSME digital readiness survey of 250 Indian MSMEs by PayPal highlights that 29 per cent of these firms witnessed an increase in online customers and 32 per cent experienced better payment solutions.

The survey highlights that 98 per cent of surveyed MSMEs were keen on investing further towards digital payment solutions. The adoption of digitalisation by MSMEs certainly needs to be supported more and leveraged in providing innovative financial solutions.

For instance, Fintech lender Indifil has forged a partnership with Google Pay to provide instant credit to small businesses. Such measures are essential to help MSMEs manage their liquidity mismatch and overcome their working capital needs, otherwise hampered by collateral needs and delayed payments.

The digital payment ecosystem holds immense potential for MSMEs by helping them expand their online customer base and enabling faster flow of funds.

Moreover, by adopting the digital payment ecosystem, MSMEs can move away from their outdated ways of managing finance, which results in a loss of ₹67 lakh annually. Digital systems would streamline various repetitive tasks, which otherwise result in loss of work hours and higher overheads. Further, according to a RazorpayX report, 35 per cent of SMEs are hesitant in adopting digital solutions due to limited understanding and inadequate training.

Hence, it becomes essential to provide training and generate more awareness among MSMEs about digitalisation of banking systems and their operational dynamics to make the digital transformation smoother.

A strong impetus towards greater digitalisation in finance is the need of the hour. Doing so will reduce the dependence of MSMEs on informal sources of finance and reduce their operation cost given the latter’s high lending rates.

Knock-on benefits of cost reduction and timely delivery of payments include firms being able to focus on improving performance by obtaining quality certification and investing in R&D, both of which are essential enablers of value chain integration and a source of competitive advantage.

Additionally, the contribution of foreign investments in MSMEs also requires substantive consideration, because, for example, in the EU, MSMEs are the leaders in R&D, and their entry into India may also play an important role in addressing the twin challenges of investment and R&D.

Reddy is a Postdoctoral Research Associate in Economics at the King’s India Institute, King’s College London. Gopalakrishnan is the Lead Adviser and Head, Trade and Commerce, NITI Aayog

Published on May 01, 2022
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