Small and medium enterprises

Abstract:

Chapter 1: Introduction:

Small and medium enterprises have different definitions in different countries. In India, it is known as the Micro, Small and Medium Enterprises (MSMEs) which is defined in terms of investment required. The MSMEs include all the enterprises in which the total investment does not exceed more than Rs. 50 million. The European Commission defines SMEs on the basis of the work force employed, total turnover of the business and the balance sheet total. In the US, the criteria for recognition is based on the work force employed.

Small and medium sized enterprises (SMEs) are one of the principal driving forces in economic development. This sector has been recognised as growth engine around the globe. A healthy and vibrant SME sector contributes in a high and sustainable economic growth. They encourage private ownership and entrepreneurial skills, they are flexible and can adapt quickly to changing market demand and supply situations. They provide employment opportunities to the masses, help diversify economic activity and make a significant contribution to exports thereby increasing foreign trade.

Many economies have acknowledged the need for growth and development of SMEs for industrial restructuring and have formulated national SME policies, programmes and enterprise development policies. Enterprise helps boost productivity, increased competition and innovation, thereby creating employment and prosperity, and revitalizing the communities.

Get Help With Your Essay

If you need assistance with writing your essay, our professional essay writing service is here to help!
Find out more about our Essay Writing Service

SMEs contribution to the foreign trade has been ever increasing. During the last decade, there has been a considerable increase in the foreign trade arising from the products of these SMEs. The open trade policy has been a great success. The policy makers in developing countries like India, Sri Lanka, Pakistan, and many other South Asian countries have been continuously reviewing their policies to help the functioning of these SME units.

Finance is a subject of major concern to the SMEs. The financial institutions like banks and other money lending firms have come forward with plans of funding these units at very competitive rates. Subsequently, there has been an increase in the lending by such financial institutions to the SMEs. This has increased the efficiency of the SMEs to a great extent.

Chapter 2: SMEs: An Overview

Contribution of SMEs:

SMEs are the backbone or the key drivers of the industrial economy. They can also be described as the engines of growth of the industrial sector. Although they are individually small, collectively they play a multiplayer role in the development of an economy. They have a multiplayer impact in developed as well as developing economies. The main USP of SMEs is low cost production i.e. the ability to manufacture low volumes profitably, meet niche requirements, capitalize on local skills and resources, provide outsourcing opportunities and most importantly create jobs.

The below mentioned table indicates the contribution of SMEs across diverse economies. (Table-1)

Table 1: Contribution of SMEs across diverse economies

The sector has been consolidating over the years. What is new is the articulation and recognition of this process and its pump priming role. Therefore national SME policies, programmes and enterprise development policies have been formulated to support smooth working of SMEs and to overcome major obstacles such as lack of legislation, promotion and infrastructure. This can be done in the form of promotion programmes, positive discrimination hand holding and advocacy. Policy initiatives seek to highlight basic SME skills in low cost production.

SMEs have an impressive presence in service industry ranging from the simple and traditional organisations to the most modern and hi-tech ones. SMEs contribute not only in terms of quantitative factors such as output, employment, income, investment or exports but also in terms of qualitative factors viz the synergies they promote with large industry, their contribution towards balanced regional growth, their contribution in nurturing entrepreneurial spirit, innovation and in providing a nationwide pool of skilled and trained manpower.

While the comparative advantage of SMEs are well acknowledged, SMEs also have their share of pros and cons which prevent them from realising their full potential. They have to face some problems such as lack of proper guidance in the initial stages, lack of funds in the times of crisis, lack of proper marketing strategies, stiff competition from big players, lack of access to latest technology, no proper infrastructure etc.

Therefore, although new SMEs are emerging very rapidly worldwide, the number of SMEs closing down every year is also very high. Also because of the twin forces of globalization and free trade policy of WTO, there is a serious threat to the SMEs sector. It will have to reorient and reinvent itself to overcome these challenges. This can be done by restructuring the small scale organisations, and if nothing works, they have to be closed down. Closures are undesirable but sometimes they are advisable from the resource allocation point of view. Thus the high rate of entries and exits reflect the dynamic nature of this sector and also explains why it is seen as an industrial incubator.

As mentioned earlier, SMEs play a very important role in the development of an economy, especially from the employment point of view. They are very effective for the generation of employment for both skilled as well as unskilled workers. Therefore labour extensive countries should opt for SMEs. Even the underdeveloped or developing countries which are capital intensive and labour extensive, SMEs can be a great help. There has been increasing growth of SMEs worldwide in the recent past. The government of the developed and developing economies have been formulating policies which promote smooth working of the SMEs. SMEs have contributed significantly in the developed as well as developing countries.

In the European Economic Area (EEA) and Switzerland there are more than 16 million enterprises; of which less than 1% comprise large companies while the rest are SMEs. Two thirds of the job opportunities are provided by SMEs in this region and the remaining one third of the job opportunities are by large companies. SMEs are considered the backbone of Asia Pacific region as they account for 90% of enterprises. They provide around 32% – 48% of employment and their contribution to Gross Domestic Product is around 60% – 80% in individual Asia Pacific economies.

Even in the United States, SMEs contribute greatly. It contributed at around 43% of the net employment opportunities from 1990 – 1994.SMEs are considered the engine of economic growth in both developed and developing countries not only because of low cost production but also because of low unit cost of persons employed as compared to large scale enterprises. Thus they provide a significant share of overall employment. Also SMEs assist in local and regional development by regional dispersion of economic activities, thus helps achieving fair and equitable distribution of wealth. SMEs not only contribute towards the GDP but also towards the export revenues.

Although SMEs are at a disadvantage in terms of finance, technology, human resource development and networking; SMEs involved in foreign trade are very dynamic. This may be due to its low-cost labour intensive nature of its products; and since these units generally use indigenous raw-materials; they have a positive effect on the trade balance. For example, SMEs in OECD member states produce about 26% of OECD countries’ exports, and about 35% of Asian exports. Also SMEs increase flexibility in the provision of services and the manufacture of a variety of consumer goods and competitiveness of the market place and thereby curb monopoly of large enterprises. All this leads to fostering of self-help and entrepreneurial culture by bringing together skills and capital through various lending and skill enhancement schemes. Thus SMEs not only enables an economy to maintain a reasonable growth rate but also imparts resilience to withstand economic upheavals.

Chapter 3: India’s SME scenario:

The Indian Small and Medium enterprises sector formally known as the Small Scale Industries (SSI) has had a notable importance since the period of Mahatma Gandhi. SSIs were set up in the rural parts of India with a view to inculcate the habit of self reliance amongst the people. Later on, after independence, the SSI units were an important source of income to the people of India. Indian policy makers had noticed the importance of this self reliant industry and had always been striving hard for their progress.

After achieving independence in 1947, India drafted and adopted the Industrial Policy of 1948 which meant that the government would act as both an entrepreneur and also as a governing body. With the beginning of the planning of a free India in 1951, the role of SMEs has been earmarked specially.

In its industrial policy, the government started announcing special schemes for the growth of the SMEs in India. It was in 1956, during the Second Five Year Plan that the government announced the Second Industrial Policy, clearly stating the importance of the SME sector. This gave an impetus to the development of SMEs in a manner that made it possible for them to achieve the objectives of:

Ø High contribution to domestic production.

Ø Significant export earnings.

Ø Low investment requirements.

Ø Operational flexibility.

Ø Low intensive imports.

Ø Capacity to develop appropriate indigenous technology.

Ø Import substitution.

Ø Technology-oriented industries.

Ø Competitiveness in domestic and export markets

Today, small and medium enterprises (SMEs) are the ladder of progress for a nation’s economy, especially in case of developing countries. They contribute handsomely to the exports, the industrial base, the Gross Domestic Product (GDP) and the Gross National Product (GNP) of the nation. Small and medium enterprises help provide employment and various facilities to the society.

In 2006, the Government of India passed an Act known as the Micro, Small and Medium Enterprises Act (MSMEDA), 2006 to define SME sector of India. This Act defines micro, small and medium enterprises in India on the basis type of sector namely manufacturing and the service sector. In case of manufacturing sector, the size of the enterprise is decided on the basis of investment in plant and machinery. In case of service sector enterprise, the size is decided on the basis of investment in equipment required to set up the industry.

Table 2: Definition of SME in India.

Strategic Importance of Indian SMEs:

In Indian economy, the SMEs occupy a place of strategic importance due to its contribution to the overall output, exports and employment. The total number of SMEs has been increasing rapidly. The total number of registered enterprises has been around 3million and has been increasing at an even faster speed. They contribute about 50% of the total industrial output and constitute 42% of total exports. These units produce approximately 8000 units which range from very basic to highly sophisticated products. By providing employment opportunities to nearly 29.4 million people, this sector takes the credit for employment to the largest number of workforce.

Chart 1: Growth rate of SSI sector vis-à-vis Total Industrial Sector.

Chart 2: Growth Rate of Employment in the SSI sector.

Link: http://www.smebank.org/SME%20Sector.htm#2

Role of Indian SMEs:

The role of SMEs in the overall economic growth of the country has been fundamental and has been achieving steady progress over the last couple of years. With a view from the industrial development of India and the overall economic growth, SMEs have to play a vital role since their labour intensiveness helps to generate employment opportunities. In a developing country like India, the SME sector is of utmost importance in order to eradicate poverty and hence to drive sustainable growth. In case of countries where the capital resources are scarce, and an abundant supply of labour, SMEs help in the efficient allocation of resources by implantation of labour intensive production process.

Performance of Indian SMEs:

In the late 1940s, there were around 80,000 units. Today, the total number of units has increased tremendously and the total number of units is approximately 13 million units in 2006-07. Of the total 13million units, around 55% are in the rural India and the rest in cities and urban regions.

Table 3: Number of Small and Medium Enterprises.

The contribution of the SSI sector to the GDP was approximately 13% in 2000-01; this has grown to a 15.5% in 2007-08. The performance of the SSI sector in terms of economic parameters such as number of units, production, employment and export during the last decade is indicated in the table below:

Table 4: Performance of Small Sector in India

The SME has not only been successful in increasing its contribution to the GDP, but it has also outperformed the organized sector to a great extent in terms of production and also in employment creation.

Table 5: Share of SME output to India’s GDP

Employment:

The employment opportunities created by the SMEs is considerable. It is evident from the table below that for every 10 million rupees invested by the SMEs’, more than 4 times of employment opportunities are created; more than any other sector in India. It is clearly seen that in the year 2006, for every 10 million rupees invested in SMEs, generated employment opportunities for around 151.4 persons, whereas, the same amount invested in the other sectors would create employment opportunities for around 37.4 persons only.

Table 6: Investment to employment ratio

Exports:

The SME sector is a major contributor to the total exports of India. Of the total exports by India, approximately 50% exports are contributed by this sector. SMEs are responsible for 35% of the total direct exports and 15% are contributed by its allied activities. The indirect exports may be in the form of export orders of other large units or in the form of production of various parts and components for the making of the finished product. The major trading houses, merchant exporters and the export houses play a vital role in the export development.

The non traditional products account for more than 95% of the exports. The exports from the SME sector have increased tremendously during the last decade. The growth of the garments, leather, gems and jewellery units in the recent past is the reason for the increase in the exports by the SME sector. The SME sector dominates the sports goods, readymade garments, woollen garments and knitwear, plastic products, processed food and leather products industry.

The table below indicates these segments and the corresponding SME contribution. (Table 7)

Table 7: % of SSI in total Export

SME exports growing in tandem with total exports:

SMEs constitute an important segment of India’s industrial production with a contribution to 33% of its exports. During FY03-06, India’s total merchandise exports in US dollar terms witnessed a CAGR growth of 25%, while in the same period SME exports grew at a CAGR of 24%. The remarkable contribution of SMEs in generating employment in the country has been instrumental in addressing issues pertaining to poverty and inequality of income. As per the Third All India Census on Small Scale Industries-2001-02, highly populated states such as Madhya Pradesh, Uttar Pradesh, West Bengal, Maharashtra, Karnataka and Jharkhand together contributed to around 55.4% of the total exporting units in India. In terms of distribution of value of exports from the SME sector, states like Punjab, Haryana, Uttar Pradesh, Tamil Nadu and Maharashtra together contributed 64.75% of total exports.

Chart 3: Share of SME export to total exports

The composition of export basket of SME’s in India, it has both traditional and non-tradition commodities in nature. There are few commodity groups which are exclusively exported by SMEs such as sports goods, cashew, Lac etc. In the commodity group of engineering goods, SMEs constitute around 40% of the total exports of this commodity group. Similarly, SMEs in basic chemicals & pharmaceuticals finished leather and leather products and marine products account for around 44%, 69% and 50% of the export share in their respective commodity groups. In view of the Government of India’s ambitious target of average GDP growth rate of 9% during the 11th Five Year Plan, SMEs have to play a vital role in achieving this target. It is imperative for the government to address the major issues plaguing the sector and take further inclusive growth oriented policy initiatives to boost the sector. This includes measures addressing concerns of credit, fiscal support, cluster-based development, infrastructure, technology, and marketing among others. As mentioned earlier, SMEs constitute 34% of India’s merchandise exports and in order to increase India’s export share to the global trade, SMEs are expected to enlarge their scope manifold.

Problems Faced by Indian SMEs:

The SMEs in India have been facing lot of issues that hinder the performance and the survival of this sector. The government has been striving hard to provide with policies that would help the smooth functioning of the SMEs. The main problems that have been faced by the SMEs are:

Finance:

Micro, Small and Medium Enterprises, especially the micro enterprises have been facing the problem of inadequate access to finance. This is mainly due to the lack of information on financing activities and also due to the traditional business style. In India, there is also a lack of private equity, venture capitalists and business angels entering the MSME sector which would provide easy financing options to businesses which have unique ideas.

The availability of finance has been a major problem for the SME sector. The SMEs have not been able to have easy access to the loan offered by the various commercial banks and other financial institutions. This is despite the Reserve Bank of India (RBI) and the Ministry of Finance having laid down instructions to the banks and financial institutions to encourage easy financing options to the SMEs. According to Morris et al., 2001:11; “there are strong structural underpinnings to the inadequate flow: the organisational structures of banks, and processes within them, have taken them far from task orientation and have created a specific bias against small loan portfolios.” The government has been constantly seeking new ways to make access to loan funds an easy process for the SMEs.

The small industries sector has been worst hit by the problem of financing. These units have not been able to understand their financial situation and also they haven’t been able to maintain transparency in their financials. The banks and financial institutions have been hesitant with regards to providing financing solutions by means of loans to these small units. This is because in the recent past, the loans that have been offered to some of these units have been transformed in to non-performing assets and hence, the banks have been trying to avoid this high level of risk. The banks and other financial institutions have been in fact extending more of their loans to the medium industries sectors in order to comply with the RBI regulation of financing for the ‘priority sector.’

Infrastructure:

After finance, availing good infrastructural facilities has been a topic of concern for the MSME sector. The infrastructural facilities that are available in the rural parts of India differ substantially with those available in the cities and the urban parts of India. There has been growing concern towards the supply of power at affordable rates to these units. In the rural parts where the rates are comparatively lower than the urban parts, the adequate supply of electricity has been an issue.

The lack of newer technological knowhow has been growing. There has been a huge difference in the technique used in the towns to those used in the villages. Those in the urban areas have now been able to make use of computers and other computer operated machines whereas in the villages, the traditional methods of production are still being used. The transport facilities have not been developed very well. In spite of so many highways being constructed, there has not been ease of transporting facilities for the SMEs at affordable rates. This hinders the rural and semi-urban markets to access new and larger markets in the other parts of India.

Lack of skilled labourer:

Lack of skilled labour hampers the productivity of the SME unit. The skilled labour can make better use of resourced and could also be able to handle computers. Skilled labourers can be of great help with means of management and marketing.

Product Reservation:

For the purpose of good productivity, there has been product reservation which means around 800 products are being reserved to be produced only by the SMEs. The list is being revised on a regular basis but under political influence. The main purpose of product reservation was to create local employment by means of using locally available resources. But due to increased political influence, the main purpose of the reservation has been lost. The SMEs are at times not informed that they produce the reserved product.

Role of Government for SME development in India:

The Government of India has recognised the role of MSMEs in the overall development of the country’s economic situation. The MSMEs are of utmost importance in terms of employment generation, share to the GDP, share to the industrial output, foreign exchange generation, etc. The Government of India has implemented various policies in conjunction with the state government, the RBI and various NGOs for the betterment of the MSMEs in India.

As a stepping stone towards MSME development, the Ministry of Small Scale Industries (SSIs) was combined with the Ministry of Agro and Rural Industries to form the Ministry of Micro, Small and Medium Enterprises (MSMEs). This helped to formulate policies on a national basis bringing all the enterprises whether rural or urban under one cabinet. The main purpose of the Ministry of MSMEs was of drafting policies, programmes, development projects and schemes and also to keep a check on the implementation of these policies.

The Government of India’s has launched a landmark initiative by the introduction of the MSEMD Act, on 2nd October, 2006. It is due to the enactment of this Act that there has been an increase in the SME competitive strength. The issues related to the growth of SMEs had been surfaced and thus, the SME had been able to accept challenges and reap the benefits of large scale economies. The co-ordination of policies at both the state and the national level has helped strengthen the role of SMEs not only at the lower but also at the higher level. A recent policy introduction by the Tamil Nadu government to encourage the agro-based industries by means of providing a wide range of incentives, support for infrastructure development, subsidies for investing in industrially backward areas, capital investment and technology development with an aim to sustain a growth rate of over 10% in the food and agro based sector.

The Government of India has set up various institutions at both national and state level which are both a governing as well as a support body for the SMEs in India. The Ministry of Micro, Small and Medium Enterprises, Small Scale Industries Board, Small Industries Development Organisation (SIDO), National Small Industries Corporation (NSIC) Limited, The Khadi and Village Industries Commission (KVIC) and Coir Board work in co-ordination with the various institutes and assist the SMEs at both national and state level.

Today, the working of the Ministry has lead to the existence of various SME governing bodies which help the smooth functioning of the SMEs. The Industrial Development Bank of India (IDBI), the Small Industries Development Bank of India (SIDBI), National Small Industries Corporation (NSIC), the SME Rating Agency of India (SMERA), etc. all play a convincing part in the development and smooth functioning of the SMEs in India.

Policies implemented by the Government:

The Government of India has been reviewing its policies for the SMEs. The various organisations set up in coordination with the Ministry of Micro, Small and Medium Enterprises look after the formulation and implementation of the various policies for the SMEs.

Finance:

The Government of India in co-ordination with the Reserve Bank of India (RBI), the countries apex bank has been striving hard in order to create policies for making available easy financing options to the SMEs. The RBI has been issuing directives for every bank and financial institution to maintain a quota of funds to be made available to the Micro, Small and Medium enterprises.

The Government of India has set up special financing institutions that provide easy finance options to the SMEs at very nominal interest rates. The Government has taken many initiatives to make finance readily available to the SMEs:

Industrial Development Bank of India:

Industrial Development Bank of India (IDBI) was instituted in 1964 as a wholly owned subsidiary of the RBI as the top institution for providing finance to the SME sector. The Government of India in 1975 passed a law for de-linking IDBI from RBI and making it the principal financial institution for

(i) co-ordination of the working of institutions engaged in financing, promoting or developing industry;

(ii) assisting the development of such institutions; and

(iii) Providing credit and other facilities for development of industry and for matters connected therewith.

IDBI has brought about a revolution in industrial growth by means of providing finance for medium and long term projects in co-ordination with the national policies. The range of products offered by IDBI has been increasing in every field of industrial need be it manufacturing or services sector. IDBI has been empowered to provide financial assistance to all types of small enterprises.

Small Industries Development Bank of India:

The Government, in April 1990, established the Small Industries Development Bank of India (SIDBI) as a fully owned subsidiary of the Industrial Development Bank of India in order to promote financing activities for the Small and Medium Enterprises on a nationwide basis. In March 2000, the government amended the SIDBI Act and de-merged it from IDBI. The amendment led to the change in the capital structure, shareholding pattern, business and borrowing provisions.

The SIBDI has two subsidiaries namely SIDBI Venture Capital Fund and SIDBI Trustee Company Limited. The Credit Guarantee Fund for the Small Industries and Technology Bureau for Small Enterprises are the two associate organizations that work in co-ordination with SIDBI.

Since the foundation of SIDBI, it has been assisting the micro, small and medium sector (MSMEs) providing those with suitable schemes which are tailor made to suit the need of individual organizations. It assists in the setting up of new projects, expansion, diversification, modernization and rehabilitation of existing units. After the de-merger of SIDBI from IDBI, it has introduced several new schemes and products in order to meet the need of both new and existing SME units. It has been maintaining its policies and revising them from time to time keeping them in line with the policy plans of the Government and RBI.

Competitiveness:

The Government has been striving hard in order to provide a competitive edge to the units in the global environment. In order to increase the productivity of the MSME sector so as to overcome the competition that these units can face in the global markets and also to face the competition from the multi-national companies in the local Indian markets, the Government of India has introduced the National Manufacturing Competitiveness Programme (NMCP) in the year 2005-06.

The NMCP programme was implemented to shift the focus of the SMEs from the production to the competitive side of business. There was a need for the SMEs to introduce some structural changes and therefore this programme was introduced. The programme was initiated to increase the competitiveness at the individual firm level and not at industry or sector level.

The need of the hour was to address issues such as technology up gradation, cost reduction, in time delivery, total quality management (TQM) and to enhance the customer service. The NMCP worked in co-ordination with the SMEs and helped attain an environment for the accomplishment of these issues.

National Commission for Enterprises in the Unorganised Sector:

The National Commission for the Enterprise in the Unorganised Sector has been set up to improve the productivity of the unorganised sector. It acts as an advisory board and a supervisory body for the informal sector for generation of large scale employment opportunities on a sustainable basis, particularly in rural areas.

Reservation:

The policy of product reservation had been started in the year 1967 with the government’s objective of attaining socio-economic development by reserving the manufacturing of products solely by the SME sector. The Government introduce this policy with a view to improve the productivity of the SMEs especially in the rural areas which would in turn help to increase employment opportunities and also initiate the people to take up self employing business opportunities.

The Government of India had reserved some products to be manufactured only by the SSI sector. In 1984, the list contained as many as 843 products to be manufactured only by the SME sector. But in the recent years, due to the lack of technological up gradation and competitiveness on the part of SMEs, the has been reduced to as low as 21 products. The de- reserving of the products has been progressive for the re introduction of the SMEs in the main stream.

Simple Process:

The registration of the SMEs was earlier a very painful and lengthy process. This system has now been replaced with the much simpler Entrepreneur’s Memorandum (EM). The introduction of the EM has been the most valuable achievements of the MSMED Act, 2006.

The Need of Credit as a Lifeline of Business:

Finance or credit is of crucial importance for any business to grow and survive. If adequate finance is not available, even the best plans need to be put to halt. In case of MSMEs, credit is needed at every stage be it start up, diversification, technological up gradation, survival and expansion. If finance is not readily available, there is every possibility that the best performing unit can fall sick thus leading to the closing down of the unit.

Thus, the need for a focused credit policy for the MSMEs was recognised by the Government of India. Hence, a credit policy with the following terms was laid down:

Priority Sector Lending:

Providing of credit to the MSME sector has been made compulsory by the government under the Priority Sector Lending Scheme. The priority sector includes agriculture, small enterprises and businesses, retail trade, etc. Under this scheme,