Financial Requirements Of Small Scale Industries Economics Essay

In the previous unit you learnt about Financing in large industries. In this unit you are going to learn about Small scale industries (SSI) in India and their financial requirements. You are going to learn about the role played by DFIs in the growth of SSIs. In addition to that you are going to learn about regulatory requirements and the challenges of the small scale industries.

Worldwide small industries have been accepted as the engine of Economic Growth and for contributing in a large scale to the economic growth of any country. The major advantage of this sector is its employment potential at low capital cost. In India this sector comprises of the Micro Small and Medium enterprises (MSMEs).

Consequently in India Ministry of Micro, Small and Medium Enterprises was formed in the year 2007 to take care of their needs. (MMSME).

As per the latest statistics (4th Census of MSME Sector), this sector employs an estimated 59.7 million persons spread over 26.1 million enterprises. It is estimated that in terms of value, MMSME sector accounts for about 45% of the manufacturing output and around 40% of the total export of the country. 

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Small-Scale industrial Sector gains its importance from the two basic premises of economic development policies namely ‘balanced’ development and ‘sustainable’ growth of the economy which calls for certain minimum level of diversification of the economy. In Indian economy where Agriculture in the predominant primary sector, which is depending on the rainfall, such a diversification has to be in the direction of the growth of industries in general and small-scale industries in particular. Even though agriculture remains as the backbone of our economy, all the production requirements of the nation is not being absorbed by it and provide productive employment.

The need to diversify economic activities and shift the unemployment from agriculture to other sectors arises due to this. SSI sector or was one such sector which is labour intensive and hence provides a lot of scope to absorb such labours from agricultural sector to the allied activities like – the development of infrastructure and employing them in less technical jobs

Therefore unlike other sectors of the economy manufacturing is the only sector which has large number of productive, forward and backward linkage effects. Due to this a balanced approach will give a push to the economy and thus aid in achieving the sustained overall growth of the economy.

Objectives

After studying this unit, you should be able to:

describe small scale industries sector in India

explain the financial requirements of Small Industries sector

describe the role of DFIs in the growth of Small scale industries

explain the regulatory requirements in financing SSI

list the Challenges faced by DFIs in financing SSI

6.2 Small Scale Industries in India (SSI)

Industrialisation in India since independence has been predominantly based on the development of only large scale industries. The policy of the government during the early planning era was to develop import substituting heavy industries as the ‘key stone’ with traditional SSI as an adjunct to meet day to day demands. As per experts small industries must be encouraged to grow to achieve a stable Gross Domestic Product growth trajectory.

Mahatma Gandhi was among the earliest advocates of small industry in India. But his focus of was on the expansion of traditional and rural manufacturing industries and not on the creation of the modern, small, urban factory sector. Mahatma Gandhi advocated the setting up of Khadi and Village industries, which is a type of Small Industry whose most significant aspect in Indian Economy is that it created employment at a very low per capita investment.

Prof. Prasanta Chandra Mahalanobis, who set the pattern of the Second Five-Year Plan conceived small-scale sector as a supplier of consumer goods to support workers in the large scale sector of heavy industry. Industrial development becomes incomplete without the development of SSIs, since this sector provides opportunity to utilize the abundant manpower and unexploited resources. Accordingly in the process of reshaping and developing the Indian economy under the aegis of Five Year Plans, SSI Sector is rapidly coming into prominence.

Importance of the small scale sector can be gauged by the account given by Small Industries Development Bank of India (SIDBI) which caters to the need of small industries which is follows:

The Small Scale Industries sector, over the years, has grown steadily and occupied an important place in the economy. Contribution of the sector in terms of generation of employment, output and exports is quite significant. The number of registered units in the SSI sector has increased from 0.42 million as at end-March 1974 to 26 million at end-March 2007 (which is the latest census) .This sector accounts for 45% of the total manufacturing output and 40% of total export output of the country.

Government has also reserved certain products exclusively to be manufactured by MSMEs.

In 2006 a new bill was passed, ‘The Micro, Small and Medium Enterprises Development Act,’ which defines the enterprises as the following, “a small enterprise, where the investment in plant and machinery is more than twenty five lakh rupees but does not exceed five crore rupees.”

The act also envisaged the setting up of a National Board for Micro, Small and Medium Enterprises which was set to “examine the factors affecting the promotion and development of these enterprises and review the policies and programmes of the Central Government in regard to the facilitating the promotion and development and enhancing the competitiveness of such enterprises.” These steps have made the small industries sector to be a significant player in global market place.

This Board is also to make recommendations to the Government on the matter of the development of such enterprises and how to overcome their problems.

Further a Task Force was constituted in the year 2009 by the Prime Minister of India, which studied the MSME sector and made a lot of recommendations, most of which have been implemented by the Government. The gist of the recommendations of the high level task force is as follows: Share of micro enterprises in MSME lending should be increased to 60% in a phased manner and should be achieved in the year 2012-13. It would be mandatory for public sector bank to achieve this target and achieve a growth on the number of Micro enterprise by 10% each year.

Also, Planning Commission of India constituted a working Group on MSMEs growth in the 12th five year plan with Secretary of Ministry of MSME as its chairman and 46 members representing various Ministries /offices of Government of India. It also had representatives from state governments, industry associations and NGO’s. The main job of this group is to study and carry forward the recommendations of the Prime Minister’s task force and suggest specific action plan to achieve them within the 12th Five year plan period. Further the group will also study and formulate proposals and schemes for the unorganised sector of small industries.

Due to all the steps taken by the government Small Industries sector in India has been growing steadily and plays a significant role in the economy of the country, both within India and also at global level.

Below Chart shows the Growth of MSME in India as of the latest census.

YEAR

MSME UNITS

ANNUAL INCREASE

% OF ANNUAL INCREASE

(LAKHS)

(LAKHS)

2003-04

113.95

4.06

4.07434

2004-05

118.59

4.64

4.07196

2005-06

123.42

4.83

4.07285

2006-07

128.44

5.02

4.06741

2007-08

132.44

3.96

3.0831

6.3 Financial Requirements of Small Scale Industries

SSI units require funds for various purposes. For starting their business, they require fixed assets which comprise of land and building, plant and machinery, furniture and fixture, etc.

Besides, these units also require funds to finance other fixed assets also, which include goodwill, trade mark, current and non-current assets. To feed machinery, raw materials and stores are required. To process raw materials into finished goods, certain manufacturing expenses have to be incurred. Every time, minimum stocks should also be maintained which comprise of raw materials, stores, stock in process and finished goods etc by the SSI unit. Similarly, goods are normally sold on credit basis and accordingly, certain cash is required until the collection is made from customers i.e. sundry debtors. Ancillary units face the problems like delayed payment by parent units, resulting in sundry debtors.

Thus, each unit requires funds to maintain current assets which include cash, raw materials, and stock in process, finished goods, sundry debtors and short term investment, and working capital

To finance all these fixed assets and current assets, each unit raises funds, which include long term finance and short-term finance.

The sources of short-term finance could be:

1) Bank borrowing for working capital,

2) Sundry creditors,

3) Deposits/borrowing from friends, relatives and others, and

4) Deposit received from customers.

The sources of long-term finance include:

1) Owner’s capital, that is, equity,

2) Deposits/Loans given by owners (partners/directors) to the firm,

3) Term loans from financial institutions,

4) Hire purchase/leasing facility from National Small Industries Corporation or similar organisations,

5) Credit facilities from commercial banks,

6) Machinery purchase under IDBI Bill Rediscounting Scheme, and

7) Seed capital, margin money, subsidy, soft loans from Government/Financial Institutions, etc.

The above are largely external sources for raising finance.

Owner’s capital and deposits/loans are internal sources of finance. Funds can be generated internally by the entrepreneur through Capital. In the case of medium size enterprises raising of equity capital can be one of the sources. In small enterprises run by proprietorship or partnership firms the capital contribution is done by the proprietor or the partners. Part of the profits generated can also be ploughed back in to the business.

Venture capital is also one of the sources of finance. In Venture Capital Funds which are many in number financing a project is done only after studying its feasibility and profitability.

Now we shall briefly see how these financial needs are fulfilled by the various agencies engaged in this task.

Self-Assesment Questions

State true/false

An important problem faced by small scale industries in the country is that of finance. (T)

Credit will never be an input for sustained growth of small scale sector and its availability continues to be a matter of concern. (F)

Industrial development becomes incomplete without the development of MSMEs, since this sector utilize the minimum manpower and resources. (T)

Small scale industrial system is recognised as an instrument in bringing about a balanced regional growth by setting up small scale industries in under developed areas and employment to the local people.

Prospective Term Loans are provided by NSIC-are for acquiring Land and Building, machinery, equipments and working capital.

6.4 Role of DFIs in the Growth of SSI

The role of Small industries in the development process of a nation continues to interest the rulers of the nation and hence play an important role in their policy making.

Small industries’ formidable and very common problem is finance. Small scale industries have a weak capital base of their own since they are mostly proprietary or partnership concerns. Further SSI units are basically small in size and cannot make investments on their own in infrastructure like power, communication or pollution control measures.

Various development financial institutions have been set up with a view to ensure adequate finance to small industries sector, as per the lines envisaged in the industrial policy of the government.

“Development Financial Institutions” are characterised by the following functions.

They are engaged in financing of sectors of economy where the risks involved are beyond the acceptance limits of commercial banks.

Also, DFIs are mainly engaged in providing long-term assistance.

DFIs generally meet the credit needs of riskier but socially and economically desirable objectives of the nation’s policy.

We shall see how the various Development Finance Institutions (DFI) which plays a vital role in the industrial development of a nation supports the needs of Small industries.

4.1 Small Industries Development Bank of India (SIDBI)

First and foremost of the development financial institutions set up in India exclusively for the benefit of Small industries is SIDBI. SIDBI, an Apex Financial Institution set up by an Act of Parliament in 1989, as a wholly owned subsidiary of IDBI (Industrial Development Bank of India) has been set-up as a principal financial institution for promotion, financing and development of Small scale industries in the economy.SME

Apart from providing finance, both directly to MSMEs and indirectly through financial intermediaries, viz., Banks, State Financial Corporations (SFC),Non-banking Finance Companies (NBFC), etc., it has taken a number of proactive measures for the benefit of MSMEs including setting up subsidiaries / associate concerns providing support services like provision of Venture Capital, Credit Guarantee, Rating, Technology Services etc. which have immensely benefited the sector.

Refinance by SIDBI

Small Industries Development Bank of India (SIDBI) under its Charter, has been, inter alia, assigned the task of being the main purveyor of term finance to the small scale industrial sector in the country. Term loans extended by financial institutions to small scale industrial projects irrespective of the location and form of organisation of the unit are eligible for refinance assistance from SIDBI. Similarly, assistance is also made available for modernisation and rehabilitation of small industries. SIDBI provides refinance at concessional rates of interest in respect of loans to certain special category of borrowers.

Refinance scheme is introduced to facilitate the flow of funds to industrial units in the MSME sector through eligible Primary Lending Institutions (PLIs), comprising of scheduled banks, State Financial Corporation’s (SFCs) State Industrial Development Corporations (SIDCs), etc., SIDBI grants refinance against term loans granted by the eligible PLIs to eligible industrial concerns for setting up industrial projects in the MSME sector and for their expansion/modernisation/diversification.  

Other important schemes of the SIDBI are given below:

Composite Loan Scheme: The scheme covers composite loans up to Rs. 50,000 sanctioned to artisans, village and cottage industries and small scale industries in the tiny sector by eligible institutions. Assistance is provided for equipment finance or working capital or both. As the loans can be covered under the Credit Guarantee Scheme of DICGC, eligible institutions have been advised not to insist on collateral security.

National Equity Fund Scheme: With the objective of providing equity type of support to small entrepreneurs tiny/small scale sector and for rehabilitation of viable sick units in the SSI sector, the SIDBI provides equity fund scheme. The scope of this scheme was widened in 2000-01 raising the limit of loan from Rs. 6.25 lakhs to Rs. 10 lakhs and project cost limit from Rs. 25 lakhs to Rs. 50 lakhs.

Debt restructuring mechanism:

With a view to improve flow of credit and to ensure restructuring of viable and potentially viable debts of MSMEs, the Reserve Bank of India has issued guidelines for implementation of Debt Restructuring of MSME’s. Prudential Guidelines on MSME Debt Restructuring by banks have been formulated and advised to all commercial banks by Department of Banking Operations & Development of Reserve Bank of India.

Setting up/Development of Industrial Estates

Another scheme handled by SIDBI is setting up of industrial estates / development of industrial areas including such projects found eligible under KVIC model. Strengthening of existing industrial clusters / estates by providing increased amenities for smooth working of the industrial units, setting up of warehousing facilities for SSI products / units. Providing support services viz., common utility centres such as convention halls, trade centres, raw material depots, warehousing, tool rooms / testing centres, housing for industrial workers, etc.and any other infrastructural facilities which will benefit predominantly SSI units / entrepreneurs.

SIDBI Venture Capital Limited (SVCL)

SVCL is a wholly owned subsidiary of SIDBI, incorporated in July 1999 to act as an umbrella organisation to oversee the Venture Capital operation of SIDBI. SVCL manages the various Venture Capital Funds launched/ being launched by SIDBI and has a mission to catalyse entrepreneurship by providing capital and other strategic inputs for building businesses around growth opportunities and maximize returns on investment. Their mission is to catalyse entrepreneurship by providing capital and other strategic inputs for building businesses around growth opportunities and maximize returns on investment.

SIDBI Technology Development and Modernisation Fund

SIDBI has set up Technology Development & Modernisation Fund (TDMF) scheme for direct assistance of small sale industries to encourage existing industrial units in the sector, to modernise their production facilities and adopt improved and updated technology so as to strengthen their export capabilities. Assistance under the scheme is available for meeting the expenditure on purchase of capital equipment acquisition of technical know-how, upgradation of process technology and products with thrust on quality improvement, improvement in packaging and cost of TQM tools and acquisition of ISO-9000 series certification.

4.2 State Financial Corporations (SFCs) :-

To provide medium and long term credit to industrial undertakings, which fall outside the normal activities of Commercial Banks, a Central Industrial Finance Corporation was set up under the Industrial Finance Corporation Act, 1948 (XV of 1948).The State Governments wished that similar Corporations should also be set up in the States to supplement the work of the Industrial Finance Corporation. The intention is that the State Corporations will confine their activities to financing medium and small scale industrial and will, as far as possible, consider only such cases as are outside the scope of the Industrial Finance Corporation.

The State-level financial corporations play a crucial role in the development of small and medium enterprises in the concerned States. State financial corporations set up at State Level to cater the needs of industries in the State also provide funds required by Small Scale Industries sector. They are either set up by a particular state government or jointly by two or more state governments. They provide financial assistance in the form of term loans, direct subscription to equity/debentures, guarantees, discounting of bills of exchange and seed/ special capital, etc.

SFCs have been set up with the objective of catalysing higher investment, generating greater employment and widening the ownership base of industries. They have also started providing assistance to newer types of business activities like floriculture, tissue culture, poultry farming, commercial complexes and services related to engineering, marketing, etc. The Corporation will be further authorised to underwrite the issue of stocks, shares, bonds or debentures by industrial concerns.

4.3 State Industrial Development Corporation (SIDC)

State Industrial Development Corporation (SIDC) which were set up under Companies Act as wholly owned subsidiary of the respective State Government operate at a higher level than SFC’s and set up to take care of financial needs of large industries and also cater small industries. These SIDCs extend financial assistance in the form of rupee loans, underwriting subscriptions to shares/debentures, guarantees and also opens letters of credit on behalf of its borrowers.

State Industrial Development Corporation primarily work as development banks promoting industrial projects in small and medium scale sector.

4.4 National Small Industries Corporation (NSIC)

National Small Industries Corporation Ltd. (NSIC), is an ISO 9001-2008 certified Government of India Enterprise under Ministry of Micro, Small and Medium Enterprises (MMSME). NSIC has been working to fulfill its mission of promoting, aiding and fostering the growth of small industries and industries related micro, small and medium enterprises in the country. NSIC on its part is contributing to the financing of MSMEs.

Their schemes are mainly as follows:

Bill Financing: Financing on bills drawn by Small Scale Industries for supplies made up to 90 days is provided.

Working Capital Finance: Finance for augmenting working capital of viable and well managed units, on selective basis in case of emergent requirements, to enable them to pay off their purchases of consumable stores and spares and production related overheads particularly electricity bills, statutory dues, etc.

Export Development Finance: Finance is provided for Export oriented units to meet their emergent requirements. Pre and post shipment finance shall also be provided to such units at such terms and conditions.

Equipment Leasing Scheme: In order to assist SSI units to procure industrial equipments for modernisation, expansion and diversification of the industry, Equipment leasing scheme was introduced.

Refinance Scheme for Modernisation of Small Scale Industries: The primary objective of the Scheme is to encourage industrial units overcome the backlog of modernisation and to adopt improved and updated technology and methods of production and prevent mechanical and technological obsolescence.

.

4.5 Commercial Banks

Besides SIDBI, SFCs and NSIC commercial banks play a vital role is taking care of the finance needs of Small industries. Separate departments are set up in each bank for this purpose.

Over the years there has been a significant increase in credit extended to this sector by the banks. As at the end of March 2011, the total outstanding credit provided by all Scheduled Commercial Banks (SCBs) to the MSE sector stood at Rs.4785.27 billion as against Rs. 3622.90 billion in March 2010 registering an increase of 32%.

To ensure enhanced credit flow to the sector, and more so to the micro units, in terms of the recommendations of the Prime Minister’s Task Force on MMSMEs, constituted by the Government of India, banks have been advised to achieve a 20 per cent year-on-year growth in credit to micro and small enterprises; the allocation of 60% of the MSE advances to the micro enterprises is to be achieved in stages by 2012-13 viz. 50% in the year 2010-11, 55% in the year 2011-12 and 60% in the year 2012-13 and achieve a 10% annual growth in number of micro enterprise accounts. The Reserve Bank is closely monitoring the achievement of targets by banks on a quarterly basis.

4.6 Loan re-construction pertaining to SSI Sector.

India MSME Asset Reconstruction Company Ltd (ISARC):

ISARC is the country’s first ARC supported by a large number of public sector banks and undertakings set up under the guidelines of RBI and SARFAESI Act, 2002. It will strive for speedier resolution of NPAs (Non-performing assets) with a focus on MSME sector.

ISARC vision is to become the leading Asset Reconstruction Company which would unlock the idle NPAs lying in the Financial Sector, including Banks/FIs, with a focus on the NPAs in the MMSME sector, for their productive use by resorting to innovative resolution mechanisms of NPAs.

Asset reconstruction companies are formed to acquire, manage and recover illiquid and NPAs (non-performing assets) from banks and Financial institution

Having regard to the need to unlock funds locked up in NPAs, SIDBI has promoted ISARC in association with Public Sector Banks, LIC and State Financial Corporations with a focus on NPAs of MSME sector.

Basically, ISARC will be adopting the popular business model of ARCs of purchase of NPAs from the Banks / FIs based on valuations and resolution of the same by way of sale to prospective buyers or / and restructuring of the liabilities etc. The transaction will be done either through the mode of Security Receipt or by way of cash. All business will be undertaken on a highly transparent manner and purely on commercial terms as per the provisions of the RBI guidelines and SARFAESI Act, 2002.

NBFCs( Non-banking finance Companies)

Non-banking financial companies (NBFCs) are fast emerging as an important segment of Indian financial system. It is an heterogeneous group of institutions (other than commercial and co-operative banks) performing financial intermediation in a variety of ways, like accepting deposits, making loans and advances, leasing, hire purchase, etc

They play a critical role in a developing economy like ours, where financial inclusion remains a distant goal. NBFCs generally focus on those areas where banks are either uncompetitive or where they do not find the returns worth their while. In doing so, they have consistently demonstrated a superior ability to innovate and reach out to unbanked areas.

Not surprisingly then, NBFCs in India flourish in the medium to long term finance to the MSME sector that are key to the country’s economic growth in the coming years.

The working and operations of NBFCs are regulated by the Reserve Bank of India (RBI) within the framework of the Reserve Bank of India Act, 1934 (Chapter III B) and the directions issued by it under the Act.

When we talk of financing we should also talk of Credit Guarantee schemes which we will discuss later in this material.

Refinance Scheme for Getting ISO Certification: SIDBI provides refinance for obtaining ISO Certification, expenses on consultancy, documentation; audit, certification fees, equipment and calibrating instruments required would be taken into account for determining the loan requirement. Existing industrial concerns in the micro and small enterprises sector having a good record of past performance and sound financial position are eligible.

4.6 NABARD:

In case of Small and Micro Enterprise Sector, NABARD will provide refinance for such activities in rural areas / other areas to NBFC’s financing the Small and Micro Enterprises. The small and micro (service) enterprises shall include small road & water transport operators, small business, professional & self-employed persons, and all other service enterprises.

NABARD provides refinance assistance to the NBFCs under two windows namely,

Automatic Refinance Facility (ARF): without going through the detailed procedure of

Pre-sanction formalities. The NBFCs are expected to appraise the proposals at their own level, be satisfied about the technical feasibility, financial viability etc. and finance the borrowers.

Pre-Sanction Procedure. : The refinance assistance to NBFCs above the ARF cut off

level will be provided under Pre-Sanction procedure. NBFC is required to forward the project proposal for sanction to the concerned Regional Office after appraising the project and being satisfied about it’s technical feasibility, financial viability and bankability.

4.7 Small Scale Industries Infrastructure Development Fund (SIIDF)

One of the major reasons for the failure of some SSIs is inadequate infrastructural support. Power, communication, pollution control along with credit is the major factors which help promote SSIs. Adequate infrastructure is required even to permit the SSIs to absorb and use existing credit

The Study Group for Small-Scale Industries has recommended setting up of an Rs 2,000-crore Infrastructure Development Fund for small-scale units. The fund will be utilised in creating, revamping and upgrading the industrial infrastructure for SSIs, including upgrading the infrastructure in the existing industrial estates. The members of the Study Group consist of representatives of the Small Industries Development Bank of India (SIDBI), the National Small Industries Corporation, non-government organisations and the Development Commissioner of SSIs apart from academics.

Self-Assesment Questions

Fill in the blanks:

6. ________ _____ face the problems like delayed payment by parent units, resulting in sundry debtors.

7. SSI units are basically small in size and cannot make investments on their own in __________ like power, communication or pollution control measures.

8. The financial assistance by SIDBI to SSI is __________ through the existing credit delivery system comprising NSIC, SFCs, SIDCs, SSIDCs, commercial banks, co-operative banks and RRBs.

6.5 Regulatory Requirements

We shall discuss the regulatory aspects with regard to financing of the Small Scale Industries sector by studying the various acts and regulations applicable to financing the Small Scale industries sector.

SIDBI Act 1989

SIDBI was established as an apex body on April 2, 1990 under the SIDBI Act, 1989, was set-up with a mission to empower the Micro, Small and Medium Enterprises (MMSME) sector. The provisions of this act are applicable for all financial support schemes of SIDBI.

The preamble to the Small Industries Development Bank of India Act, 1989 defines the objectives of SIDBI as follows:

“the principal financial institution for the promotion, financing and development of industry in the small scale sector and to co-ordinate the functions of the institutions engaged in the promotion and financing or developing the industry in the small scale sector and for the matters connected therewith or incidental thereto.”

The Bank’s vision as envisaged in the Act is to emerge as a single window for meeting the financial and developmental needs of the MSME sector to make it strong, vibrant and globally competitive, it also wants to position SIDBI Brand as the preferred and customer – friendly institution and for enhancement of share – holder wealth and highest corporate values through modern technology platform. Apart from providing finance, directly to MSMEs and it also finances indirectly through financial intermediaries, viz., Banks, SFCs, NBFCs, etc.

Micro, Small & Medium Enterprises Development (MMSMED) Act, 2006

The Government of India has enacted the Micro, Small and Medium Enterprises Development (MMSMED) Act, 2006 on June 16, 2006 which was notified on October 2, 2006. With the enactment of MMSMED Act 2006, the paradigm shift that has taken place is the inclusion of the services sector in the definition of Micro, Small & Medium enterprises, apar