Industry and MSMEs: policy, classification and credit

India skipped a step that most successful Asian economies took. Workers moved from farms into services and construction, while manufacturing's share of output stayed roughly flat for decades. That "missing manufacturing" is behind India's employment problem, and MSMEs sit at the centre of it: they employ many times more people than large firms, but most stay tiny and informal. For the RBI, the MSME question is really a credit question. That is why the RBI set up an Expert Committee on MSMEs (U.K. Sinha, 2019) and why MSME lending is a regular ESI and interview theme.

Industrial policy: three eras

Today only atomic energy and railway operations remain reserved for the public sector, and compulsory licensing applies to a handful of hazardous or strategic industries. The small-scale reservation of products, once running to hundreds of items, was fully removed by 2015.

Production-linked incentive (PLI) schemes pay firms a percentage of incremental sales over a base year for a fixed period, in 14 sectors including mobile phones, pharmaceuticals, auto components, solar modules and advanced batteries. Supporters point to the rise of mobile phone assembly and exports. Critics ask how much domestic value is added, whether incentives go to a few large firms, and whether the gains outlast the subsidy.

Measuring industry

• Index of Industrial Production (IIP): monthly output index covering mining, manufacturing and electricity. It has used base year 2011–12; MoSPI has been moving national statistics to newer base years, so check the current base.
• Eight core industries: coal, crude oil, natural gas, refinery products, fertilisers, steel, cement and electricity, about 40% of the IIP by weight on the 2011–12 base.
• Purchasing Managers' Index (PMI): a survey index where a reading above 50 signals expansion.
• Annual Survey of Industries: detailed data on registered factories.

How MSMEs are classified

The MSMED Act, 2006 originally used investment in plant and machinery, with separate limits for manufacturing and services. Since July 2020 the classification is composite: an enterprise must satisfy both an investment limit and a turnover limit, and manufacturing and services are treated alike. Export turnover is excluded when computing turnover.

Worked example 1: a unit has plant and machinery of ₹3 crore and turnover of ₹8 crore. Turnover fits micro, but investment exceeds the micro limit of ₹2.5 crore. If either limit is crossed, the unit moves up, so it is small.

Worked example 2: investment ₹20 crore, domestic turnover ₹120 crore plus ₹60 crore of exports. Exports are excluded, so turnover for classification is ₹120 crore, above the small limit of ₹100 crore. The unit is medium.

Registration is online through Udyam (since July 2020), self-declared and linked to PAN and GST data. The Udyam Assist Platform (2023) brings informal micro enterprises without GST registration into the formal system, so that loans to them count as priority sector lending.

The missing middle

India has a very large number of micro units, relatively few medium ones, and a small number of large firms. Firms that start small tend to stay small. Reasons include: regulatory thresholds that make growth costly, reliance on informal credit, limited access to large buyers, and competition from informal units that pay fewer taxes. The result is low productivity across most of the workforce.

MSME problems and responses

What banks and the RBI do

• Priority sector lending: micro enterprises have a sub-target of 7.5% of adjusted net bank credit.
• Collateral: banks may not take collateral for loans to micro and small enterprises up to ₹10 lakh.
• SIDBI (1990): refinance and fund-of-funds support for MSMEs.
• Digital public infrastructure: GST data, the Account Aggregator framework and the Unified Lending Interface allow lending on actual cash flows rather than land.

Model answer outline (15 marks)

Question: What constrains the growth of MSMEs in India? How can the financial sector help them scale up?

1. Opening: MSMEs' role in jobs, output and exports; the composite classification.
2. Constraints: credit gap, delayed payments, informality, technology, the missing middle.
3. Financial sector's role: cash-flow-based lending via GST and Account Aggregator data; TReDS; credit guarantees; SIDBI refinance; equity through SME platforms and funds.
4. Policy support: 45-day payment rule and Section 43B(h); Udyam and Udyam Assist; cluster programmes.
5. Risks: credit guarantees can weaken bank screening; restructuring can delay recognition of stress.
6. Way forward: formalisation incentives, faster payment enforcement, data-based credit scoring, market access through government e-procurement.
7. Conclusion: finance is necessary but scaling up also needs markets, skills and simpler regulation.

Short model answer (10 marks)

Question: Why are delayed payments a serious problem for MSMEs, and what has been done about them?

MSMEs often supply large companies and government departments that pay late. For a small firm with thin capital and limited bank credit, locked-up receivables mean it cannot buy inputs or pay wages, and must turn to expensive informal credit. In effect, the MSME ends up financing its larger buyer.

The MSMED Act requires buyers to pay micro and small suppliers within the agreed period, which cannot exceed 45 days, and to pay compound interest at three times the RBI's bank rate on delays. Since 2023–24, Section 43B(h) of the Income Tax Act allows a buyer to deduct such payments as an expense only when they are made on time, which gives the rule financial teeth. The MSME Samadhaan portal handles complaints.

On the financial side, TReDS platforms let MSMEs sell invoices accepted by large buyers to financiers through auctions, so they receive cash quickly at a rate based on the buyer's credit rating. Mandating large companies to join TReDS has widened its reach. Remaining gaps include enforcement against government buyers and small firms' fear of losing customers if they complain.

Practice questions

1. Under the composite criteria, can an enterprise be micro by investment but small by turnover?
   • It would be classified as small; if either limit is crossed, the unit moves up.
2. Is export turnover counted for MSME classification?
   • No, it is excluded.
3. What is the maximum payment period to micro and small suppliers under the MSMED Act?
   • 45 days.
4. Which two activities remain reserved for the public sector?
   • Atomic energy and railway operations.
5. What is the PSL sub-target for micro enterprises?
   • 7.5% of adjusted net bank credit.
6. How many industries make up the index of eight core industries?
   • Eight: coal, crude oil, natural gas, refinery products, fertilisers, steel, cement and electricity.

What to do next

• Memorise the classification table and redo the two worked examples.
• Read the RBI's priority sector master direction section on MSMEs.
• Revise with the employment guide and the infrastructure guide.