Indian SMEs in Global Value Chains: Status,Issues and Way Forward

Abstract

Small and medium enterprises (SMEs) account for bulk of the enterprises in most countries and play a crucial role in global value chains (GVCs). In India, micro, small and medium enterprises (MSMEs) constitute around 30% of the gross domestic product (GDP), accounts for 50% of exports and a major share in employment. Under the Aatmanirbhar Bharat Abhiyan, the Central government intends to enhance the share of MSMEs in exports to 60% in the next 5 years. The government also plans to increase the contribution of the MSMEs to 40% of the GDP. In this context, this article examines how effective the government policies have been in the past 10 years to help Indian MSMEs integrate in the GVCs. It first presents an overview of the MSMEs in India, focusing on their exports and global market integration. It then examines the schemes and policies of the Ministry of Micro, Small and Medium Enterprises, and provides an empirical estimation (2000–2001 to 2020–2021) of the impact of government schemes/programmes on MSMEs integration in the GVCs. Based on key informant interviews, it identified the core issues faced by the MSMEs and makes recommendation on how to address them, so that, the targets set by the government for enhancing the contribution of the sector to GDP and exports can be achieved.

JEL Codes: F10, G28, O10, O20, O57

Keywords

SMEs GVCs policy India financial inclusion digitalisation

Introduction

Globalization, trade liberalization, proliferation of trade agreements and rise in connectivity has led to greater economic integration and development of global value chains (GVCs) since early 1990s. This has, in turn, led to emergence of new models of global business, which includes global sourcing, flexible production, a focus on core business along with subcontracting and outsourcing. With the advent of fourth industrial revolution (4th IR), technology upgradation, innovation and knowledge creation have become a key component of business competitiveness and efficiency (Ando & Kimura, 2005).

In most countries, small and medium enterprises (SMEs) play a key role in inclusive economic growth and trade. SMEs are estimated to account for 80%–99% of firms in any country and they account for 60%–80% of global employment (International Finance Corporation [IFC], 2013; World Trade Organization [WTO], 2016). In Asia, the micro, small and medium enterprises (MSMEs) account for 96% of total enterprises, employ 62% of the labour workforce and contribute to around 42% of the gross domestic product (GDP) (Asian Development Bank [ADB] & Asian Development Bank Institute [ADBI], 2015). SMEs also have a higher rate of sales growth than large firms (Cusolito et al., 2016). Thus, a substantial share of any nation’s economy, in both developed and developing countries, is supported by the SMEs. These firms are the key drivers of sustained and inclusive growth; generate employment; facilitate trade and investment and promote innovation (BIAC et al., 2016). In case of countries in East Asia and Southeast Asia, SMEs have also played a key role in export growth and diversification, poverty mitigation, economic empowerment and the fair distribution of income and capital (Asasen et al., 2003; Harvie, 2002, 2008, 2015; Harvie & Lee, 2002, 2005). Around 80% of the global trade and GVCs is through SMEs (United Nations Conference on Trade and Development [UNCTAD], 2013).

The MSME sector is often referred to as the backbone of the Indian economy (Mukherjee, 2018), contributing to around 30% of the GDP, around 50% of exports and accounts for a major share in employment. India had over 63 million MSMEs. Under the Aatmanirbhar Bharat Abhiyan, linking India to GVCs, the Central government intends to enhance the share of MSMEs in GDP to 40% and in exports to 60% in the next 5 years.

Literature Review

The process of globalization and the growth of value chains has offered new market opportunities for SMEs, to integrate in GVCs and a number of studies found that most of them are able to respond flexibly and adaptively to rapidly altering regional and global demand (OECD, 1997). In India, a study by Mukherjee (2021) concludes that participation in GVCs has increased between the period 2005–2015, especially in sectors such as textiles, coke, refined petroleum, information technology (IT) and information services. Reddy and Sasidharan (2020) found that the participation of SMEs in GVCs has been rising since the early 2000s. GVCs enable the MSMEs to specialize in particular segments of manufacturing and integrate into the worldwide production chains and further economic development via increase in productivity and higher exports (Kowalski et al., 2015). Participation in GVCs and cooperation within a network of upstream and downstream partners can increase the firms’ information flows and learning possibilities as well as to introduce new business practices and use more advanced technology. Furthermore, this will lead to greater growth and earning potential (UNCTAD, 2010).

Digitalisation can help SMEs to integrate in GVCs. In a survey-based study of 600 European SMEs by Abel-Koch (2016), more than 70% of firms stated that digitalisation makes it easier to integrate foreign customers and suppliers to the value chains. Cusolito et al. (2016) found that the use of the internet reduces the cost of exporting for SMEs, thereby increasing export participation. Ganne and Lundquist (2019) found that smartphones can enhance the participation of SMEs of developing countries in GVCs. A study by Oxford Economics (2017) found that small businesses with their own website were almost four times more likely to export vis-a-vis those of same size that do not have a website. Ray and Miglani (2020) found that MSMEs in the automotive sector, which have heavily invested in digital technologies, experience productivity and product sophistication gains. Fourth IR technologies, such as artificial intelligence (AI), internet of things (IOT) and blockchain can enable SMEs to play a more active role in GVCs (Lanz et al., 2018). An empirical study by Banga (2019) shows a positive relationship between digital competence (in the form of digital capability and share of skilled labour) and firm-level upgradation of Indian firms participating in GVCs, which helps these firms capture higher value in GVCs.

Studies also highlight that technology can help to ease other barriers like access to finance and help SMEs to integrate in GVCs. With the growth of digital products and Fintech, studies have shown that greater participation of SMEs in GVCs through digital financial inclusion (UNCTAD, 2005; World Bank, 2020). Technologies, like blockchain, can make it easier for SMEs to build trusted and reliable credit history, make transactions on a peer-to-peer basis and address barriers associated with access to finance through traditional channels, like physical banks (Ganne & Lundquist, 2019). The provision of digital financial services reduces costs of financial management, customer management and integrate supply/value chain management tools for SMEs (Global Partnership for Financial Inclusion [GPFI], 2020a). Online and mobile banking/finance and new financing tools like online crowdfunding can supplement finance for SMEs (GPFI, 2020b).

Existing studies have highlighted a number of barriers to SMEs integration in GVCs. SMEs have restricted access to formal sources of finance like banks and other forms of collateral-based credit, which impedes their participation in GVCs (Cusolito et al., 2016; Harvie et al., 2013). Firm-level literature highlights that sunk costs, rent for land, wage bill and other components restrict internationalisation of firms (Greenaway et.al., 2007; Lu et al., 2018). A survey by OECD and WTO (2013) of 700 lead firms and suppliers in sectors such as agri-food, textiles and apparel, tourism, information and communications technology and transport and logistics in 120 countries showed that developing country suppliers ranked ‘lack of access to finance’ as the main obstacle for the SMEs in entering, establishing or moving up the value chains. A survey by the ADB and ADBI (2015) in four Asian countries namely, Kazakhstan, Papua New Guinea, the Philippines and Sri Lanka, found that limited access to finance was one of the five serious impediments for SME participation in GVCs. The problem of financial constraints is more prominent for MSMEs than larger firms, given their limited ability to raise capital from external sources. Enhancing financial inclusion for SMEs can help improve their competitiveness and enable SMEs to access the benefits of GVC participation (ADBI, 2021; GPFI, 2017; Kuzmisin & Kuzmisinova, 2016). There are other issues such as access to technology and digital inclusion, stringent quality requirements and lack of market knowledge which can act as a barrier for SMEs participation in GVCs (Criscuolo & Timmis, 2017; OECD, 2007). These studies also stress on the important role played by governments in enhancing the integration of MSMEs in GVCs through appropriate policy measures.

In case of India, a number of studies have identified access to finance as a critical factor for SMEs participation in GVCs (Charan & Kishinchand, 2016; Reddy & Sasidharan, 2020). A survey by Federation of Indian Chambers of Commerce and Industry (FICCI) and Grant Thornton (2011) ranked ‘availability of finance’ as one of the top issues for MSMEs’ integration into GVCs. Reddy and Sasidharan (2020) also found that there is a negative impact of financial constraints on Indian MSMEs’ decision to integrate into the supply chain. Charan and Kishinchand’s (2016) survey of Indian MSMEs in Bangalore indicated that the key challenges in SMEs’ access to finance include the availability of collateral, high lending rates, procedural complications and the delays in obtaining a loan.

Thus, the existing literature confirms that MSMEs will benefit from integrating in GVCs. However, they do face a number of issues like access to finance and technology and there is a need to improve their efficiency and productivity and support them in integrating in GVCs. Government, through its policies and schemes, can play a key role in supporting the integration of MSMEs in GVCs. However, in the context of India, there are hardly any comprehensive study that provides an in-depth analysis of the impact of different government policies/schemes on MSMEs integration in GVCs and the perception of MSMEs of their barriers and requirements. This article aims to fill that lacuna.

Objective and Layout

The objective of this article is to examine how effective the government policies have been in the past 10 years to help Indian MSMEs integrate in GVCs. It first presents an overview of the MSME in India, focusing on their exports and global market integration. It then examines the schemes and policies of the Ministry of Micro, Small and Medium Enterprises (referred to as the MSME Ministry) and uses an ordinary least square (OLS) regression from the year 2000–2001 to 2020–2021, to examine the impact (success and gaps) of government schemes and programmes on MSMEs integration in the GVCs. Following this, the article focuses on the key issues faced by the MSMEs and makes recommendation on how to address the issues, so that, the targets set by the government of 40% and 60%, respectively, of the contribution of the MSMEs to GDP and exports can be achieved.

The article is divided into six sections. The next section presents the overview of MSME sector in India, its contribution to the economy and trade and the status of MSME’s access to finance. The fourth section presents the methodology and results of the regression analysis of government schemes and policies. The fifth section presents the results of the key informant interviews (KIIs), including their perception of key barriers and policy gaps. The sixth section draws the policy recommendations highlighting areas where the policy should focus on to facilitate the integration of MSMEs in GVCs and enhance their contribution to GDP and exports.

Overview of Micro, Small and Medium Enterprises Sector

According to the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 MSMEs are defined as ‘all enterprises engaged in production of goods pertaining to any industry specified in the first schedule of Industrial (D&R) Act, 1951, and other enterprises engaged in production and rendering of services subject to limiting factor of investment in plant and machinery equipment respectively’ (Government of India, 2006).

In June 2020, to facilitate ease of doing business, the Government of India (GoI) introduced a new criterion for classifying MSMEs, based on their annual turnovers (see Table 1).

According to the National Sample Survey, 2015–2016, India’s MSME sector comprises 63.4 million units; 31% of which are in the manufacturing sector, 36% in trade and 33% in other services. Out of these, micro enterprises constitute more than 99% of enterprises, small enterprises constitute 0.52% and medium enterprises constitute less than 0.01% of total enterprises (Ministry of Micro, Small and Medium Enterprises [MSME Ministry], 2021a).

Table 1.

Revised Classification Applicable with effect from 1 July 2020.

Composite criteria: Investment in plant and machinery/equipment and annual turnover
Classification	Micro	Small	Medium
Manufacturing enterprises and enterprises rendering services	Investment in plant and machinery or equipment: Not more than ₹10 million and annual turnover; not more than ₹50 million.	Investment in plant and machinery or equipment: Not more than ₹100 million and annual turnover; not more than ₹500 million.	Investment in plant and machinery or equipment: Not more than ₹500 million and annual turnover; not more than ₹2,500 million.

Source: Ministry of Micro, Small and Medium Enterprises, Government of India. https://www.msme.gov.in/know-about-msme

MSMEs accounted for 29% of the GDP in 2016–2017 (see Table 2). MSMEs have provided employment to around 110.9 million people in 2019–2020 (MSME Ministry, 2020). It is important to note that the current estimates of MSMEs’ economic contribution do not take into consideration the contribution made by the unorganised sector, due to unavailability of data, which is around 80% of the total MSME present in the country according the KIIs.

Table 2.

Contribution of MSMEs in India’s Economy at Current Price (₹ million).

Year	MSME GVA	Share of MSME in GVA (%)	Share of MSME in GDP (%)
2011–2012	26,225.74	32.3	30
2012–2013	30,205.28	32.8	30.4
2013–2014	33,899.22	32.7	30.2
2014–2015	37,049.56	32.2	29.7
2015–2016	40,255.95	32	29.2
2016–2017	44,057.53	31.8	28.9

Source: Annual Report 2018–2019, Ministry of Micro, Small and Medium Enterprises, p. 27.

MSMEs accounted for around 49.6% of India’s exports in 2019–2020 (April–August), an increase from 43% in 2012–2013 (Press Information Bureau [PIB], 2019). The trend in growth of MSME exports in the period 2012–2013 to 2018–2019 is presented in Figure 1.

Figure 1.

Source: Created by authors using data from RBI (2019) and Directorate General of Commercial Intelligence and Statistics, 2021.

Focusing on the credit requirements, there is a credit gap in the MSME sector between ₹20 and ₹25 trillion. As of 31 March 2019, the banking sector had ₹17.4 trillion credit outstanding to MSMEs, out of which scheduled commercial banks account for 90% of total credit. As per RBI data, the share of non-banking finance companies (NBFCs) in outstanding credit to MSME was 9.3% in March 2019. This trend is expected to accelerate with the emergence of Fintech companies (typically registered as NBFCs) focused on this segment (RBI, 2019).

Regression Analysis

The Annual Reports of the Ministry of MSMEs for the last 10 years presents various schemes and programmes of the government, which have been launched at different points of time to facilitate the integration of MSMEs in GVCs.¹ An OLS regression from the year 2000–2001 to 2020–2021, is used to examine the impact (success and gaps) of government schemes and programmes on MSMEs integration in the GVCs. The government schemes focus on enhancing competitiveness of MSMEs, digitalization and increasing usage of technology, enhancing access to credit, technology upgradation, innovation, assistance in market development, skill development and training for export promotion; have been selected for the analysis based on identification of key barriers faced by MSMEs which includes lack of access to credit, lack of digital financial inclusion, need for technology upgradation and need to do research and innovate. The barriers were identified through literature review and during the KIIs (see section ‘Primary Survey’).

While the Annual Reports of the Ministry of MSMEs presents the schemes and policies, the actual expenditures on a number of heads are missing. Therefore, we resorted to dummy OLS regression from the year 2000–2001 to 2020–2021, to examine the factors/government schemes and programmes assisting or promoting MSME in their GVC integration process and what hindrances do MSMEs face and what needs to be done in such a situation. Such dummy regressions have been used in cases of dearth of data available at the firm level or studies related to SMEs and their contribution and performance in the economy by Alfred and Park (2007), Hussinger (2008), Sterlacchini (2001), Arnold and Hussinger (2005) and Andersson et al. (2008). Another study related to use of dummy regression in management research have been done by Searle and Udell (1970). Given the data gaps, we have used similar methodology.

The structure of the ANOVA² models is as follows:

Y_{i} = B_{1} + B_{2} D_{i} + u_{i} .

where Y is the dependent variable; D_i are the dummy variables and u_i is the error terms.

The variable Y represents the integration of Indian MSMEs into the GVCs. Integration of GVC was taken as 0 or 1, where 0 indicated no integration or limited integration and 1 indicated successful integration.

In this model, we took a number of independent dummy variables/dummy explanatory factors explaining the integration process in enhancing competitiveness and integration in the GVCs. The examples of schemes that can support the SME integration GVCs are detailed out in Table A1. In most cases, data on enrolment or usage of the schemes are missing. Wherever data are available, it is presented along with the description of the explanatory variables below:

X₁ = Promoting competitiveness-related programmes, for example, the National Manufacturing Competitive Programme (NMCP) which aimed to support the SMEs to increase productivity. The Ministry of MSME has already started implementing the NMCP.

X₂ = Usage of IT. This includes schemes/programmes for setting up e-readiness centre, using of digital services and web-based clusters. The MSME ministry has promoted a business-to-business (B2B) portal. During 2019–2020, 25,157 units were registered in it and in 2020–2021, 38,070 members enrolled till 31 December 2020, and the revenue generated up to 31 December 2020, through the B2B portal was ₹59.7 million.

X₃ = Credit availability. The government has introduced schemes, like Credit Guarantee Trust Fund for Micro and Small Enterprises (CGT SME) to help with collateral free loans.³ The Credit Guarantee Scheme for Subordinate Debt (CGSSD) for stressed MSMEs was launched on 24 June 2020. As on 31 December 2020, 12 banks have been extended guarantees of ₹176.6 million to 178 borrowers. On 13 May 2020, the finance minister announced a fund-of-fund for MSMEs which will infuse ₹500,000 million for MSMEs as equity, but more details are not available. Under the Emergency Credit Line Guarantee Scheme (ECLGS), ₹1,375,875.4 million has been sanctioned and ₹920,902.4 million has been disbursed up to 3 August 2020.

X₄ = Technology upgradation. For examples, schemes, like technology and quality upgradation support to MSMEs.⁴ However, there are no details available except that funds have been released.

X₅ = Research and innovation-related schemes. While this is covered partially under many schemes, there are no schemes focusing specifically on this issue.

X₆ = Marketing assistance scheme. To promote participation in overseas fairs and exhibitions in the international market, the government has introduced market promotion schemes such as International Cooperation Scheme, Marketing Assistance Scheme and Procurement and Marketing Support Scheme (P&MS).⁵

X₇ = Skill development. For example, the Entrepreneurship Skill Development Programme (ESDP) and Assistance to Training Institutions (ATI).⁶ In the year 2018–2019, 18 technology centres set up across the country have provided training to 208,174 trainees, supported 39,859 units and earned revenue of ₹3188.2 million.

X₈ = Export promotion and training-related schemes. This includes schemes to educate the MSMEs about the export markets and latest design of packaging technique, improve their packaging standards and highlight the importance of packaging.

The values taken were either 0 or 1 depending on the year when the programme was launched.

Results

The results presented in Table 3 show that the T-value is positive and significant for promoting competitiveness programme, usage of IT, market assistance schemes, skill development initiatives, export promotion training scheme. This implies that the schemes have helped the MSMEs to integrate in GVCs. Credit availability showed a positive but is not statistically significant in influencing MSME competitiveness and integration into GVCs. Technology upgradation and innovation schemes are yet to make any significant impact on the MSME in terms of competitiveness and integration process. These are two key areas of concerns as Indian MSMEs try to integrate in GVCs in an era of fourth IR.

Table 3.

Impact of Different Policies and Programmes on SMEs GVC Integration.

Adjusted R-square = 0.56, Number of observations = 22 Dependent variable—Integration of MSMEs into global value chains
Independent Variables	T-value (p-value)
Promoting competitiveness	6.25 (0.23)
Usage of IT	4.50 (0.4)
Credit availability	1.12 (0.63)
Technology upgradation	−5.63 (1)
Research and innovation schemes	−4.14 (1)
Marketing assistance scheme	6.65 (0.12)
Skill development	4.80 (0.23)
Export promotion training scheme	6.25 (0.20)

Source: The authors.

Primary Survey: Key Informant Interviews and Stakeholder’s Consultations

To understand the perceptions of the MSMEs with a focus on the issues that they face in integrating into GVCs and their perception of the impact of government schemes and policies, KIIs and stakeholders’ consultations were conducted with 25 companies and 10 industry bodies. The KIIs include MSMEs, their industry organisations, consultants/practitioners in the MSME sector and policy makers in India. Five MSMEs have been selected from five sectors each, namely, apparel, engineering, tourism, IT and agro-processing for the KIIs to understand the sector-specific issues and requirements. The KIIs specifically covered SMEs who are members of export promotion councils and Federation of Indian Micro and Small and Medium Enterprises (FISME). All the SMEs interviewed were engaged in exporting prior to the coronavirus (COVID-19) pandemic. A semi-structured questionnaire was used to understand their mode of doing business and GVC integrations, what are the key barriers that they are facing and what kind of support do they need. The key questions included:

How do the Indian MSMEs engage in GVCs and connect to their buyers and consumers?

What kind of digital technology do MSMEs use and what has been the change post-COVID-19 pandemic?

What has been the overall impact of the pandemic on your business in general and exports in particular? What are the major changes in doing business and in integrating in GVCs pre-and post-COVID-19? Have you benefited from India’s existing trade agreements? Please elaborate.

How are the MSMEs adjusting to the new global norms?

How satisfied are the MSMEs with the measures taken by the Indian government to support them, in general and during the pandemic?

What are their views on the new definition of MSMEs?

What are the top five barriers that you face in integrating into the GVCs? Please elaborate.

What do Indian MSMEs need from the government to help them integrate in GVCs?

The survey was conducted between November 2020 and April 2021.

Key Findings

The KIIs examined the status of MSMEs with regards to integration in GVCs, the mode of doing business, key issues faced and what they want from the government.

According to the KIIs, MSMEs account for over 40% of exports, but only around 25% of the overall MSMEs in the country or even lesser number may be engaged in trade. In the export markets, they are often sub-contracted by the tier 1 partners. Only 50% of MSMEs interviewed had got direct contracts through buyer–seller meets or personal contacts, and only four firms said that they have got business by connecting on-line.

In the past, developed countries were the key markets for the Indian MSMEs and many of them were contract manufacturers or service providers to firms from these countries namely the United States of America (USA), United Kingdom (UK) or European Union (EU) member states. A number of them are engaged in imports from China and Association of Southeast Asian Nations (ASEAN) countries. However, of late, there are facing a number of issues in their key export markets and are losing their market share to MSMEs from other countries like Vietnam in case of manufactured product exports. This is because countries, like Vietnam, have trade agreements with markets like the EU and the USA, where companies get duty free access for products like apparel. Many Indian MSMEs are now trying to diversify to other markets and are, therefore, exploring new markets in ASEAN, Africa and SAARC (South Asian Association for Regional Cooperation) countries like Bangladesh and Nepal.

Impact of COVID-19 Pandemic

Prior to the COVID-19 pandemic, very few MSMEs were using online technology to get business. After the pandemic-related lockdown in March 2020, any of them have adopted digitalisation at a fast pace, but they need finance and support for digitalisation. The pandemic led to a complete disruption of supply chain, and it became difficult for the MSMEs, with limited working capital to support their employee and other costs. Eighty per cent of the companies interviewed said that they have experienced a double digit fall in revenue due to fall in demand in the FY 2020–2021. This is especially true for manufacturing sector and some services sector like tourism. The pandemic and the sudden lockdown in March 2020 have led to a situation where SMEs could not meet deliveries on time due to disruption of supply chains, shortage of containers and shut down of factories. The entire travel and transport industry collapsed. This led to cancellation of orders and lack of access to finance and working capital. Due to lack of capital and orders, many SMEs have either shut down or are at high risk of closing permanently.

Regarding their workers and employees, interviewees pointed out that the workforce in the IT companies are used to the concept of work-from-home, but in case of manufacturing, there is a requirement for workers to be present at the shopfloor. Given that many workers are contractual, and companies faced working capital crunch, they could not pay the workers. Therefore, migrant workers went back to their villages/native place. Thus, when the factories opened there was a shortage of workers. Implementation of social distancing norms and health-related safety measures among workers (like asking the workers to wear a mask) has enhanced the costs and time taken by the management. Under a normal situation (prior to the COVID-19 pandemic), majority of the interviewees (85%) did not face any issues in getting skilled workforce; but during the pandemic, they faced skill shortages.

In the FY 2020–2021, the government had announced an economic package worth ₹30 trillion under the Aatmanirbhar Bharat Abhiyan due to the pandemic, with several measures catering to MSMEs, including liquidity infusion and business support. These include new schemes, like Niryat Rin Vikas Yojana (NIRVIK); which provides high insurance cover, reduction in premium for small exporters and simplified procedures for claim and settlement; emergency credit line to MSMEs from banks and NBFCs up to 20% of outstanding loan credit up to 31 October2020; ₹200,000 million subordinate debts for stressed MSMEs; ₹500,000 million equity infusion for MSMEs through fund-of-funds for expanding size and capacity. According to the interviewees, this was not enough and most of the existing schemes saw a decrease in funds. For example, there was a decline in funding under the Prime Minister’s Employment Generation Programme (PMEGP); Entrepreneurship and Skill Development Programmes (ESDP); Scheme for Promotion of Innovation, Rural Industry & Entrepreneurship (ASPIRE)) (also see, Ministry of MSMEs, 2021a). In the budget for FY 2021–2022, a total amount of ₹156,996 million was allocated for development of the MSME sector, which is more than double of previous year (Ministry of MSMEs, 2021b). However, the participants of KIIs were not sure how these funds can be accessed and felt that most of the incentives like the production-linked incentive (PLI) scheme are for larger companies and not for MSMEs, especially in a situation of demand crunch. They said that they needed an immediate relief package as is given by countries, such as Singapore, Germany or New Zealand.

Barriers

According to the interviews, the key barriers in integrating in GVCs in the last 2 years includes access to finance, technology gaps, inability to innovate, inability to meet the higher quality standards in markets like the EU and the USA, and growing trade protectionism (see Figure 2). The KIIs confirmed that there is a gap in government policy and schemes with respect to support for access to finance, innovation and quality improvement and technology upgradation and help in automation. The survey was during the COVID-19 pandemic and MSMEs strongly felt the need for technology upgradation and digitalisation and were suffering from lack of working capital and loss of market due to COVID-19-related lockdown and supply chain disruptions.

Figure 2.

Source: Authors’ calculations based on KIIs and stakeholder consultations.

Perception about the Top Five Barriers

Limited access to finance: According to the interviewees, on one hand, over 80% of MSMEs are present in the informal sector and do not have access to formal institutional credit. On the other hand, banks have not been able to use their funds targeted at MSMEs under the priority sector lending scheme. MSMEs face high interest rates; the Export-Import Bank of India provides loans at the rate of 10–12% compared to countries like China where loans are provided at a rate below 1%. Banks and business organisations pointed out that MSMEs are also considered high risk. MSMEs are unable to provide collateral; they do not pass the rigid credit conditionalities of banks or institutions like Small Industries Development Bank of India (SIDBI). There is also a lack of a unified alternative credit rating mechanism in India. The availability of digital credit and innovative Fintech products are limited. Focusing on the COVID-19-related financial assistance, around 60% of the respondents pointed out that government initiatives under the Atmanirbhar Abhiyan have been narrow in scope, since they target only MSMEs which are registered (which is around 10% of total MSMEs) or have access to formal institutional finance (which is only around 6–7% of total MSMEs). Thus, the benefits of the schemes have not percolated down to the firms that are in actual need of finance. Our KIIs found that even for SMEs with a bank account, no measures have been taken to support their working capital unlike in the case of farmers where there has been a direct money transfer to their bank accounts.

Issues with technology upgradation: MSMEs face constraints in fourth IR technology adoption. While they want to automate, there is an associated cost and training requirements. Around 90% said that there is limited support from government for technology and skill upgradation. Other South-east Asian countries, like Vietnam, have issued several laws and policy programmes to support science, technology and innovation at the firm level. For example, the science and technology law, the technology transfer law and the law on intellectual property rights (OECD, 2021).

Limited support for innovation and research and development (R&D): There is a lack of support by the government for R&D in India resulting in a large gap between the requirements of foreign clients and what Indian SMEs have to offer. Almost 80% of the MSMEs, were of the opinion that the government does not promote and encourage enough R&D and innovation. The lack of schemes and funds allocated to promoting innovation for better quality products (e.g. improved shelf life) or to meet the global sustainable development goals (SDGs). In recent years, foreign clients have been increasingly focusing on whether companies are meeting the SDGs.

Growing trade protectionism: There is a growing trade protectionism, globally and in India, which has been accentuated by the pandemic. There are sudden increases in tariffs and non-tariff measures leading to higher inputs costs. For example, there are issues in imports of raw materials like steel, a key input into the engineering sector, due to several new import control measures and quality checks being imposed. According to the KIIs conducted, it is difficult to obtain bank guarantees and thus get clearance of the goods because of the Custom (Administration of Rules of Origin under Trade Agreement) Rules (CAROTAR, September 2020).⁷ India has also imposed an anti-dumping duty on flat rolled steel products that are plated or coated with alloy of aluminium and zinc originating in, or from China. The duty is in the range of USD13.07–173.10 per tonne for 5 years. In addition to this, the Directorate General of Foreign Trade (DGFT) Notification No 33, 28 September 2020 requires importers to compulsory register in the online system—Steep Import Monitoring System (SIMS) for iron and steel, and the registration number will have to be entered for clearance of the consignment by Customs. The registration fee is ₹1 per thousand (subject to a minimum of ₹500) and a maximum of ₹0.1 million on aggregate cost, insurance and freight value of imports. These are additional costs. Thus, the introduction of these import control measures have led to price rise of steel in India by 50% in 2020, as compared to the global price rise of around 20%. This has adversely impacted MSMEs in the engineering sector and reduced their global competitiveness. Around 75% of MSMEs said that the standards set by the Bureau of Indian Standards (BIS) is becoming more difficult to abide by, at the same time, the government does not offer enough training and information on the standards of key export markets which are offered by other countries. Around 80% felt that import controls for raw materials and intermediary products will adversely impact exports. Further, tariff increases will make it difficult for India to sign trade agreements with key export markets like the USA or the EU. In 2019, the withdrawal of the generalized system of preferences (GSP) by the USA has already adversely impacted MSMEs in certain sectors, like engineering.

Adhering to standards and requirements: SMEs pointed out that they do face issues in adhering to standards and requirements of key developed country markets and the existing training offered in India through joint capacity building programmes with importing countries is far less than offered by other developing and least developing countries like Cambodia. The SMEs and their business organisations agreed that there are quality issues in the exports, but this is mostly related to their lack of knowledge and understanding of the standards and requirements. There is no go-to handbook or a barrier market report (e.g., the annual National Trade Estimate Report on Foreign Trade Barriers released by the United States Trade Representative [USTR]), which can help cover knowledge gap about the key markets.

Conclusion and Policy Implication

The government wants to increase the share of MSME in GDP to 40% and in exports to 60% in the next 5 years. In that context, several schemes and policies have been launched. The empirical analysis shows that while the schemes for promoting competitiveness, usage of IT, market assistance schemes, skill development initiatives and export promotion training scheme have shown positive and significant results, schemes for credit availability is positive but not statistically significant in influencing MSME competitiveness and integration into GVCs. Technology upgradation and innovation schemes are yet to make any significant impact on the MSME in terms of competitiveness and integration process. The KIIs found limited access to finance, difficulties in technology upgradation and limited support for R&D and innovation, as the top three issues. Therefore, based on the empirical analysis and the KIIs, the government policies and schemes need to focus on three key areas: credit availability, support for research and innovation and support for technology upgradation. Along with this, there is a need for go-to-market handbook for key markets. Business associations and export promotion councils can develop such handbooks and conduct training for their members. In a difficult time of growing protectionism, there is need to build capacity and awareness among SMEs about the trade agreements, standards and processes and requirements of importing countries. It is important to do research on how other countries have used trade agreements for the benefit of their SMEs.

To enhance access to finance, the government should focus on the specific needs of the MSMEs with respect to access to finance, which includes financing gaps in working capital, access to funds at lower interest rates, etc. Government should encourage banks and Fintech companies to enter into partnerships to develop innovative non-collateral-based financial packages and processes for digital financial inclusion of MSMEs. There is scope for traditional financial service providers to partner with technology companies for smart use of data and development of innovative financial services, which may be explored. There is also a need to increase access to digital financial services by development of an interoperable digital payments’ infrastructure and development of hybrid and flexible digital products customised to the needs and requirements of the MSMEs.

Schemes can be designed for technology upgradation and supporting SMEs in onboarding into fourth IR technologies. There is need to design schemes for research and innovation, which is a major gap in the policy.

Overall, there is a need to review and optimize the schemes and have a few targeted schemes which are addressing the issues faced by MSMEs. There are data gaps in allocation under schemes, scheme utilisation and effectiveness. Such data need to be collected and analysed, and policies should be data driven and evidence based. The government is collecting a lot of data on MSMEs through various portals, however, there is limited information on their performance. There is need for longitudinal data collection and reporting of the performance of MSMEs in trade and in areas like digital inclusion and technology upgradation. For this, regular surveys can be conducted to understand the status, and the concerns and needs of MSMEs. This will help the government to provide targeted solutions.

To conclude, in an era of growing protectionism, most of survey participants did not ask for market protection or higher tariffs. They wanted support (both fiscal and non-fiscal) to become competitive and to integrate in the GVC. With targeted and well-structured schemes and policies to support the MSMEs in their GVC integration, it will not be difficult to enhance the share of MSMEs in GDP and exports.

Footnotes

Acknowledgements

The authors are grateful to all survey participants and would like to thank Drishti Vishwanath, Eshana Mukherjee and Devyani Gupta for their valuable inputs.

Declaration of Conflicting Interests

The authors declared no potential conflicts of interest with respect to the research, authorship and/or publication of this article.

Funding

The authors disclosed receipt of the following financial support for the research, authorship and/or publication of this article: The key informant interviews for this study were funded by the Foreign, Commonwealth & Development Office, United Kingdom (UK) under their joint capacity building programme with the Indian government, Economic Policy and Prosperity Partnership (EPPP), to support the Department of Economic Affairs, Ministry of Finance in their G20 negotiations. This article presents some of the results of the pilot survey in India.

Appendix A

Notes

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