The new MSME norms

Manoj Kamat

The Parliament recently introduced a Bill that redefines the way MSMEs work

The Micro, Small and Medium Enterprises (MSMEs) will now soon be defined based on their annual turnover, thanks to The MSME Development (Amendment) Bill, 2018 cleared by Parliament. Globally two most important elements are used to define MSMEs – turnover and employment. However, in India at present, the classification of MSMEs is based on the investment made in plant and machinery/equipment. The recent move changes the classification norms for MSMEs from ‘investment in plant and machinery/equipment’ to ‘annual turnover’ and is claimed to be a big relief for the sector.

The Change

The new legislation envisages a new classification for small scale industries in the country. According to the new classification scheme, any business with a turnover of up to ₹5 crore will be considered a ‘microenterprise’. The other slabs are ₹5-75 crore for ‘small enterprise’ and ₹75-250 crore for ‘medium enterprise.’ At present, as per 2006 definition, there are two sets of definitions based on investment slabs depending on whether the units produce goods or services. Under the goods category the investment slabs are up to ₹25 lakh for micro, ₹25 lakh to ₹5 crore for small and ₹5-10 crore for medium while in the case of trading/services, the slabs are up to ₹10 lakh, ₹10 lakh to ₹2 crore and ₹2-5 crore each. The distinction between trading and manufacturing has been removed in the new definition.

The Impact

The new piece of legislation will largely impact the Indian industry. The number of MSMEs registered on Udyog Aadhaar Memorandum (UAM) Portal in 2018 (since September 2015) is 48.40 lakh. However, as per the data received from the 73rd round of the National Sample Survey on ‘Unincorporated Non-Agricultural Enterprises (excluding Construction)’, conducted by National Sample Survey Office (NSSO), Ministry of Statistics and Programme Implementation (during July 2015 to June 2016) finds the total number of MSMEs in the country at 633.88 lakh and out of which only 4000 enterprises as large. These MSMEs have an elephant-sized contribution to the economy. India’s export of products from the MSMEs increased to $137.1 billion in 2016-17 from $130.8 billion in 2015-16, registering a growth of 4.8 per cent which is an improvement from the negative growth of 5.9 per cent in 2015-16. It is also pertinent to note that 97 per cent of MSMEs operate in the informal sector, with the share in the gross output of informal sector of about 34 per cent, while the share of informal sector manufacturing MSMEs in total GDP is around 5 per cent according to the National Accounts Statistics.

Implications

The new definition based on turnover will bring clarity on multiple fronts. While removing the arbitrary nature of the earlier investment-based definition, the turnover-based definition is expected to ease many constraints to deliver results for the overall development of the MSME sector. Firstly, the investment-based definition is unintelligible as the actual credit requirement for operations is often unrelated to the capital investment. Using an old (investment based) definition paves way for inefficiencies as the focus is on extending or limiting the investment in order to fulfil the criteria rather than being based on the business requirements. One important advantage is that it will deliver a better understanding of the credit needs of MSME units by banks. Another significant benefit that the new definition can bring about is the manner in which the assets are funded, as MSMEs were not able to enjoy the benefits of asset-light financing options such as operating lease and shared ownership of assets. Given that the working capital requirements are more a function of the operations rather than capital investment, turnover will be a better measure to assess the funding requirements and accordingly a more realistic allocation of credit will be possible. Reclassification basis annual turnover will thus stimulate investment in this sector by removing the investment-based anomaly.

Secondly, the old definition has a serious problem that it incentivises promoters to keep the investment size small to retain the MSME tag. This norm unintentionally hampers investment in the sector as increased fixed assets would mean that the incentives receivable as a small or medium enterprise would reduce or stop. The ‘investment in plant and machinery/ equipment’ as the measure to be qualified as MSME requires self-declaration of investment and susceptible to manipulation and underreporting of asset value. Using the new turnover-based classification would curb this practice and at the same time bring down asset verification costs. Thirdly, the new turnover criteria will also help the units move seamlessly from one category to another (Micro to Small and Small to Medium). Under the investment criteria, there was a need to increase investment for a unit to move up the chain, which may not have been required in many cases except for satisfying the definition.

The MSME sector attracts a lot of attention and support from multilateral agencies who would require a definition that is in alignment with the global benchmarks. The turnover definition is a step towards a harmonised classification. The new norms considering annual turnover for reclassification will reflect a clearer picture regarding MSMEs as the earlier ones were prone to present skewed data as older enterprises with historical investment value would be termed as micro-units, whereas a similar set-up today would be qualified as medium or large, based on the current much higher value of investment. This became a deterrent for new entrants, especially in sectors requiring large capital expenditure.

The new, turnover based criterion is aligned to the GST regime and is likely to create a transparent and objective environment for the sector, so that the information available with the GSTN Network and other sources can be used. Overall, the turnover based classification will promote the ease of doing business and will put in place a non-discretionary, transparent and objective classification system. Based on the above arguments it is expected that the reclassification will provide a big relief to the sector.

Opposition from trade bodies

Large sections in this sector including the trade organisations recognised as ‘related to the Sangh Parivar’ like that of Laghu Udyog Bharati and Swadeshi Jagran Manch have ardently opposed the new arrangement. If the opinion of these organisations is to be believed, ‘the new move will erode the existing base of MSMEs in the country’. These organisations have voiced apprehension that importers and multinationals engaged in trading activities could pass themselves as MSMEs and take away their benefits. The registration of a manufacturing unit itself is feared to be difficult if it is based on turnover alone, as turnover can show huge changes leading to changes in classification over a period of time leading to chaos. It is also feared that new classification will crowd out a large number of small units from the benefits targeted at them as there will be much higher demand for such benefits from a greater number of businesses. If these fears turn out to be true, this will definitely harm the interest of SME which are largely family run and struggle for existence, and depend a great deal on such incentives and concessions for survival. The removal of the distinction between manufacturing and service will further add to the numbers and negatively impact on the manufacturing and thereby the creation of jobs and enterprise development. The bodies have suggested for redefining the criteria to ₹50 lakh for micro, ₹50 lakh to ₹5 crore for small and between ₹5 crore and ₹10 crore for medium enterprises.

Given the above support and opposition, the newly proposed norms are expected to foster higher productivity, efficiency and improved ease of doing business in the MSME sector. However, the apprehensions are also worth nothing. If the worst fears of the trade bodies are addressed well, the new classification norms would certainly have a positive effect on employment generation and investment, which is essential to propel the economy to the next level of growth

The writer has a Post Doctorate in Economic Policy and PhD from IIT Bombay in the subject of Financial Economics. He can be reached at: mskamat@gmail.com

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