After demonetisation, the informal MSME sector needs careful handholding if they are to make the transition to the formal economy.
The sudden announcement of demonetisation of higher currency notes on November 8 ended the festive season-led bounce in consumption demand and abruptly abruptly halted economic activity. It couldn’t have come at a worse time.
The impact has been widespread but varied greatly from sector to sector. As cash was suddenly withdrawn those sectors which were cash intensive were hit the hardest. Informal sector which accounts for almost half of India’s GDP and 90% of employment is almost entirely cash based. The great majority of micro, small and medium enterprises (MSMEs) are unorganised (not covered by the Factories Act) and are a subset of the larger informal sector.
The impact of demonetisation for MSMEs has played out in three dimensions. First, due to cash withdrawal limits, even the basic functioning of units got choked. Units found it difficult to pay wages and meet expenses for transport.
Second, most MSMEs found demand of their products and services taking a dip. From services such as hotel and restaurants to manufacturing sectors as auto to consumer durables witnessed considerable contraction in demand. According to SIAM, in December 2016, the auto sector witnessed sharp drop in numbers and it effected a 25% cut in production of two-wheelers and around 20% cut in production of commercial vehicles. MSMEs are integral part of the auto supply chain.
The impact was uneven in rural and urban areas. The rural segment was hit even more than their urban counterparts because of greater prevalence of cash, a thin bank branch network and poor penetration of digital payment systems.
In rural and urban areas, housing and construction account for substantial economic activity. There are over 60 MSME product categories directly linked to housing. (If you take the cement and steel out of a middle/lower middle class dwelling, almost all other inputs have a MSME stamp: electrical wiring, sanitary and building hardware, plywood, fan, furniture, tiles & flooring etc.)
Third, the lack of cash and push for digital payment systems have made a large section of MSMEs nervous. A lot of economic activity is fine dealing with cash because it is easy and free of transaction costs. But the MSMEs have their own worries if they are made to shift from cash to digital payments. Many of them under-report employment or production to avoid the rigours and hassles associated with complying with prevailing laws, rules and regulations. They are forced to operate in an informal or partly complaint manner by the habit, prevailing practices in their trade and out of fear of the regulatory departments.
The traders and small businesses have fears that excise, sales tax, income tax, labour and many other regulatory departments will start digging into old matters once the traders agree to start following various rules and regulation as part of doing business.
While the monkeys of problems like difficulties in accessing finance, cartels of raw material producers and inspector-raj were already on the back of MSMEs, demonetisation and push for digital economy have exacerbated their pain.
Therefore on the eve of Budget, the expectation is: Will the finance minister announce a package for MSMEs to relieve them of some of their pain?
Wither demand revival?
While the immediate cash crunch is more or less over, the pressure for demand-revival from large companies is becoming too loud to be ignored by the finance minister. After demonetisation, MSMEs hope for the announcement of a comprehensive policy that will help informal sector MSMEs transition slowly to the more formal sector.
Such a policy may incorporate some sort of general amnesty that puts the fears of traders and small businesses at rest, and assures them of a regime that is reasonably free of corruption and rent seeking.
There are a number of issues holding back the MSME sector from surviving and expanding.
Prime Minister Narendra Modi started the ‘Make in India’ initiative with the idea that higher value-add is captured domestically, thus creating jobs and wealth in India. But the trade policies being followed are directly opposed to this objective. Import duties and other restrictions are placed on import of commodities and raw materials while value-added finished products are allowed to be imported at lower duties! Take, for example, steel. Tariffs were raised by 50% in the last Budget. It did not satiate the producers’ greed, so a ‘licence-permit raj’ era tool of ‘Minimum Import Price’ (MIP) was brought in. Once the MIP as a tool got accepted in the steel industry, the aluminium industry is demanding further duty protection along with MIP.
What happens to the thousands of downstream MSMEs that use steel and aluminium as a raw material and employ millions? If ‘Make in India’ is to succeed what is needed is that rates of custom duties on various stages of production – from raw material to finished products should be finely differentiated, allowing small breathing space to each of the entities that bring a value-add element.
To provide succour to fund starved MSMEs, the setting up of an online platform that will allow discounting of supply bills was suggested by Kamath Committee. To make it purposeful, it is necessary that the invoices are uploaded mandatorily and status of deemed acceptance is granted to them to convert them into negotiable financial instruments. This will not only provide much needed liquidity to MSMEs but will also usher in financial discipline in corporate and PSUs, which is equally important for the country’s financial system.
Therefore, legislative backing may be provided to upload the invoices mandatory on buyers and grant status of deemed acceptance enabling them convert these into negotiable financial instruments.
There can be no doubt that for a country teeming with human resources (looking for gainful employment), the government should encourage enterprises to generate more employment for the same capital. It would be a big incentive if any increase in social welfare and bonus expenses in a year, over the last year may be allowed as a 300% weighted deduction for the purpose of tax calculations. Less than 3% of MSMEs are body corporates under the Companies Act. A majority of the MSME sector is composed of proprietorship and partnership firms. One of the major reasons of this peculiar phenomenon is the absence of income tax slabs at lower rates for lower income companies as is the case for individuals. Therefore, income tax for enterprises operating in this much desired company format may be levied in slabs as available to individual tax payers.
In conclusion, post demonetisation, keeping in view of set of issues that need to be addressed to alleviate the pain of MSMEs, Jaitley needs to come up with a comprehensive package.
Anil Bhardwaj is secretary general, Federation of Indian Micro and Small & Medium Enterprises (FISME).