Merely Disallowing Some Global Tenders Won't Help MSMEs. India's Procurement Process Needs Reform.

The key to amplifying the government's announcement for tenders up to Rs 200 crore will be to rationalise the eligibility criterion for bidders.

Earthquakes don’t kill people. Buildings do. A few years down the road from today, we could end up with a similar version of the same saying – national lockdowns don’t kill people. Poorly-run economies do.

The Rs 20 lakh crore relief package announced by Prime Minister Narendra Modi was much awaited. The question is how will it become visible on the ground.

Delivering the first tranche of this fiscal stimulus, the finance minister provided six relief measures pertaining to micro, small and medium enterprises (MSMEs). One of these was disallowing global tenders by the Centre for the procurement of goods and services if the value is less than Rs 200 crore, thus providing more business opportunities for MSMEs by decreasing competition. The objective behind this move is laudable indeed.

The problem, however, is that public procurement in India is plagued with many other factors, and unless a few of them can be evened out, the policy impact of this announcement may be rather limited.

For instance, the way tender processes are designed in India, they disadvantage small firms for no particular reason. And that affects surplus distribution adversely. Firms often face problems like lack of transparency, accountability, bid rigging and widespread corruption. In the circus, big firms use their networks, connections, past knowledge and influence with the government in order to get past these hurdles. Small firms and MSMEs are unable to invest in these costs and therefore opt out of the race.

Five years ago, India extended a $250-million line of credit to Mozambique to develop the electricity supply in Maputo. But after hearing reports of corruption, the Indian government has asked the Mozambique government to dismiss the current contractor and float a new tender. Credit: Wikimedia Commons

The way tender processes are designed in India disadvantage small firms for no particular reason. Representative image. Photo: Wikimedia Commons

One of the main reasons why MSMEs fail to get tenders is because of the high eligibility criteria present in the bidding documents. It’s true that a minimum eligibility requirement creates necessary screening mechanisms to prevent frivolous applications and attract serious and deserving ones. This is done to minimize the risks and show prudent use of public money. But this inevitably creates entry barriers. If implemented without adequate design considerations, these eligibility rules may impose huge ex ante costs on (especially small) firms and deter them from applying in the first place. This may have serious public policy implications with potential to inflate firms into monopolies.

Why does the Indian public procurement process actually discriminate against small firms? We decided to find out. The authors conducted a survey* of 59 tender documents selected randomly under the category of roads, highways bridges and other civil works in 2018-19. The data was pulled out of the government portal which had a detailed description on the eligibility criteria of each one of them.

What are some of the takeaways of this exercise? Firstly, we noticed that a range of high-worth projects had a very tight application window. And there was no correlation between how big the project is and how long is the application window open for. Clearly this favours large firms as they have enough experience in preparing the documents needed for applications. Small firms may not be able to manage tender documentation with few resources.

We also observed a rather high value of ‘Earnest Money Deposit’ (EMD). This is the amount of money applicants have to park with the government at the time of application and will be returned/adjusted with the project, if awarded. While this again invites only serious candidates, the EMD values are rather high – they ranged from 2-3%. If a firm is applying for ten equivalent tenders at the same time, they will have to knock out 20-30% of the tenders’ values out of their operational costs. This can financially amputate MSMEs.

In addition to all these barriers, the size of a firm in terms of annual sales or turnover restricts MSMEs to take part in the bidding process. In our sample, we found that almost two-thirds of firms must have an experience of ‘completing’ at least one project worth 80% of the tender value.

Alternatively, they should have done two projects worth 50% or three projects of 40% of the estimated bid value. We discovered that for more than half the tenders, bid capacity required was more than the tender value. Further, more than 70% of the tenders had a minimum average annual turnover requirement, and one-third had a minimum net worth requirement. Minimum working capital of 10% of the tender value was being demanded for most road projects.

Going into the details of these tenders, we realized that in most cases, these stringent eligibility criteria did not always make much business or economic sense. Perhaps they may have remained in the framework of public procurement as vestiges of the past, and risk-averse bureaucrats had never wanted to reform them. In fact, despite having such strict selection procedures, procurement contracts get routinely breached or experience significant cost overruns and massive delays.

The problem is also compounded by the fact that India, unlike most other countries, does not have a law on public procurement. Government officials rely on ‘General Financial Rules’, and they have to often map it against their own departmental rules, or other central government directives. This leads to bureaucratic confusion which only cripples the departments further. A result of this is that big firms can easily manage to secure the tender. Ironically, most of these big contracts are subcontracted to smaller firms multiple levels down the channel. The firm which does the job gets a tiny share of the bid value. Procuring firms only secure high values of rent. And they are utterly wasteful.

Public procurement in India contributes to more than a quarter of its GDP. This is frighteningly huge. Corresponding figures for the European Union is 16%, OECD’s (which includes Europe, US, Japan) is 12% and varies between 15-20% in emerging economies. Here, public procurement has a material impact on wealth distribution between firms. And therefore, if employed creatively, can act as a useful tool in the present times to address unemployment woes.

The key to amplify the government’s package announcement will be to rationalize the eligibility criterion in tenders. For starters, the government can at least direct small tenders to be awarded only to local and small businesses. This would be the first desirable way to vocalize the local.

Diya Patel studies economics at NMIMS, Mumbai and Yugank Goyal is an associate professor at OP Jindal Global University.

*The results of this academic exercise were published in the American Journal of Economics and Sociology