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Table A-8: Estimates of Technical Efficiency
Remarks:
- Figures in parenthesis are statistics
(ii) Efficiency index is ratio of technical efficiency of one class of firms over sample average
Table: Total Number of Manufacturing Establishments, Their Employment, Emoluments, Output and Gross Value Added
V. THE IMPACT OF NEW ECONOMIC POLICY ON SMALL ENTERPRISES IN INDIA
Successive rounds of liberalisation have transformed the macro economic facric of the regime for small enterprises development. The approach of the previous regime, of low cost capital and cheap services supplied by the government, are out of place in context where financial repression is unlivable and expenditures on sprawling government departments have to be unavoidably pruned. Far-reaching reforms in India’s financial system, trade and investment policy and structure of taxation have overtaken the lagging systems for promoting small industry. Therefore, small enterprises will be caught in a cleft unless their support system keeps pace with developments in the rest of the economy and the government devises meaningful support systems are devised.
Although it is premature to state definitive conclusions, a preliminary analysis suggests that the unfolding system continues to be skewed in favour of the large Indian corporate and multinationals. The, industrial regulatory system was hitherto characterised by a host of regulatory constraints which kept the cost of doing business high for large companies, it probably discriminated against small companies even more. Since permission for undertaking industrial activities had to be obtained in many different ways from the central government, the systems was based against less well endowed smaller companies because of the resources required for obtaining these permissions at the central level. Economic reforms have substantially disbanded the barriers to entry in almost all industrial sectors and hence in this respect the position is now better for the entry of small scale enterprises into the industrial sector. Further, in some other respects, particularly in the case of capital markets and availability of credit the situation may have become worse for small-scale enterprises. Small-scale industry policy continues to be hobbled by archaic system of social legislation.
In this section, we will review the ramifications of a gamut of economic policy reforms as they impinge on the relative competitiveness of small and medium scale enterprises on the one hand and large Indian corporations and multinationals on the other. In particular, we will focus on the impact of financial sector reforms, trade reform, foreign investment and technology reforms on the transaction costs and flow of credit to large and small companies.
5.1 Capital Markets
The deregulation in capital markets has most certainly worked to the advantage of large companies. Greater access to both the domestic and international capital markets has opened a whole new avenue for large companies to raise equity capital. The slow emergence of the bond market will open yet another avenue for which companies to raise debt capital in addition to the existing source of debt finance from the domestic financial institutions and that of fixed deposits. Small companies are, therefore, placed at a disadvantage since they do not have equal access to either domestic or international capital markets. Moreover, the volumes of capital that are being mobilised are so enormous that the relative importance of corresponding business in Indian stock markets is declining. The bias has been partly counterbalanced by the budget of 1996-97 which allowed Foreign Institutional Investors to invest in unlisted companies.
The figures for peak level investments in 1993-94 illustrate both the relative importance of inflows of overseas capital and their disproportionate distribution to large firms. GDR and Eurobond issues upto the end of October 1994 (i.e. 1991 till 1994) amounted to a closed to US $ 4.5 billion compared to US $ 6.2 billion issued by private sector companies in the domestic stock markets and US $ 8.4 billion disbursed by the Indian financial institutions. Nearly half of the GDR and Eurobond issues were accounted for by the top 20 companies of the Indian corporate sector although fast growing small companies are also beginning to take advantage of the opportunity.
Furthermore, the costs of equity capital have fallen after the Controller of Capital Issues (CCI) was disbanded. Equity capital does not any longer have to be issued at formulae fixed by the CCI and can be priced at levels reflecting the future earnings of the company or what the market is willing to bear. Consequently, large companies have been able to increase the price of their offers and to lower their cost of capital. Large companies have taken advantage of this opportunity to replace their higher cost debt capital with cheaper equity. Indeed, large companies had an opportunity to profit from parking their surplus cash in the inter-corporate markets when the interest rates rose following a credit squeeze.
Alternative sources of financing for small and medium scale companies like venture capital are yet to develop and traditional options for financing exhibit limited potential for expansion. Due to an overly long delay in the announcement of a new set of guidelines for venture capital which are expected to pave the way for domestic and foreign investors to invest in venture capital funds, their fund base has not been enlarged to make any significant impact on small and medium scale enterprises.
Moreover, the Malegam committee recommendations have limited the access that small and medium scale enterprises will have to the traditional stock markets. Henceforth, only companies with investments in excess of Rs. 5 crore will be eligible for listing on the BSE, NSE and other exchanges. Small and medium scale companies can be quoted on the over the counter market but this exchange has been unable to overcome its initial teething problems. A highly sophisticated trading system and advanced technology, notwithstanding, the OTCEI has witnessed a decline in the traded volumes.
In response to the new developments in capital markets, some private equity funds have entered the Indian capital market, Draper, Ind-Ocean, First National etc, have opened up shop to invest in unlisted companies. The stringent listing requirements on the stock exchanges will drive small and medium scale enterprises to private equity funds. Such funds specialise in assessment of projects promoted by relatively less well known entrepreneurs before their companies are listed on the stock exchanges. They effectively screen and prepare unlisted companies for floatation in the public stock markets. But there are few such funds as yet, an most of them are foreign funds.
Even though the quality of paper issued in the capital markets will improve substantially, the recourse to private equity is reportedly limited to the largest among the small companies. In an environment where information flows are incomplete and slow, the identification and assessment of new projects is costly and it is not possible for private equity to finance very small projects. Venture capital can potentially play a more important role for start-ups if it has the opportunity to diversity its risks. It is, therefore, an essential supplement for private equity funds to succeed in the Indian capital markets.
Here the state of development of the venture capital industry in India is a cause for considerable worry. India has the dubious distinction of having one the smallest venture capital industries in the world and is small even in comparison to its counterparts in Asian countries. The graph illustrates that the number of venture capital companies per 10 million capitals is about 1 compared to more than 100 in Singapore.
Furthermore, the information systems to identify good projects, so necessary for investment in unlisted companies, are in a primitive state of development. The experience with bought-out deals, which were an important source of financing for medium-scale companies in 1994, suggests that the markets can collapse unless investors can systematically detect poor quality projects and ignore them.
Competitive small companies have no systematic way to communicate their worth to the capital markets and raise finance at costs that reflect their individual risks. It is possible for modern small companies to raise capital at relatively low costs since their growth rates are known to be higher than the average industrial growth rate. However, systematic methods for assessing the worth of their projects does not exist in the country.
In the emerging economic climate in India, small companies need support to facilitate their access to capital markets. Financial intermediaries are required for the assessment of their projects and to communicate their worth to the capital markets.
5.2. Financial Markets
Term Loans
The fulcrum of the financial system supporting concessional finance for the small and medium scale industry has been the Long Term Operations Fund. This fund contributed by the Reserve Bank of India helped to refinance term loans extended by the State Finance Corporations and the State Industrial Development Corporations to the small and medium scale enterprises.
Over the last five years, the importance of the Long Term Operations Fund has declined as a result of the fiscal crisis. Increasingly, the Small Industry Development Bank of India has had to borrow from the markets at higher costs. Table 5.1 below shows that bonds, debentures and deposits account for nearly thirty percent of the resources raised by the SIDBI (excepting the amounts transferred from the IDBI, equity and market assistance funds) after reaching a peak of 35 percent. A part of the pressure of the resource crunch has been relieved by generous funding support from overseas donor organisations. The share of concessional finance raised from the government has declined to 30 percent. In the future, it is likely that SIDBI will be required to borrow even higher amounts from the market.
Moreover, the financial vulnerability of the State Financial Corporations and the State Industrial Development Corporations and their low rates of recovery has decreased the levels of refinancing. As the rules for income recognition become more stringent, SIDBI is constrained to limit the refinancing of loans extended by SFCs and SIDCs in a poor state of health. The table below shows that the level of lending to SFCs/SIDCs declined from its peak in 1991-92 till 1994-95. In the latest year of reporting, however, refinancing levels have again increased as SIDBI,s trust in commercial banks was enhanced by their improved financial state.
The financial system traditionally dedicated to meet the needs of the small and medium scale industry has decayed while new opportunities are opening to the large sector. This is a major weakness of the emerging economic system in the country that is loaded against the small scale sector. This is happening at a time when the demand for capital has risen as market opportunities grow and new capacities have to be created by all sectors of industry including the small scale industry. With the kind of rapid industrial growth that is expected and necessary to achieve an overall higher rate of economic growth there is a great need to encourage to entry of new entrepreneurs and to help small scale enterprises grow in the coming years. Hence there is a need to review the existing system for the provision of capital to small scale enterprises in the new economic environment.
Working Capital
Historically, small scale industries have had a privileged access to bank lending. Priority sector lending was available to them at concessional rates of interest. Since interest rates were controlled at less that the market rates, the higher risks and costs of investing in small borrowers were not reflected in the lending rates. Moreover, small borrowers benefited from the implicit subsidies inherent in the lax standards for provisioning for bad and doubtful debts.
The deregulation of interest rates began in October 1995 and was taken further in July 1996. To begin with, scheduled banks were granted the freedom to fix interest rates on term deposits with maturities of over two years. This was later relaxed further when they were allowed to fix interest rates for term deposits with maturities of over one year. The benchmark rate of interest for the banks is the prime lending rates and the excess over it reflects the risks of lending to individual borrowers. Consequently, interest rates have risen sharply for small companies. The concessional lending under priority sector lending hardly softens the burden since no more than Rs.2 lakh can be borrowed under this scheme.
Moreover, the obligation to provide for bad and doubtful debts has now been extended to small loans. Provisioning for non-performing assets of less than Rs.25,000 has been enhanced to 10 percent for the year ending March 1996 from 7.5 the year before. From 1996-97 onwards, the rules will be the same as for amounts more than Rs25,000.
The impact of stricter regulation of the banking sector is already reflected in the supply of credit to the small scale sector. A study of clusters of small enterprises done by the NCAER3 shows that most of them have experienced a fall in the supply of credit. The only clusters unaffected are the glass manufacturing and woolen hosiery and knitted products sector which have vastly improved their export performance. Overall, the relative share of credit to the small sector has fallen from 13.0 percent of the incremental non-food gross bank credit in 1994-95 to 11.4 in 1995-964.
This clearly constitutes a series of great alarm for the small-scale sector which is heavily dependent on the availability of bank credit for its health. In recommendation of this problem the government and Reserve Bank of India had appointed a Committee under Shri P R Nayak, Dy. Governor, RBI to took into the credit problems of small scale enterprises. We have summarised their main recommendations elsewhere and than suggested further measures in the Chapter on recommendations.
Undoubtedly, large companies are also affected by the stringent supervision of the banking system. However, they have more options to cope with short supply of credit. Creditworthy large companies have the choice to raise capital by commercial paper and certificates of deposits. Many of them have also established in-house finance companies as an additional means to raise resources. Finally, they can take recourse to international capital markets especially as India enjoys the confidence of overseas investors.
In the emerging economic climate in India, small companies will have to inevitably rely more on trade credit which has been their traditional source of finance as bank credit has become more difficult as seen above and other sources of finance such as the securities markets are out of reach or sources such as venture capital funds are yet to materialise. Their costs of debt will rise, as interest costs remain high. In periods of economic downturns, small companies will be extremely vulnerable as the costs of servicing debt rise.
5.3 Trade Policy
Imports
The Import Policy has undergone drastic changes since 1991. Whereas earlier there where very few products that were freely importable into the country and licenses have to be obtained for most imports, now, almost all items are freely importable except for consumer goods. Consequently, in the earlier control regime, all most all most all items reserved for small-scale industries were not allowed to be imported. Thus small-scale enterprises producing reserved items were protected against both large domestic companies as well as foreign companies make such products. With the large scale trade liberalisation that has taken place a large number of items reserved for small scale industries are now freely importable. (see Appendix 1 for details). Furthermore, the government has recently announced that it is now considering a phased removal of quantity restrictions on consumer goods imports over a period of 5 years. Once this happens almost all items currently reserved for small-scale industries would become freely importable. With reservations inhibiting small companies from expanding and achieving economies of scale such companies may kind it increasingly difficult to compete against the imported items if they are not allowed to invest further and to upgrade technology in the coming years.
Since 1991, three fourths of the products that were previously subject to import licensing procedures are now freely importable. Till 1991, a positive list of products was allowed to be imported which has been replaced by a negative list of items that cannot be imported. Out of 5,021 Harmonised System tariff lines at the six-digit level, 4,000 products were subject to quantitative restrictions. By December 1995, more than 3000 tariff lines covering raw materials, intermediates and capital goods were freely importable. The remaining items consist of consumer goods and agricultural commodities. Even here, no less than 1,487 tariff lines in the restricted list can be imported under the freely traded special import licenses granted to export houses / trading houses / star trading houses. Finally, as already mentioned the imports of consumer goods will have to be eventually permitted in accordance with India’s commitment to the WTO.
Exports
The successful completion of the Uruguay Round of negotiations has prepared the ground for a substantial decline in non-tariff barriers to imports into the developed markets. The countries that have entered into free trade agreements have already removed non-tariff barriers ahead of the transition period permitted by multilateral rules. The NTB coverage ratio of India’s exports is estimated to be 29 percent which is expected to drop to 5 percent6.
India stands to gain a great deal from the new rules since a very high share of its exports have Europe as their destination. India as an early entrant in the European markets especially for textiles has accumulated quotas over a period of time. It could, therefore, maintain its market shares even after many other Asian countries made a bid for the European markets. As non-tariff barriers are withdrawn, India will benefit from the expanded volume of imports but will also be subjected to increased competition from the Asian countries.
Research studies indicate that South Asia will be a major beneficiary from the removal of the Multi Fibre Agreement (MFA). South Asia’s output and exports of textiles will increase by 17 percent and 26 percent. As for clothing, output and exports are expected to increase by 91 percent and 254 percent7. The judgment of scholars is that the gain from expanded trade will be far greater than the loss of rents from the end of quotas.
However, the potential benefits will be realized only if India can keep its costs down. In nominal terms, India is one of the cheapest offshore locations for production for textiles and clothing. After making adjustments for productivity and absenteeism, however, India’s competitiveness falls and its costs are higher than in Korea and China by about two thirds8. Low productivity and high levels of absenteeism are inherent in the small scale of production.
5.4 Transaction Costs
In the era of protection, large companies incurred higher transaction costs as they had to comply with a variety of regulations under the Industrial Development and Regulation Act. On the other hand, small companies were exempt from the IDR Act if they employed less than 50 people with the use of power and 100 without its use. Consequently, small companies had an edge over large companies.
Moreover, large companies had to conform to the rules laid down by the MRTP Act on expansion, diversification and merger of companies. The costs of doing business for large companies was also high because case-to-case approvals were required if the equity investment was more than 40 percent or if a sector was otherwise reserved for the public sector. Small enterprises were generally exempt from such rules that applied to the large Indian corporate sector.
In the emerging economic climate in India, the large Indian corporate sector has been relieved of the many transaction costs inflicted by the earlier policy regime. They do not any longer have to invest an enormous effort to deal with licensing procedures before they begin production. Moreover, the costs incurred on case-to-case approvals have declined, as many sectors formerly reserved for the public sector are now open to the private sector. Similarly, special permissions are not required for expansion, diversification and mergers of associate companies.
Furthermore, other transaction costs for large companies have declined as related systems have been streamlined. The procedures for purchase of technology, for making foreign exchange payments and for hiring overseas manpower are subject to much less discretionary oversight than they did before. Similarly, the costs of raising capital in the capital markets has been reduced after the Office of the Controller of Capital was disbanded.
The transaction costs specific to small business, on the other hand, have virtually remained constant. Above all, the insidious "Insidious "Inspector Raj" continues to throttle the very vitals of small enterprise. An intricate system of social legislation including social security, medical insurance and labor laws traps enterprise into a vicious circle of paper work an bureaucracy. Similarly, the systems for registration and other business laws have not been differentiated for large and small companies. They are, moreover, administered by a variety of ministries which have conflicting objectives and obtuse procedures. Thus, considerable thought needs to be given on how to help small-scale enterprises in coping with the prevailing system of "Inspector Raj" which makes it extremely difficult for them to function efficiently. Our recommendations attempt to address these issues as well.
As the burden on infrastructure services worsens, moreover, the transaction costs will only increase for the small-scale sector. Larger industry has access to capital to find private solutions to poor public services but the same is not possible for the small scale sector. A classic instance of the phenomena is telecom services. Whereas large companies have installed V-Sat networks to cope with the variable quality of telecom services provided by the public networks, the small-scale sector is unlikely to be able to invest large amounts to deal with such constraints. On the contrary, the opportunity costs of abysmal civic and urban services, and of environmental corrosion have risen steeply especially in clusters which have witnessed exponential growth rates. Access to infrastructure services at low costs will be essential for both the encouragement of new entrepreneurship an as well as growth of existing small companies. Such attention therefore needs to be given to the provision of such services on a commercial and economic manner for small-scale enterprises. Our recommendations in this regard have therefore focused on the provision of infrastructure services to small-scale enterprises which are groups in clusters.
5.5. Business Services
The convenience of doing business is influenced considerably by the cost and quality of services available to enterprises. In the era of protection, small business in India was entitled to free or low cost services provided by the government. On the other hand, the large sector had to pay for services if they were at all available.
Large companies had to mostly do without services as this sector in India was underdeveloped and dominated by the state. Financial services, for example, were almost non existent as the somnolent nationalised sector was not motivated to supply them. Management and technology consulting services were scarce as overseas companies could not operate in the country. Similarly, the choice for training services was limited since policy restricted payments to overseas experts. Consequently, large companies had few options even when they had an interest in purchasing superior services.
Currently, however, the large sector has many more options to source services to improve their competitiveness than the small-scale sector. The quality of financial services is vastly improved as a result of the entry of numerous merchant banks and private banks who tends to specialise in corporate services. Large companies now have the option of hiring overseas technical expert to assist them. Superior management consultancy is available to them as a result of entry of a large number of overseas and domestic consulting firms. Similarly, quality control services have improved as a result of linkages with overseas institutions is this field.
The advantage of vastly superior external sources of services is reinforced by greater freedom to hire better-trained manpower. Ceilings on salaries have been substantially relaxed so that large companies now have opportunities for learning in the plants of their overseas collaborators. Large companies are also able to draw on an increasing pool of professionally trained managers.
On the other hand, the traditional sources of support services for the small scale sector have fallen into disrepair as a result of the fiscal crisis. The most useful source of information, knowledge and skills remain the buyers. State sponsored institutions have been unable to keep pace with modern technological developments, to increase their geographical reach or to respond quickly enough to meet the demands of the day.
Small companies, moreover, have to make do with workers with a bare modicum of literacy and barely adequate skills. The demand for skills, however, has risen as keener competition is experienced with the entry of multinationals. Small companies cannot any longer expert to survive on the strength of their lower costs. The era of stagnant technologies has come to end so that non-price factors are the determining factors for survival.
5.6. Technology
Large companies have a free hand to enter into strategic alliances and joint ventures with overseas companies. Since multinationals can acquire equal or majority control, they are more willing to share technology. The increasing collaboration between large Indian companies and the multinationals will also enable the transfer of tacit knowledge of firms that will form the basis of product innovation.
The choices of small and medium scale companies, on the other hand, are far more limited. Their potential partners are overseas small and medium scale companies who, infect, have a better reputation for innovation. However, the investment climate in India is not yet perceived to be hospitable enough to attract firms of a smaller size. Furthermore, special steps have not yet been taken to address the issues of collaboration between Indian and overseas small and medium scale companies.
Meanwhile, the remaining option for small and medium scale enterprises in India is to strengthen linkages with large Indian and multinational companies for transfer of technology. However, the reality is the subcontract exchanges especially established to facilitate relationships between large and small companies have floundered. Large and small companies, typically, enter into long-term stable relationships but this has not been possible in India.
Large companies cannot invest any more than 24 percent in small companies and they cannot establish long-term relationships on this basis. Stable and long term alliances with large companies for sharing of technology will enable small companies to take advantage of the potential for higher volumes of subcontracting business. However, such mutually beneficial relationships will only be possible when small companies have greater latitude to enter into joint ventures with large foreign and Indian companies.
5.7. Excise Concessions
The most important incentive for small companies, excise duty concessions, has been watered down by MODVAT and the reduction in excise duty rates. Under the era of protection, large companies had to pay very high levels of duty. Consequently, excise duty waivers upto a threshold levels an concessional rates, thereafter, implied that small firms could afford to sell at much lower prices or realised higher levels of profit.
As a result of the fall in excise duty rates and MODVAT, the relative difference in the tax burden for large and small companies has declined. Large companies can claim MODVAT benefits on inputs and capital goods so that the cascading effect of excise duty taxation is factored out. For many commodities, especially consumer goods, the rates of excise duty have also fallen.
5.8. Conclusions
Our brief review of the relative impact of the new economic policy on the small and large companies suggests that the former cannot grow by default anymore. The large Indian companies and multinationals now have the advantage of greater access to capital markets, superior business services and technology. Small enterprises can continue to grow in such an environment if they are fortified with positive strengths.
Indian policy has to be redesigned to afford a fair chance for small enterprises to survive and prosper in the emerging economic climate in India. Their transaction costs have to be lowered by the reform of the legal and institutional structure. The financial system will have to be refurbished to direct larger flows of capital to the small-scale sector. Finally, small-scale industry needs a wider choice of superior business services to cope with change. It is only then that they can expect to compete with large companies on an equal footing.
VI. NEW POLICY DIRECTIONS
6.1. Introduction: The premises
Indian industrial policy has had a pronounced penchant for the promotion of small and medium scale of enterprises; a sentiment that remains in tune with the realities of the day. From the very early stages of industrial development, the government in India assiduously fostered an elaborate structure of institutions that met a wide array of needs of the small scale industry. In an economic environment that was chanacterized by a pervasive system of commands and controls, entry into industry and success subsequent to entry was heavily dependent on the entrepreneur’s ability to obtain licenses, quotas and permissions from the central government. The system was heavily biased against small and medium entrepreneurs who could not participate successfully in this competition for licenses and quotas. Consequently much of the policy regime for providing support for small scale industries was protectionist in nature and itself provide for special access for small enterprises to raw materials allocation, imports, credit, etc. similarly, the policy of reservations specifically addressed the difficulty of small enterprises in competing with the large in obtaining industrial licenses and the like, and set aside specific areas for their exclusive operations. These institution were, however, moulded by a protectionist and scarcity ridden economy. In the unfolding liberalising economic environment, the extant institutions are patently incongruous and have to be recast to address the needs of the day.
In retrospect, the premises of the earlier regime for small industry development have to be reconsidered to take into account the experience of the last two decades and to prepare for the future evolution of this sector. Hitherto, government policy sought to nurse new enterprise but overlooked the needs of growing companies. In a context where an unprecedented expansion in market size is taking place, the guiding principle of support institutions for small industry should arguably be to reinforce the impulse for accelerated expansion. The social benefits of the enormous public expenditure in nurturing new enterprise can be realised if small scale companies grow rapidly.
In the past, state policy for small scale industry stressed protection of fledgling enterprises against predatory competition from large companies. There was excessive emphasis on small enterprises being in competition with the large. The experience, however, in other countries suggests that small and medium enterprises are as often complementary to the operation of large enterprises, as they are in competition. There is a wode range of relationships that exist between the small, medium and large segments of industry small firms can act as ancillaries, suppliers, sub-contractors and the like. Each of these relationships imply interdependence rather than dependence of one on another. Consequently, new policies being designed to support small scale enterprises must encourage such interdependence.
In a context where market failure was pervasive, state owned institutions were the surrogate for equivalent private sector services. As detailed earlier, both central and state government have, over the years, set up a host of institutions which directly provide support services to small scale over the years, set up, a host of institutions which directly provide support services to small scale industry. This took place in an environment where such support was not forthcoming from within the private sector. However, government institutions can only be one source of information and expertise for small-scale companies. Internationally, small-scale companies are nourished by myriad sources of skill and knowledge.
Growing enterprises, however, have altogether different needs that existing state owned support institutions are unprepared to meet. The demand for capital is swelling but skills for project development have not kept pace and the finances of the term lending institutions for small companies are in a perilous state. Business services have to be delivered promptly which is not possible for bureaucratically run state organisations. Technology of a more recent vintage s required and workers have to be retrained to assimilate them. The antiquated infrastructure is a fetter on enterprises who have access to markets to grow at an accelerated rate. State institution have to be located close to centres of enterprise to sense emerging needs and to address them speedily.
The accent on nurturing new enterprises has also resulted in inadequate attention on improving the competitiveness of small and medium scale enterprises. An overriding influence on the collective fortunes of small and medium scale enterprises is their overall business environment. Southern Italy’s (popularly termed as "Third Italy") extraordinary success in fostering competitive small and medium scale firms, confirmed by similar experiments in several developing countries, has established that such companies needs linkages with numerous organisations and individuals for their sustenance1.
Individually, small enterprises are powerless to structure the institutions affecting their performance. Collective action by business associations, local governments and support organisations is indispensable for acquisition of knowledge and skills to renew production and marketing methods of individual enterprises. The predominance of government in all aspects of small industry development in India emasculates other agencies who can contribute to strengthening small and medium scale enterprises.
Internationally, regional beehives of small and medium scale enterprises are a hallmark of their development, their multiplication and growth aided by investment in complimentary services and infrastructure. Individual enterprises are interlocked into a network of relationships that sustain their growth. The Expert Group visualizes clusters as the centerpiece of a future strategy of promotion of small and medium scale enterprises. Such cluster can lower transaction costs, help realize informational economies and lower the costs of credit surveillance.
Fortunately, the ground has been prepared to fashion a new regioe for the growth of small scale enterprises. Above all, clusters of small scale companies have emerged spontaneously around the country. Private companies now supply a host of business services to small scale companies hitherto delivered by state owned institutions. A few business associations are prepared to shoulder the responsibility of improving the business environment and others will follow if the right signals are sent out by the government finally, the state governments have an adequate administrative infrastructure to address the demands of industrial districts in their regions.
In India, agglomeration of small and medium scale enterprises has often taken place spontaneously unaided by government policy, close to target markets, sources of raw materials and human skills. The prodigious growth in such clusters in the 1980s, driven by cheap labor and access to markets, is slowing down dragged sown by their primitive state of infrastructure and services. The stark reality of decrepit infrastructure, environmental erosion, endemic technological obsolescence and the poignant abuse of child labor in such clusters is an eloquent indictment of the extant policy for small industry development2.
Clearly, the prevailing emphasis on protection of small companies and the attendant mechanisms are inappropriate in the current context. Instead, the growth of small industry has to be assisted by promotional means and this will require several changes.
The tiny and small scale industry in India is indiscriminately treated as an infant and protection by reservation of products remains in place despite liberalization in other domains of economic activity. This is entirely unnecessary since small scale enterprises are predisposed to invest in product groups where small size is a competitive advantage and a variety of technology and market related factors preclude the entry or expansion of large firms.
Similarly, fiscal benefits lavished on small enterprises have discouraged the beneficiaries from graduating into large and medium scale companies. Consequently, the social benefit from the investment in nurturing new enterprises is not fully realized by their subsequent growth. Infant industry protection should therefore mainly benefit tiny enterprises.
On equity considerations, the government sought geographical dispersion of growth by investing in the infrastructure of backward areas. In reality, enterprise has not been forthcoming in backward areas developed by the government. Instead, dispersion of growth as unexpectedly taken place in regions where markets have grown and some communities has the resources and the grit to invest in industrial growth. The social benefits of infrastructure investment will be higher if it dovetails enterprise.
A variety of central and state governments small industry development agencies providing a gamut of professional services, ranging from consulting to quality control, have been rendered ineffective by their entropy. These institutions can be revitalised if business related services are divested from administrative ministries and are delivered by independent corporations.
Government can meet its obligations more effectively if it incurs the cost of nurturing new enterprises. Its expenditures can yield the greatest social benefit, of facilitating entry, if they are confined to new entrepreneurs mostly in micro-enterprises. Moreover, government aid should be largely restricted to activities at the time of formation.
Small and medium scale companies prefer and can afford services offered by the private sector. However, government can play a useful function by sharing the costs of common facilities such as training, technological upgradation, infrastructure development, effluent treatment and market promotion.
The energies of government agencies are exhausted by the minutiae of promotion and regulation while evolution of policy has languished. A law for small business has been recommended by several government committees but has not been enacted as yet. New demands on legal and institutional development such as provisions for Limited Partnerships and for recovery of receivables have still to be satisfactorily addressed.
The supply of credit and investment capital to small enterprises from state level institutions has shrunk due to poor recovery of loans. So far, monitoring mechanisms to increase the rate of recovery have not been instituted. Similarly, the venture capital industry plays a marginal role due to its small fund base in the absence of private pension funds and insurance companies.
As detailed at th beginning of this report, a strong rationale exists for exceptional state support for fostering small scale enterprises. This has always been recognized in India. Now in order to keep in step with the changing domestic and international environment, it is imperative that a new approach for promoting the small-scale sector be developed. The state must increasingly use its scare resources to act as a facilitator rather than as a direct provider of services. This requires a new approach. The past policies have also concentrated excessively on small-scale industry to the exclusion of other activities. It must be recognized that enterprise exists in a whole host of activities, and in many areas such as software development and other industrial support services, the distinction between industry and services is increasingly getting blurred. Consequently, the new approach must for the support of small-scale enterprises (SSEs) as a whole.
As documented in chapter IV the small scale industry sector in the country is characterised by a striking dichotomy of the co-existence of tiny and non-tiny sectors with differing organisational profile, needs and constraints. The predominance of the tiny sector in the industrial scene is established beyond doubt by a few recent enquiries. According to All India Census of Small Scale Industries (AICSSI) 96 percent of the small enterprises are in the tiny sector. A sample study conducted by the NCAER-FNST team reveals that nearly 87% of their respondent firms belonged to this category. The statistics provided by AICSSI on the MSME-DO units in the country reveal that nearly 82 per cent of the employment in the MSME-DO sector is generated in units with less than 15 lakh of investment in plant and machinery and upto Rs. 30 lakh production. They also possess characteristics distinct from those of the non-tiny sector.
As related aspect of this dichotomy in the small industry sector is the declining share of output in traditional industries (comprising khadi an village industries, handlooms, handicrafts, coir and sericulture) from 16.10 percent in 1973-74 to 10.71 percent in 1991-92 and a corresponding increase in the proportion of modern small scale industry (excluding powerlooms) from 53 percent to 82 percent. The traditional sector units largely belong to the tiny sector, the co-existence of a vibrant modern enterprise sector accounting for only 13% in number, 55% production and 41% in employment and a subsistence traditional sector forming 87% of total units, 45% of production and 59% of employment indicates the relevance of evolving policy directives differently for these two sectors addressing their specific nature.
The core competence of most of the tiny units is their flexibility and capacity to customise. Unfortunately the policies so far have not addressed these strengths adequately. Rather, they have been allowed to assume the dimension of an endemic problem of technological obsolescence coupled with primitive business practices. The Expert Group proposes that the government should pay special attention to the modernisation needs of the tiny sector, given its competitive advantages. The country’s industrialization process still have long way to go and there will be a continuing need to foster new industrial and business entrepreneurship for the foreseeable future. It is the new entrepreneurs starting tiny units today who could be the industrial titans of tomorrow. Thus the Expert Group places particular emphasis on encouraging the entry of new entrepreneurs and on promoting the growth of tiny units as they prosper.
The approach of the Expert Group is based on these basic premises and our recommendations are made accordingly.
6.2. Role of Government
6.21. The Role of Central and State Governments
In the 1950s, the central government had a legitimate rationale to foster small and medium scale enterprises since it took the lead in initiating this new idea. Since then, however, most states have created adequate administrative infrastructure to address the needs of the small and medium scale enterprises. Most states have a minister and secretary designated to supervise the small scale sector. They also have a Director of Industries, supported by a large number of functionaries, to assist him or her in promoting industries3. The central government, therefore, should increasingly withdraw from the implementation of most promotional programs and regulatory functions governing the small and medium-scale industry.
Central government agencies will serve a more useful purpose if their duties are largely confined to policy formulation and institutional development. The central government should take the lead in promoting the kind of new approach that is being suggested here for the support of small scale enterprises. The would require consultations with state governments, the result of which could be a model support package for small enterprises which the state governments could then implement. Such a support package should have enough flexibility to take care of the many differences that exist between states. The centre-piece of the new approach is an increasing public private partnership in setting up support systems for small scale enterprises. Such public private partnership would thrive particularly in clusters of small-scale enterprises. The central government will always continue to have the responsibility for farming fiscal policies, trade policies and the like. In addition, since a major requirement for helping small scale enterprises to become competitive is their technology upgradation, the central government should also assume such a role in promoting technology development programmes in the support of the small scale industries. In this context the central government can take on special projects such as building linkages with universities and other training institutions in India and abroad as well as with clusters overseas. It is also better positioned for residual functions such as monitoring international trade developments affecting the small scale industry as well as liaison with international development agencies.
As documented in chapter IV the data on small scale industries bristles with inconsistencies that can only be sorted out by national agencies. The statistical information published by the DCSSI is not consistent with that provided by the National Accounts Statistics. The Expert Group therefore recommends that the Centrals Statistical Organisation and the Ministry of Industry from a group to improve the quality of statistical information on small scale industry as well as to identify additional needs of the industry and other users of this information.
In the area of extension activity, the functions of the central and state government agencies overlap and create confusion among entrepreneurs. The Small Industry Development Organization (MSME-DO), the principal promotional agency at the Center, through its Small Industries Service Institutes (SISIs) and extension centers for specific products, provides technical and management consultancy for new and established entrepreneurs, training in technology and management, conducts entrepreneurship development programs, techno-economic surveys, etc. similarly, the District Industry Centres (DICs), the focal point of promotion at the state level, have a General Manager who supervises extension services for technology, raw materials, credit, economic investigation, training, marketing and village industries. The services at the DICs are rudimentary and more complex problems are referred to the SISIs.
Evaluation of the impact of such services predictably find that government services are plagued by insufficient resources and poor quality of services. According to one state level study, 60 percent of entrepreneurs are not even aware of the services provided by the Direct Industry Centres4 . This is not surprising since most users are not happy with the services about 61 percent in a sample investigated by the NCAER reported that they were not satisfied.
The promotion of small an medium scale enterprises is an aspect of regional development that is best pursed by state governments. On the other hand, the present structure of institutions governing small enterprises has been created in the image of central planning and is unable to respond to local aspirations. The growth of small an medium scale enterprises is usually rooted in peculiar characteristics of a region e.g. small scale software enterprises have multiplied in Bangalore sustained by a tradition of technical education dating back to colonial times. State governments need greater latitude to fashion the mechanisms appropriate to their endowments, skills and historical peculiarities.
District Industry Centres were established as the main link between the state and central governments and small scale industries whereas they were originally setup as promotional agencies. The DICs currently function mainly as regulators, they are used extensively as registration centres for small scale industries whereas much industry has been delicensed, they are continued to be various requirements for the registration of small scale industries. Such registration is usually necessary to avail of the various incentives that are available to small scale industries. The DICs administer the various incentives programmes of state governments such as capital subsidies, fiscal incentives, raw material allocations, power subsidies and the like. They are also supposed to provide clearances in a single window. However, evaluation of District Industry Centres suggests that they have not succeeded in achieving their limited objective of single window clearance5. Entrepreneurs still have to shuttle between a variety of departments for clearance of projects. The extension work of DICs has languished as 46 percent of them were found to have not updated their technical and information6. A fair assessment would be that the DICs are unable to cope with administrative overload.
The Expert Group therefore recommends that a completely new look be taken on the functioning of the District Industry Centres in order to make them more promotional rather then regulartory. DICs would acquire additional significance if they can weave a web of linkages with other institutions. They should function as key conduits for information flowing from a variety of channels for dissemination to local business firms. The District Industry Centres can function with greater efficiency if they can draw on other resources from business, they can work in association with local councils constituted of members from industry, banks, training institutions, etc. The function of councils should be to solve problems encountered day-today.
Presently, a large number of sector specific institutions are involved in the promotion and administration of small enterprises. Most of these institutions have been set up by the central government at various times, they inclide institutions like the Khadi and Village Industries Commission (KVIC) the Khadi and Village Indistries Board (KVIBs) Development Commissioner (Handlooms), Coir Board, Silk Board, Tea Boad, etc. most of these central promotional agencies do not have distinct presence at the field level. Further, regulatory agencies like the Labour Department and the Pollution Control Boards function in entirely separate settings with litle coordination with promotion agencies. The result is regulation by multiple agencia and insufficient presence of the promotional bodies at the decentralised level. It has been said earlier that a good system of decentralised administration should have minimum regulatory channels and a single source of information. Together with this, there should have minimum regulatory channels and a single source of information. Together with this, there should be multiple channels of support and services with integrative features. To achieve this purpose, would be advisable to set up a flexible broad based District Enterprise Promotion Agency (DEPA) to replace the present DICs. It should be constituted as a broad based district level society with representation from the Departments of Industry, Revenue, Labour Environment & Sales Tax, banking institutions, state financial institutions, state industry corporations, small industry associations and the local governments. The representatives of the specialised promotion agencies of the central and state governments could be standing invitees to this body. Conceptually, this agency can be developed an autonomous agency functioning as a single stop service for information, grievance redressal, clearances, coordination an project planning. Similarly, the Department of Small Scale Industries is conceived to be structured as an umbrella body for the promotion of small enterprises. Since this department is now envisaged to promote small scale enterprises in general, the Expert Group recommends that its nomenclature be now changed to Department of Small Scale Industries and Business Enterprises. With this structure in place, we expect that coordination at policy and conceptual levels will be achieved at the central level in the Development of SSI. Similarly coordination and integration at the field / execution level will be achieved in the District Enterprise Promotion Agency.
It would be useful to explore how such an agency could be made more autonomous and services oriented. Effective support of small scale industries now requires greater technical expertise than is presently available in the DICs. An autonomous structure would help making it possible to recruit people with appropriate expertise which would otherwise not be feasible within the current governmental structure. The effort must be made to form public private partnerships so that government could continue to provide substantial funding support-say sliding from 90% now to 50% in 10 years time. The rest should be raised from industry association partners and from fees for services. The funding pattern would have to vary between districts. Those districts which have industry clusters would be able to contribute larger proportions of funds whereas in less developed districts the government would have to shoulder greater responsibility. Such restructured DEPAs should function as centres for bringing together different local institutions on an organised basis to solve local day to day problems. Local councils should be formed involving representatives of government, banks, industries, training institutions, government regulators and the like. Such a forum would provide the basis for initiating promotional activities which are necessary for the support of small scale enterprises in the district. In order to encourage specific support activities for technology upgradation, pollution control, quality upgradation etc. the government should set up a fund at the state level from which matching funds could be sort for the promotion of these activities.
All this does not mean that the State should wash its hands off its role as a promoter of small scale enterprises. As outlined in the beginning there is enough evidence of market failures and externalities that there is a clear promotional role for the states. But, this must be made much more performance oriented. Furthermore, the state should not try to perform functions that are now quite ably perform by private sector itself.
In general, state intervention will continue to be relevant in the further primarily to reap external economies from collective action. However, government budgets will have to be proportionate to performance. Part funding will be means to extract results from expenditure incurred.
The Coordination of Support to Tiny Units
The performance of the existing public sector units like the DICs and DISO service institutions have been found tobe particularly lacking in providing services to tiny units. Lack of interaction, networking and proper coordination among various agencies are the other weaknesses that have resulted in special difficulties in the sphere of extension services for tiny units.
There is an urgent need to evolve an institutional mechanism to facilitate co-ordination at all levels of activities relating to entrepreneurship / small business promotion. Though the district and state level institutions are currently given the responsibility of extending support to the tiny enterprise sector, as suggested above, the government should look forward to the formation self-regulating resource networks at the district and state levels, where the support institutions like financial institutions, entrepreneurship organisations and public support organisations work in collaboration with entrepreneurs and industry associations as partners in the process of removing barriers to entry into business and industry of tiny units, and fostering their growth.
The area of operation of the state and district level support network should be focused sharply on information gathering, dissemination and advisory functions to the tiny sector. The new enterpreneurs are in need of such services at the per-investment / state-up phases at low cost.
We have already suggested above the restructuring of DICs as DEPAs with joint "ownership" between government and other non-government institution like industry associations. We have also suggested the formation of local councils to assist in identifying the promotional needs of small scale enterprises. Tiny units need a special focus sonce their assistance needs are greater. The Expert Group therefore recommends that these restructured DICs or the newly proposed DEPAs have a special focus for the assistance of tiny units. Each of these agencies must have a special unit which is primarily oriented towards catering to the specific requirements of the new entrepreneurs in the tiny sector.
6.22. The Private Sector and the State
Government agencies can also be fortified if they restrict their mandate to a few functions while the remaining needs are met by the private sector. The tasks chosen by government agencies should alleviate recognized market failures. Arguably, new entrepreneurs encounter formidable barriers at the point of the entry. Government efforts will realize the greatest social benefits if they are focused on "start-up" incentives for tiny enterprises and newentrepreneurs7. Moreover, the participation of government agencies in the actual delivery of services should be minimized to the extent possible and phased out over a period of time.
Recent surveys have confirmed that private sector consulting companies have emerged as the prime source of services for small enterprises. Thus an NCAER study found that 136 units had utilized technical consulting services in three consecutive years out of a sample of 657. Out of these, the source of services for 29 companies was the SISIs while an overwhelming 82 units got it from respondents expressing satisfaction. Curiously, the relatively larger companies expressed greater satisfaction with government extension services than the smaller units. In general, public sector extension services are considered to be cheap but slow and inefficient. On the other hand, the private sector is preferred for its faster delivery and greater efficiency but is more expensive.
The Expert Group is proposing that policy support must be broadened from the current support of only small scale industries to all small scale enterprises. The past approach has been to provide technical support and other services by the government agencies themselves. Now that such support is available from private sector business services companies of different kinds such as consulting companies, software companies, technical consultants etc, these business support services themselves should become eligible for receiving bank credit on the same basis as small scale industries at present. Technical Consultancy Organisation (TCOs) have been promoted by financial institutions and concerned state governments, as public sector organisations. In their present from it is not possible for SIDBI to support them. In order to encourage such services to come up in the private sector, it is recommended that SIDBI open a special window for the funding of technical consultancy organisation and other business support services aimed mainly at small scale enterprises. To begin with, for a period of fice years, consideration could be given to provide equity support in the setting up of such enterprises. This could be done through a mechanism similar to the national equity fund, but the funds should be made available to the specialised SSI branches of commercial banks located in industrial clusters for assisting such business support enterprises. Such support measures would go a long way in providing both adequate financial and technical support services to small scale industries while increasing new small scale enterprises themselves.
Similarly, the private sector should be encouraged to invest in infrastructure and common professional services such as training and quality control in clusters. Government should only share part of the capital costs.
Private Sector Technical Support for Tiny Units
Tiny enterprises are increasingly sourcing services from the private sector, though they do get some assistance from the existing government agencies. Given the nature of tiny enterprises and their owner entrepreneurs they generally find it easier to take the assistance of private small services enterprises or of individually. Among the functions of the special tiny enterprise unit in the proposed DEPAs would be the promotion of tiny and small business support enterprises for which help other tiny enterprises. State governments could provide some subsidy element for promoting such activities. In this manner collection of data relating to markets, technology, business opportunities etc could be done on a commercial basis with the help of young professionals. The data thus collected should be computerised and made available to the entrepreneurs, business counselors and entrepreneurs trainer-motivators on payment.
A cadre of young business counselors equipped with the knowledge and skills of opportunity identification, business planning and knowledge about procedures and formalities could be created. They would be attached to the proposed DEPAs and existing service institutions. Retraining of the existing extension officers to develop counseling skills is also recommended.
The business / industry associations may be encouraged to start counseling services. The state through the existing National Entrepreneurship Development Board (NEDB) of the Ministry of Industry should help those who are willing to start such services build a corpus with one time financial support on a matching basis.
6.24. Corporatisation of Government Extension Agencies
Most government extension agencies ought to be reorganized as corporations so that their ability to compete with the private sector is not impaired due to organizational reasons. Thus the Regional Testing Centers and the Field Testing Centers are potentially capable of generating their own revenue and need only support from the government for a few years. Similarly, the Process an Product Development Centers, the workshops, the Central Tool Rooms the National Institute of Entrepreneurship and Small Business Development in Delhi and the National Small Industries Extension Institute can also function as companies with part funding from the government.
The earlier system of technical assistance by Small Industry Service Institutes is outmoded since they are not able to keep pace with the raid changes in technology. Evaluation studies suggest that SISIs are able to cater to the needs of low tech industries but not that of new industries such as electronics or even auto-components8. Evidently, SISIs have a low motivation to upgrade their skills to meet customer requirements. Their energies are dispersed over technical assistance as well as management consultancy and related services. The Expert Group recommends that SISIs should be corporatised and functions such as technical assistance and management should be divested to separate companies.
In the transitional period, the corporatised SISIs should be supported by matching contributions from the government, to begin with they should be entitled to government contribution twice the value of their market revenues. This should be loered to half their market revenue over a ten-year period. At the end of the ten year period when they are able to independently earn their revenue by their services, the full equity of such corporations should be disinvested in favour of the private sector.
The recommendation for corporatising the various existing government technical extension agencies is supported by the experience of the National Small Industry Corporation (NSIC). Because of its corporate character it has been able to provide leasing, hire purchase facilities and other services to small scale industry quite successfully. The entry of new private finance companies which offer similar services is now providing it with significant competition9. NSIC should also now be looking for new roles such as being a guarantor for tiny business.
Finally, specialized functions such as information ought to be assigned to institutions which pursue these tasks as part of their core activity. NISIET in Hyderabad has an information and documentation center known as SENDOC which stores and retrieves information of interest to small companies but its reach is limited. The International Trade Promotion Organization (ITPO) stores international trade data that is not widely disseminated. With the spread of information technology and Internet, as already mentioned, there is now a mushrooming of small private business enterprises which are attempting to private technical information services both nationally and internationally. The government runs information systems and attempt to use these new small enterprises for dissemination of the data base on that the government itself compiles and runs. Once again such a project would not only provide information more readily to small scale enterprises spread throughout the country but also would provide new employment and business opportunities in such enterprises themselves. If such enterprises disseminate information compiled by a credited government agencies the authenticity of the information would be insured.
6.3. Reservation Of Products And Investment Limits
6.31 Abolition of Small Scale Industry Reservations10
A keystone of the policy governing the small enterprises has been their exclusive right to manufacture specified products reserved for them. The rationale for this policy is that this is the surest way to protect small companies against competition from large companies. In reality reservations may have played only a limited role in promoting small scale industries while restricting the entry of large companies into these industries. The existence of reservation policy has also provided an illusion to the government and the country at large that adequate protection/promotion was being provided to small scale industries. This may have militated against more realistic policies for providing support to small scale industries for entry and growth. The issue of investment limit is also of greate relevance for the items that are reserved for small scale industries. In the case of items that are not reserved small scale industries are free to grow the only incentive not to grow is the loss of the various facilities and incentives that the units may have availed of as small scale units. In the case of industrial units manufacturing reserved items they are not permitted to cross the small scale investment limits an are therefore not able to grow. Instead t is often found that such units merely clone themselves and set up parallel separate units rather than expanding the original units as would have happened if the items were not reserved. Thus the reservation policy acts as a powerful barrier to growth.
The tenacious opposition to the withdrawal of this policy is rooted in the historical memory of the decline of crafts following the import of factory made products from England in the nineteenth century. The resurgence of exports of carpets, fine silk and home textiles, valued in international markets for their aesthetic qualities, gives lie to the impression that protection is indispensable for crafts. The Expert Group held wide consultations with representatives of industry associations and of state governments. It also sought the views of the central government departments and of state governments regarding this issues as well as others. As might be expected, a wide range of views was received. It was found that many associations did represent that they felt that reservation should be continued. Other felt that the reservation could be removed but on a phased basis.
After considering the issues very carefully and looking to the future of the Indian industry and its place in the world economy, and the imperatives for growth among small scale industries themselves, the Expert Group has concluded that the changed economic circumstances suggest that the obsolete policies of small scale reservations should now be abolished. At the same time we feel that transitional support should be provided to those units which might encounter some difficulty as a result of this abolition. Out judgment is that such units will not be many.
The policy of reservation prevents the successful units from growing. It therefore acts a dampener on entrepreneurship. The biggest psychological incentives for new entrepreneurs is the example of small enterprises which have grown to become large. The policy for promoting small scale enterprises should be such as to induce new entry by small entrepreneurs, and then to aid them to prosper and grow. The SSI reservations policy prevents this.
We will show that the case for reservations is fundamentally flawed and self-contradictory. Not only is it indefensible on logical grounds, the empirical realities lay bare its patent obsolescence. The policy of reservations hs crippled the growth of several industrial sectors, restricted exports and has done little for the promotion of small scale industries.
The case for reservations would be sustainable only if the minimum economic size was the same for all the products reserved for the small scale industries. Since the technology and market must still be maintained, the investment limits for individual products should vary reflecting the minimum economic scale of production it has been found that in the case of many items currently reserved for small scale industries the manufacture of these items at appropriate quality and efficiency levels requires investments in plant and machinery at a level much higher than the existing investment limits, some of these have been selectively given as illustrations. (See Appendix on small scale industry products. The existing investment limit on these items therefore precludes the quality production of such items in India.
Since the changes in the trade policy instituted since 1991 almost all items except for consumer goods are now freely importable. A careful examination of the import policy has shown that more than 550 items on the list of reserved products are now freely importable (See Appendix for details). This means that, whereas foreign companies which produce these products could sell them freely in India, large domestic companies are not free to manufacture such items. Some protection however, is provided by the applicable customs tariff. The stage is now also set for a phased removal of quantitative restriction on the remaining imports and hence more an more items that are currently reserved for small scale industries would become freely importable within a period of five years. When quantitative restrictions on the imports of consumer goods are removed, very few of the reserved items will not be imported. These facts give credence to the view that the government has allowed free competition between the Indian small scale sector and the multinationals but not with the large Indian companies.
These changes in import policy and the ongoing tariff reforms which is progressively reducing customs tariffs on all goods would mean that within the next 5-10 years, all the currently reserved items would face competition form imported products at relatively low tariffs. The Expert Group believes that this is the most powerful argument for the abolition of small scale industry reservations forthwith. The existing small scale units as well as new entrants in these industries must be provided an opportunity to investment in appropriate size and technologies to be able to complete with imports in the coming years.
Several labor-intensive industries such as garments, shoes, leather goods, sports goods, hand tools, and the like that have flourished in East Asian economies but have not done so in India due to the exclusion of large companies. The toy industry has prospered in other Asian countries but its growth in India has been unremarkable. Similarly, the light engineering industry, e.g. hand tools, is among the larger industries in East Asia but have not achieved significant progress in India. The food processing industry in India is a potential giant but its growth has been arrested by the reservation policy.
The reservation of products for the small scale sector has provide to be a barrier to growth of exports in a number of these industries. It is true that despite severe odds, some of these industries such as garments and shoes have contributed tremendously to the country’s export effort as is documented elsewhere. These are the sectors where the country exhibits significant comparative advantage. But various studies conducted by the Export Import Bank of India and others who that our export of items such as garments and shoes are limited to a narrow range of goods and exhibit low unit values. They are also not able to supply branded goods in large quantities with consistent quality to large buyers like trading houses and department stores. In the case of garments, for example, our record of exporting to non-quota countries is poor since we are not able to complete. The dismantling of the Multiple Fiber Agreement (MFA) will mean the existing quota markets will also become increasingly competitive over the next 8 year. It is therefore, imperative for future export growth to remove such small scale industry reservations so that adequate new investment and technology upgradation take place in these industries and that existing units are allowed to upgrade. It should be understood that existing units are unlikely to be hurt as they could continue exporting their current composition of products, instead they would be enabled to grow. The experience in South East and East Asian countries suggests that these industries would grow quite spectacularly if they are free in such a manner. Whereas many large units could come up in sectors such as garments, toys, and shoes, a great amount of outsourcing and subcontracting would take place so that, in fact. Even greater growth would take place in the small scale sector with the attendant employment growth.
An additional consideration that has a bearing on exports is speedy delivery. The clearest example of this can be found in the garments industry where the exporters need to use computer aided cutting machines to be able to match the delivery schedules of their competitors, Consequently, large scale investments are required.
Similarly, the poor quality of inputs manufactured in the small scale sector has its deleterious influence on the end products. This is, for example, evident in the automobile sectors markets and bicycles. The final product suffers because low quality components over the final quality of the assembled product. The result is that for export of items such as bicycles many components have to be imported.
We have also been made aware of some of the impacts of reserved items on the large industries which are the suppliers of intermediate goods to the final manufactures of the finished goods which are reserved for small scale industries. For example, in the case of the textile industry, where fiber or fabric producers supply to garment producers in the small scale sectors, domestic industry is handicapped because they do not have large scale buyers. Large industries would become more competitive if they had more demanding buyers. They would then upgrade in quality as well.
The experience with reservation tells a story of love’s labour lost. Good intentions of the government have manifestly not registered in the business calculations of small enterprises. The second census of small scale industries provides persuasive evidence of the misplace importance given the policy of reservation. Out of a total of 200 products leading in value of output produced by the small scale sector, it was found that reserved products accounted for only 21 percent. Only 210,000 small scale units, less than half out of a total of 5,82.000 units, manufactured the reserved products at all. No less than 233 reserved items out of a total of 1,076 (when expanded at a lower level of aggregation in the NIC code) were found not be manufactured at all according to the census. Although further inquiries have revealed that many of these products are found to be manufactured by some units, the fact remains that their production is in negligible quantities.
Conversely, very few of the reserved products attracted significant levels of participation from small scale unit. As many as 90 priducts were found to be manufactured by just one company each. The sum titl of the value of production of all small scale companies in as many as 692 items was a low of Rs. 10 crore of less. Just 68 reserved items accounted for 81 percent of the total value of production of reserved products and 83 percent of the units11.
In general, small scale units do not need protection by reservation and can survive in free markets. Analysis of Korean data showed that small scale companies (defined as employing between 1 to 100 employees) accounted for between 17 to 39 percent of the employment in as many as 373 industries12. They survive due to product differentiation. This can take the form of small companies specialising for consumption in different markets. Or small companies survive in niche markets requiring custom designed products. They also do well in new markets where large companies have not made their presence felt. Thus existence of product differentiation means that many SSI firms co-exists with large firms and cater to different consumption needs. In some cases small firms supply low prices products for mass consumption in local markets where larger firms cannot compete. In other cases they supply high priced products for the elite market. As the markets grow, small companies also grow in size and retain their dominant position.
The removal of reservation will also pave the way for greater equity participation from large Indian companies and foreign investors along with greater sub-contracting. Large companies will then have an incentive to establish long-term relationships and transfer proprietary technology for improving the quality of products supplied by small scale companies. It would then be much easier to establish interdependent relationship between large, medium and small industries as subcontractors, ancillaries, and suppliers of parts and components. The establishment of mother units would then spawn large numbers of small units in clusters.
Currently, equity participation by both large domestic companies and foreign direct investment is limited to 24 percent. Once the reservations are abolished there would be no reason to retain this limit. The ability of large companies and foreign investors to take equity stakes in SSI units would pave the way for a more synergistic relationships.
It is, on all these considerations that the Expert Group is suggesting that the policy of reservation be entirely abolished. We have considered the option of a phased abolition in order to give time to industry to adjust. However, in view of the overwhelming evidence that the reservation policy is now serving no purpose in the promotion of the small scale sector, we are recommending a complete abolition. The interests of the small and medium scale industry are better served by technical assistance and other programs to enhance their competitiveness. Cluster associations should be involved in the administration of funds. Part funded by the government, to improve the technology and manufacturing processes of small and medium scale enterprises. The Expert Group is of the strong view that the abolition of small scale reservations must be accompanied by a credible support package which assists units that are affected by this dereservation. The strategy and programme for such assistance is outlined in the section below.
6.32. Transitional Arrangements for Small Scale Industries Affected by Derservation
Whereas the Expert Group feels that dereservation of the items reserved for small scale industries will not substantially affect existing units, it is still necessary to provide some source of support for existing small scale units which might encounter some difficulty as a result of dereservation. As has been noted, the vast majority of small scale units are tiny units with investment of less than Rs. 5 lakh. These units currently co-exist with large units which can have investment upto the Rs. 60 lakh limit at present. Thus, it is unlikely that the existing tiny units would be affected by the introduction of new units of a larger size as a result of dereservation. Similarly it has also been noted that due to product differentiation in the demand for products at different levels, small scale units co-exist with large units in unreserved areas of industries without any difficulty. Similar would be the case for the areas currently reserved for SSI. None-the-less it is recognised that, at the margin, there would be some units which would indeed get affected by the entry of large industries into the areas currently reserved for small scale industries.
Two kinds of assistance may be required. First, existing small scale units which have not been able to expand by inducting new technologies and new equipment because of the existing investment limit should be given special assistance for expansion as a consequence of dereservation. Such support could include equity support, interest rate concessions, and technology assistance. Equity support can be given both directly and indirectly in order to assist greater internal generation of resources by existing entrepreneurs and additional fiscal concessions would help in providing such additional resources which can than be reinvested. Second, external equity support can be provided by financial institutions and banks through support by an equity fund. There could also be existing small scale units which are considerably below the current investment limit and which could be adversely effected by dereservation. Such units also get similar assistance as described above for expansion and induction of new technology.
The Expert Group recommends that the ministry of Industry should immediately set up a joint mechanism between the government and industry representatives to identify specific industries/items in which small scale units are likely to be affected by the proposed dereservation. These are perhaps among the 68 reserved items which account for more than 80% of the total value of production of reserved products. Subsequent to this identification the geographical areas where such affected units are concentrated could also be identified. The proposed assistance would then be easier to administer.
In order to provide both equity support and interest concessions the Expert Group recommends that the government should provide annual resources of the order of Rs. 500 crore over next five years, thereby totaling Rs. 2500 crore, to the Ministry of Industry for providing the proposed support. The fund should be used to leverage larger resources from banks and financial institutions in order to provide support to existing small scale units exclusively in the areas currently reserved for small scale industries. This fund should be used for the purposes of providing equity support, and interest rate concessions for funding the expansion of existing units in the reserved areas, for technology upgradation and modernization, technology absorption and for new marketing initiatives. The fund could be administered by SIDBI and other financial institutions and commercial banks on the basis of parameters laid out by Ministry of Industry for the purposes and industries which would receive priority for this support. Such provision of funds would essentially be used to provide interest subsidies for funding expansion of small scale industrial units currently manufacturing reserved items, and for funding the upgradation of technology and modernisation. Realising that such small scale units were also need support in the process of technology absorption (through training and re-training their workers, supervisors, managers, and even some oweners), it is suggested that these funds may also be used to provide for capacity building requirements of these units. It must be understood that this would be in the from of a one time support to such a small sale units and the maximum limit of about Rs. 50,000 could be put for this purpose. Further, in view of the competition that SSIs may face in th market from the large sector after dereservation this fund should also be used to assist SSIs in developing marketing alternatives. This funding would be made available to groups of entrepreneurs and industry associations if they get together to permit marketing consortia to market their products and apply credible brand names. In order to serve these different purposes it is recommended that the Ministry of Industry should provide guidelines on the specific industries and areas which would receive priorities for support from this fund. Access to it from different financial institutions and commercial banks should be made on the basis of their expertise in lending to small scale enterprises for these designated purposes and geographical locations. Such funds could be disbursed particularly through the commercial bank branches which have now been designated as special branches for small scale industries. Priority in the use of these funds must be given to tiny units.
Similarly, a specific scheme for fiscal concessions should be devised for small scale units which manufacture items in the reserved list. Full excise exemption is currently available to small scale units which have turn over up to Rs. 30 lakh; partial exemptions is available upto a turn over of Rs. 75 lakh; and these slab-wise exemptions are available upto a total turn over of Rs. 3 crore. It is suggested that, as a tranistional measure for a period of 5 years, these fiscal cinsessions may be externed for existing units which manufacture reserved items. For such units complete exemption may be granted upto a turn over of Rs. 50 lakh, partial exemption for these units at Rs. 3 crore. This measure would have the effect of increasing internal generation of funds for small scale units in the reserved sector. It would than make it easier for them to make additional investments for expansion and technology modernisation to be able to compete with large units; and also give them some price cushion in competing against any larger units that come in.
633. Investment Limits And Definition Of Small Scale Sector
The investment limits set by the Industrial Policy announced in 1991 need to be revised in accordance with the new perspectives proposed so far. Hitherto, separate investment limits have been set for small units an for the tiny units Rs. 60 lakh for the former and Rs. 5 lakh for the latter. The investment limit for SSI is most relevant for the industries producing items reserved for small scale industries. Once reservations are abolished that relevance will automatically go, and the limit will no longer be a hindrance to growth. However, limits would still be required for definitional purposes in order to determine the eligibility of units to avail of the different incentives and promotional facilities available for small scale enterprises.
Definition of Small Scale Sector
First, the definition of the small scale sector must be broadened from just that of small scale industries to small scale enterprises (SSEs). Incentives, credit facilities, and promotional facilities should than be available to all small scale enterprises. To begin with, the concept of the SSE sector, should include all business enterprises in the service sector which provide services to industrial enterprises.
Investment Limit
A revision in the ceiling for tiny enterprises is now overdue since several dimensions have to be taken into account. For one, the inflation in the last five years and devaluation of the rupee has substantially lowered the real value of the investment limits. Second, the cost of pollution prevention equipment was not included in the investment limits set in 1991. The value of other equipment suchas generator sets, tools, jigs, fixtures, R&D equipment, etc, was also not included. Taking into account all these factors, an investment limit of Rs. 25 lakh for tiny units is adjudged to be most appropriate. For small and medium scale enterprises, the threshold level should be immediately raised to Rs. 3 crore for the same reasons. By doing this a large number of smaller units at the lower end of the small industry sector which are otherwise clubbed with their larger counterparts and hence having unequal bargaining power in the market place, could be helped in the direction of stability and growth.
We are recommending a somewhat higher limit for both tiny enterprises and for small and medium enterprises so that the threshold level does not provide any disincentive to growth of small scale enterprise for the next 5 years. The thrust of policy should be on the one hand to promote the easy entry of new entrepreneurs into the tiny sectors and then to provide all help necessary for the successful enterprises to grow an prosper. It would be expected that once enterprises reach an investment level at the threshold level of Rs. 3 crore they would no longer need special assistance from incentives or promotional facilities available for these sectors.
Excise Incentives for Graduating Tiny and Small Scale Units
At present, complete exemption is available for turnover up to Rs. 30 lakh, somewhat lower concession for turnover between Rs. 30 lakh and 50 lakh an still lower for turnover between Rs. 50 lakh and 75 lakh and the threshold turnover limit for eligibility or getting such excise concession is limited to Rs. 3 crore. Some, modification is required, as already suggested for units that currently manufacture reserved items. Second, some modification may also be made to remove the disincentive for tiny units to grow beyond their investment limits. It is therefore proposed that tiny units which graduate beyond the investment limit of Rs. 25 lakh be permitted a higher total exemption limit of turnover to Rs. 50 lakh, for a period of 5 years after crossing the tiny sector investment limit. Similarly the total turnover limit of Rs. 3 crore may be expanded to Rs. 5 crore after the SSI crosses the proposed new investment limit of Rs. 3 crore, but only for a period of 3 years from such graduation. Although this would cause some complication in administration it would remove the fiscal incentive hindrances to growth. In the medium and long term tax revenues should also gain from such growth.
Restoration of Excise Exemption for Branded Goods
There is one more modification that is necessary Since 1993-94 the excise exemption available to SSI units which manufacture branded products was withdrawn in 1993-94. This reduces the incentive for large enterprises to sub-contract and outsource their branded products since we envisage a future of much closer relationships between small and large enterprise this disincentive must be removed. Indeed, this practice must be positively encouraged in the interest of promoting technology upgradation, quality enhancement, entrepreneurship and employment in small scale units. The Expert Group therefore recommends that the applicable excise exemption should be restored to units manufacturing branded products.
The tiny sector units can be gainful partners to the small and large units as vendors and subcontractors. In order to nurture and sustain such relationships between tiny, small and large enterprises, the Export Group thinks it important to bring these tiny units that manufacture branded products under the excise exemption system as proposed above.
The social benefits of nurturing new enterprises cannot be realized unless small scale enterprises are driven to grow in size and increase productivity. Investment limits and the associated benefits of excise duty concessions have deterred new enterprises from advancing into larger companies. Instead, smaller companies are tempted to expand by establishing new units of a size below the investment limits. Moreover, inefficient small companies are able to survive simply by taking advantage of fiscal concessions available to small companies.
The comparative experience of Asian countries shows that India is one among a few countries where labor productivity differential between large and small companies has not been bridged13. The labor productivity in large enterprises in Hongkong and Singapore is, on an average, only fifty percent higher than in small companies and compares well with the corresponding figure of 15 percent in developed countries. On the other hand, India, Philippines and Indonesia report labor productivity differentials that are three times higher for large companies than for small companies. Clearly, a huge productivity gain of nearly one hundred percent is in store if investment limits are raised for the small scale enterprises with concomitant reforms in fiscal incentives.
6.4. clusters
Small and medium scale enterprises learn to develop a forte in a narrow segment of business to extract the most from their slender financial and human resources. Their survival is, therefore, contingent on the aggregation of complementary businesses and infrastructure in the same vicinity. The proximity of a web of businesses lowers the units cost of infrastructure, leads to accretion of skills and is a source of informational economies. From an institutional point of view, the costs of monitoring and promotion are lowered since news spreads faster in a regional context. The consequent low transaction costs stimulate a virtuous circle of growth.
Worldwide, a common characteristic of growth of small and medium scale enterprises is their agglomeration in clusters. India is not an exception to this pattern of growth and a recent survey of the UNIDO has identified 138 such clusters (see Appendix 2). A fact of far-reaching significance is that the formation of only 13 of the 138 clusters has been induced by policy. The rest of the 125 clusters have grown spontaneously on the initiative of entrepreneurs. No less than 99 of the clusters have grown in response to market opportunities in the region, only 6 have been attracted by the availability of infrastructure and the rest 33 were drawn by raw materials or skilled labor.
The industrial estates developed by the government have been plagued by under utilization due to wrong location. A striking evidence of this can be found in NCAER’s survey of rural estates the share of functioning units was 46 percent of sheds and plots in Maharashtrs, 60 percent in Karnataka, 47 percent percent in Andhra Pradesh, 50 percent in Tripura and a dismal 22 percent in Bihar. By contrast, the rate of utilization of urban estates was much better but not entirely satisfactory, 81 percent in Karnataka, 74 percent in Haryana. 71 percent in Andhra Pradesh and 62 percent in Maharashtra and a depressing 35 percent in Bihar. Industrial estates developed by the government suffer the consequences of ignoring the overriding importance of agglomeration economies in inducing investment by small and medium scale enterprises.
An analysis of available evidence in India dies not validate the assumption that government policy alone can significantly influence the dispersion of industry14. It can, at best, reinforce any trend of voluntary movement of industry out of the traditional centres. The main results from the Indian data show some evidence of regional spread of industrial growth in the figures of industrial employment. On the other hand, statistics on valued added show mixed results suggesting that low productivity industrial activities spread to new centres. Furthermore, the figures of bot employment and value added in the unorganised sector confirm that it has not at all responded to government policies for even geographical distribution of industrial growth.
Similarly, experience elsewhere in the would confirms that regional development policies have not succeeded except where government has intervened with a comprehensive program such as in Southern Italy and has been complementary to entrepreneurial effort15. An important lesson from Italy is that a single unified regional authority governed a complete package of inter-related programs for industrial dispersion before private industry found it profitable to move to regions with low level of industrialization. A noteworthy aspect of the Italian experience is that government interventions were based on a great deal of research and analysis.
A fundamental flaw in the policy for small industry development in India has been that it has ignored the clusters that have taken root as a result of entrepreneurial effort. Worldwide experience suggests that such clusters can stagnate in their later stages of development unless they are supported by institutions. These clusters are appropriate units for focused development of a large number of enterprises in a way that lowers the cost of administration of development programs. Since these clusters usually specialise in a single area of activity, it is possible to design composite programs meeting interrelated needs. It will also possible to forge government-private sector partnerships for effective implementation of regional development programs.
The touchstone of cluster formation, the nutrient of their growth, is the cross flow of information. This is doubly true for science parks where knowledge is translated into innovative products. An uninhibited flow of information can take place in an environment of mutual trust.
The free flow of information is important not just to knowledge workers but also for the assessment of the viability of projects where tangibles like plant and equipment have not been installed. Venture capital financiers cannot evaluate the value of intangible innovative concepts unless their details are disclosed to them. However, entrepreneurs would be unwilling to share information about their inventions if they fear their appropriation by their competitors.
We have laid emphasis on the promotional facilitation role of the government in intervening to support small scale enterprises. Such support would essentially be in the nature of providing credit and technological support to enable small scale enterprises to enter new activities and to grow successfully after entering. We have also suggested that with the considerable growth that has already been seen in entrepreneurship and the appearance of the private sector in business suport activities, the future of small scale enterprises promotion would lie in public private partnerships. We have also observed that the promotion of small scale enterprises now requires much greater level of knowledge and technical expertise in order to be useful. All such activities would be practical to provide if there is some degree of information of small enterprises in certain locations, since there are also economies of scale in the provision of support services. It would be most practical if the package of promotional measures is provided to small scale enterprises in clusters.
Agglomeration economies that accrue from clustering of firms can be enhanced through planned intervention. Realisign that most of the clustered industrial complexes, both spontaneous and policy induced, are dominated by entrepreneurial tiny units, the Expert Group feels that the time has come to carry out a need assessment study for each of such clusters at the district level.
Subsequently a comprehensive and intensified policy and action programme for promoting clusters should be initiated. This should give special importance to the specific needs of tiny units, the basic elements of such a programme would be technology upgradation, skill enhancement, information dissemination and entrepreneurial competency development.
The Expert Group therefore recommends that state governments identify the existing SSE clusters and then promote new types of organisations which are joint ventures between the state governments or local authorities and business associations in these clusters. It would be found that in most clusters there already exists business association which can readily come forward to form such partnerships. In come cases they would need to be fostered anew. A mechanism that should be used by state governments is to offer funds on some level of matching basis to fund and run these promotional organisations. The Expert Group recommends that the 9th Five Year Plan should include such funds to be provided for funding and running these organisations on this basis. It should be understood that the promotional organisations being suggested : the Clusters Small Enterprise Associations (CSEA) should be autonomous and the government should only support them if the local business associations are willing to provide some level of matching funding. The level of matching funding would have to differ between different locations depending on the size and strength of clusters.
The believe that this is a very practical approach to SSE promotion in India since there already exists a large range of small scale industry clusters across the country. Many existing clusters of industries in India suffer from extremely inadequate infrastructure support since most of them have come up naturally and without the benefit of government support. The government policy should therefore be much more geared to recognise natural existing clusters and to promote infrastructure support wherever possible.
6.5. financial Support
6.51. Credit Related Problems Faced by SSEs
The discussions held by the Expert Group have shown that small scale industries experience the supply of credit as their key problem. It is claimed that not only is the availability of credit to SSI of high cost, it is not timely and is also inadequate in volume. Moreover, the past system of the financing of SSIs provides for little interaction between term loans and working capital. Term loans were available directly from State Financial Corporations (SFCs) and State Industrial Development Corporations (SIDCs), whereas working capital was then sought from commercial banks. Many SSEs therefore complain that even when they able to achieve access to term loans they were not able to obtain adequate working capital. The need therefore is for a single window approach. The past financial system has engendered a vicious cycle. On average it has been found that the recovery rate of SFCs has been around 37%. Consequently most SFCs are in a very poor financial situation, and IDBI/SIDBI now face difficulty in providing them adequate support. Given such a record it is also then not surprising that commercial banks regard small scale enterprises as risky propositions.
As regards interest rates the small scale sector had the benefit of lower interest rates during the administered interest rate regime. After deregulation of interest rates only loans of upto Rs 2 lakh are now getting these low interest rates. Loans above this amount carry deregulated interest rates. Since SSIs are usually seen by commercial banks as more risky they naturally, levy interest rates much higher than the Prime Lending Rate (PLR) on them. Consequently small scale enterprises have gone up from subsidized interest rates before economic reforms to interest rates that are higher than what large companies receive. This problem is even more acute for tiny enterprises. Thus the financing system for small scale enterprises needs considerable attention an a new approach is called for.
Discussions with various SSI Associations and other agencies, have drawn attention to a host of other credit related problems which affect SSEs.
- Need for credit rating agencies exclusively for SSE units.
- Financing for technology upgradation and modernization
- Delay in realisation of sales proceeds
- Non availability of state-up equity assistance to small SSEs and venture funds to innovative projects.
- Inadequate marketing infrastructure and credit for intangible marketing expenditure
- Need for functional autonomy for existing support service agencies such as TCOs, SISIs and the need for encouraging setting up of private sector business service enterprises in the clusters.
- Inadequate credit to micro enterprises.
- Need for resource support for shifting polluting units.
We have made an attempt to address each of these concerns in our recommendations.
6.52. restructuring of SFCs and SIDCs
Under the multi-agency approach for financing SSEs, term finance is provided by SFCs and working capital by banks. Lack of co-ordination between the two has been the major cause for the difficulties faced by SSE entrepreneurs. Several measures initiated in the past to secure better co-ordination have had only limited impact. For the tiny enterprise the distinction between term finance and working capital is not meaningful. For other larger SSEs, the process of appraisal by SFCs and banks separately is onerous and time consuming not only because they all chose to carry out appraisal sequentially rather than in parallel but also because of the tremendous bureaucratic hassles that the entrepreneur has to go through. Banks typically address the needs of the entrepreneur after SIDBI / SFC have committed their funds. It is therefore necessary that the distinction between term lending and working capital institutions be done away with and banks and SFCs increasingly get into making composite loans. It is essential for a single agency to provide all the credit requirements of an SSE under one roof though there could be some impediments in implementing the idea in the initial years. The Nayak Committee has also recommended that SFCs and banks should cover financial requirements of SSE under the Single Window Scheme (SWS) to the maximum extent. This calls for a major restructuring of SFCs and SIDCs and in the operation of commercial banks.
SFCs and SIDCs have so far been structured as state government institutions. They usually have politicians as chairmen and bureaucrats as managing directors. Over the years it has been found that the heads of these institutions have not only been generalists but have also suffered from short tenures. With the lack of expertise at the top these institutions have not been run professionally and have not developed expertise in evaluation of projects and companies and have consequently suffered from low recovery ratios arising from poor lending practices. Given th political and bureaucratic leadership of these institutions they have also suffered from the ills of behest lending. If these institutions are to be re-vitalised they would have to be restructured anew and made independent from state government. The Expert Group recommends that the IDBI in association with SIDBI devise a new scheme to revitalise these institutions. The approach should be to make these institutions autonomous by reducing government equity to less than 50%. The rest of equity could be held by other financial institutions, other private investors which have particular interest in the specific states. Naturally, for this to take place Non-performing Assets (NPAs) would have to be separated out so that the new investors would then be willing invest in these revitalised institutions. Once the restructuring is done these institutions would be able to upgrade their professional capacity for evaluating projects and monitoring them and hence be better able to provide credit to small scale enterprises.
Specialised Commercial Bank Branches and Local Area Banks
In recognition of the many credit problems faced by small scale sector the Reserve Bank of India had appointed a committee under Dy. Governor Sri P.R. Naya to suggest measures for increasing the flow of credit to the small scale sector. The Expert Group endorses the recommendations of the Nayak Committee and urges the RBI to implement them. In particular, all effort must be made to achieve the prescribed target of providing working capital of a minimum of 20 percent of the projected turnover of small scale enterprises. Among the many recommendations made by that committee a recommendation was made to commercial banks to designate special branches in areas which have a high concentration of the small scale sector. there was to be time bound action for setting up specialized SSI branches in 85 identified districts and at least 100 such dedicated branches were to be opened before the end of 1995-96. This approach is consistent with our approach of centering policy support to small scale enterprise in clusters of industries and other enterprises. A special emphasis should be given to this scheme so that special training for appraisal, evaluation and monitoring can be given to the staff in these branches. There should be at least one of these special branches in each of the clusters that are identified by state government as proposed earlier. Now that commercial banks are also allowed to do term lending, these special branches must provide term loans and working capital to the small enterprises within their jurisdiction. With this kind of a cluster approach and the professionalisation of the staff, it should be possible to increase the availability of credit to small scale enterprises and on lower costs.
The Finance Minister in his budget speech of June 1996 announced new scheme for founding new private sector local area banks. The guidelines proposed the Reserve Bank of India suggest that these banks will be subject to all the normal commercial bank requirements in terms of capital adequacy ratios and other potential requirements. Since these banks would be small to begin with, the prudential requirements would automatically force them to concentrate more on small scale enterprises. They could then be expected to sepcialise in lending to SSEs. The Expert Group recommends that the Reserve Bank of India should promote the speedy establishment of these local area banks in the districts where SSI clusters have been identified. The introduction of these banks would provide appropriate competition to the existing commercial banks. To. the extent
that the specialised SSE commercial bank branches would also be located in these clusters, it may extent that the specialised SSE commercial bank branches would also be located in these clusters, it may be expected that their own operation would also improved in the light of competition from these new local area banks. The Expert Group also recommends that the Reserve Bank of India should initiate action to provide support for special training schemes for the staff of these new local area banks so that appropriate expertise is built up quickly in these new financial institutions.
The concentration of lending to SSEs in the specialized branches and local area banks should help considerably in providing better financial support to the SSEs. Further it must be understood that there are other generic problems that would still exist in the financial support for SSEs. The key issue is inadequacy in the availability of credit information on borrowers. The cost of collecting such information is high for commercial banks. The cost of loan processing for a large loan is not too different from that of processing of a small loan. Consequently, banks naturally prefer to lend to large companies and would like to charge higher interest rate from smaller companies to cover such higher lending costs. This problem will affect the new local area banks as much as it affects the existing commercial banks. The one advantage that the new local area banks may be expected to possess is that they would probably have access to better informal information on borrowers than bureaucratized commercial bank branches. This would be so if the promoters of these new LABs would be local enterpreneurs. The Expert Group recommends that the Board composition of these LABs would benefit from the participation of the representatives from local business associations. Such participation at the Board level would help in providing better information on local small business borrowers.
None-the-less the basic problem of credit information would persist. We therefore feel that special attention has to be given to provide a mechanism to lower the credit assessment costs for banks. Our suggestions to this end are provided below.
6.54. Reducing Credit Costs for SSEs: Extending Credit Ratings Services to SSEs
The term lending institutions and banks have legitimate concerns about the low recovery of loans and these have to be faced squarely. It would be imprudent to admonish financial institutions to raise the credit earmarked for the small and medium enterprises without due consideration about their stability. Moreover, the cost of credit rises if lending to small companies is perceived to be synonymous with low recovery. There is need for a new approach and attitudinal change on the part of the banks in such a way that banks view lending to the SSE sector as an opportunity rather than a threat. In the post liberalisation era, there are discernable changes with regard to availability of credit to the small scale sector. among other things, in the absence of proper financial statements, risk assessment by lenders becomes quite difficult. The Expert Group concluded that the recovery rates have to rise to increase the stock of financial resources that can be allocated to small and medium scale enterprises.
The recovery rates can rise can rise only if banks and financial institutions have access to reliable information as well as by more stringent monitoring. Several options were explored to achieve this objective, i.e., credit rating, community, data banks on credit information and the measures required to make them more effective.
The business of credit rating has already taken root in the county and can be extended to smaller enterprises. However, the existing credit rating agencies find it more profitable to serve well endowed clients. Moreover, only a fraction of the small scale enterprises are incorporated as limited liability companies. The costs of credit rating, will be lower in clusters since a large client base will be available within their precincts if the government shares a part of the costs of credit rating agencies located in clusters, it can urge them to move there. SIDBI has already launched a scheme in coordination with national credit rating agencies to grant assistance to SSE units going in for credit rating. It is felt that SSE units need encouragement to go for credit rating either on cluster basis or individually to strengthen their resource raising capability. The costs of national level credit rating agencies would always be too high for the rating of SSEs. Thus, in order to bring down such costs what is required are local level credit rating mechanisms.
The Expert Group recommends that SIDBI in cooperation with the national credit rating agencies should promote the establishment of local credit rating agencies in the identified SSE clusters. This would require some level of equity participation by existing financial institutions including commercial banks and the national credit rating agencies. The government could provide a small seed fund to help in kick starting this process.
Community guarantee is appropriate where the clients are not fortunate to possess adequate collateral. The celebrated story of Grameen Bank an similar experiments with rural credit in Gujarat have confirmed that recovery rates rise where micro-credit is supported by community guarantee. We, therefore, recommend that cluster associations be allowed to stand as guarantors and their co-operation should be enlisted for this purpose. A few of the public-spirited associations such as the Tirppur Exporters Association are possible candidates as community guarantors. The refinancing agencies can keep an eye on the track record of these guarantors to build confidence.
We suggest that efforts be made to build data bases of credit information. The fledgling information services industry has already shown keen interest in creating data bases out of scattered information available with public institutions. However, concerns about secrecy as well the absence of known means to price information have been a barrier to the growth of the information services industry.
Potentially, information about the credit record of individuals will be the most effective means to check defaults. The information that banks and financial institutions share with data banks does not have to be divulged to the general public but can be utilised by a closed group of members bound by suitable rules. The regional banks should be encouraged to share information with data banks.
Once such a credit rating system gets established the costs of credit assessment for each LAB or commercial bank branch would get reduced. Moreover, the credit rating system would make more transparent credit quality of small borrowers so that banks are able to distinguish adequately between good risks and bad risks within the small scale sector. in principal, within the small scale sector good borrowers should be able to receive interest rates closed to the PLR, whereas borrowers of lower credit quality would then naturally be subject of higher interest rates. Such a system should help in improving the overall quality of lending to SSEs and to reduce the incidence of bad loans over a period of time. It may be expected that there would be a private sector response to such a system that provides consultancy services and would start becoming available to small enterprises to improve their credit quality. The measure proposed above would essentially improve the access of SSEs to debt funds, both for term loans and working capital purposes.
The cost of lending can also be decreased if the Small Industries Development Bank of India (SIDBI) is allowed to borrow low cost funds in international capital markets. A supporting guarantee from the government including sharing the exchange rate risk, can enable SIDBI to borrow at very low rates of interest.
6.55. Other Funding Sources for SSEs
National Equity Fund
Encouragement of SSEs start ups also requires improved access for entrepreneurs to additional equity funds. Unlike large enterprises SSEs are not able to access equity funds from capital markets until they grow to a certain level. In recognition of this problem the government has established the National Equity Fund. SIDBI has been operating the National Equity Fund which receives resources jointly from GOI and IDBI (now SIDBI). Even though the scheme is in operation for the past 10 years, the off-take under the scheme has not been adequate. Some of the commercial banks have also set up specific funds for providing equity support to new enterpreneurs. In this case also the Expert Group recommends that the National Equity Fund would operate much better if disbursement of its resources is decentralised to the cluster level. In order to mitigate the shortage of risk capital required by the small SSEs thee is need for encouraging setting up of equity funds by majority of the specialised branches of commercial banks and LABs. SIDBI could contribute upto 50% of the equity funds floated by these commercial banks / LABs out of the National Equity Fund operated by it. The Expert Group is of the opinion that such a measure would encourage accelerated flow of equity funds to large number of needy small SSEs. It would be much more likely for these clusters to have new credible entrepreneurs who could be assessed commercially for the provision of additional equity from the national equity fund. These branches and LABs should encouraged to form their own local equity fund with assistance from the national equity fund. This scheme would provide special assistance to technocratic entrepreneurs who have adequate technical expertise but inadequate resources. The assumptions of such entreprenuership would require greater technical expertise on the part of these bank branches and LABs which have already been suggested above. Resources from these local equity funds should also be available to assist existing SSEs for further expansion.
The other source of equity as well as debt that SSEs could tap are other companies, both small and large, and foreign investors. With the removal of SSI reservations there would no longer be any need to impose 24% limit on equity that currently exists on investment in SSEs by large companies and by foreign investors. As already recommended this limit be removed forthwith so that SSEs could benefit from closer relationships with large companies and foreign investors. In addition to getting better access to funds this move will also promote outsourcing of end component by large companies and promote closer technological relationship.
Encouragement of Bills Culture and Factoring Services
As a result of the 1991 policy statement, the Delayed Payments Act has been enacted. So far, it has not had the desired effect and SSEs continue to be plagued by non-payment of their dues, particularly by large enterprises. Effectively then, SSEs are providing working capital credit to large enterprises, rather than vice versa. The Act could be made more effective by inclusion of stringent provisions for non-payment of dues to SSIs. Besides commercial banks, SIDBI and SFCs have also attempted to solve the problems relating to timely realisation of sale proceed by discounting the bills arising out of sale of components / intermediates by SSE units. The bills culture should be encouraged in greater measure to mitigate the problems of delayed payment of receivables of SSEs. RBI has been restricting cash credit component which is presently 25% an 40% of the maximum permissible bank finance (MPBF) in case of large and medium borrowers and the balance being provided by way of term loans. In order to increasingly encourage the bill culture, the Group suggests that RBI may consider measures which would promote the covering of purchases from SSE suppliers through the bills route. Further measures must therefore be taken to reduce delayed payments by large enterprises. One suggestion that we have received and we recommend is that in the annual accounts of large companies. Information be provided on a statutory basis on the extent of accounts payable to small enterprises. It is felt that this would reduce considerable the incidence of delayed payments. The Expert Group recommends that the Department of Company Affairs explore this possibility.
Further, a beginning has been made by State Bank of India, Canara Bank and SIDBI in setting up factoring organisations, one each in southern and western parts of the country. This activity must be replicated by allowing factoring agencies in the private sector in different regions of the country, especially in SSE clusters by removing the legal constraints and other impediments relating to stamp duty, registration changes and the like.
6.56. venture Capital
An infant venture capital industry has existed in the country since the mid 1980s and can grow into an adult if appropriate regulatory changes are made. Its early development was nurtured by low cost capital sourced from multilateral agencies, the Indian development finance institutions, some commercial hanks and overseas donor organizations. In its first stage of development, the impact of venture capital industry on small and medium scale industry has been unremarkable although some successes point to a promising future.
Two important developments have undermined the foundations on which the venture capital industry was able to grow so far. One, the era of low cost capital has come to an end as the Indian development finance organations, the chief financiers of venture capital companies, have had to raise capital from the stock markets. Secondly, the venture capital companies now face competition from private equity found and non-bank finance companies who have entered into lager stage financing in the form of "bought-out" deals. The profits from bought-out deals, during the boom of 1994, were high enough for financiers to forego tax benefits granted by the venture capital guidelines of 1988.
So far the venture capital funds set up by private enterprises do not seem to have made significant impact in the field in supporting start-up ventures on account of paucity of funds and their inability to tap the capital market. Pursuant to the announcement made in the budget for 1996-97 SIDBI has a scheme to contribute 50 percent of the corpus of venture funds of private and public sector companies provided they are fully dedicated to SSEs. This is carried out of a Venture Capital Fund created by SIDBI out of its own resources. The fund is also used for assisting SSI units directly. Effective steps need to be taken for setting up of regional and sector-specific venture funds. This coupled with the liberalised tax incentives extended by the government to venture capital companies will go a long way in flow of credit to innovative ventures of SSE.
Against this background, venture capital companies have to find alternative means to survive in a competitive market. They will have to access capital from other large funds who can share the extraordinary risk of investments in start-up ventures. The returns from investments can also be raised by better management with experience in this specialised business. Finally, the transaction costs are so high that venture capital companies are unable to afford investments of a value less than Rs. 4 million while most small scale investments are below this threshold level16.
Venture capital companies can share risks with large funds only if private pension funds an insurance companies are permitted to invest in venture capital funds. Typically, pension funds, insurance companies and other institutional investors, with their large pools of capital, can afford to invest a small hare of capital in risky venture capital companies. In the USA, pension funds and insurance companies accounts for 71 percent of venture capital investments17. In the UK, 65 percent of venture capital comes from pension funds and foreign finical institution.
The successful management of venture capital projects is ensured by partners, who have long experience in this business in 1990, for example, 89 percent of venture capital investments in the USA were supervised by management partners who had at least 5 years of experience18. Typically, the investors enter into a management partnership agreement and have no control over day-to-day operation of the project.
The third aspect of successful management of venture capital projects is their location in science parks or some other from of cluster. Venture capital companies establish offices in such parks and network within a small community to identity start-ups for financing. Transaction costs, under the circumstance, can be kept low. Moreover, the probability of a successful venture in a science park is higher and is reported to be three times higher 19.
Several changes are required in the Indian regulatory system before venture capital companies can make a perceptible difference to small companies. The entry of private pension funds would have to be permitted and freer entry of private insurance companies would have to be possible. Moreover, the rules under the Insurance Act 27 A and 27 B stipulating investment of more than 70 percent of the capital in government securities and similar rules under pension schemes requiring 50 percent of the capital in government securities and similar rules under pension schemes requiring 50 percent of the investment in public sector bonds will have to be abolished.
The 1991 policy for small scale industries had proposed an enactment of a Limited Partnership Act so that it would be easier for SSE entrepreneurs to source additional funding from other partners who could invest in partnership as sleeping partners. This is another source of funding for SSEs. The Expert Group recommends that the Limited Partnership Act should be enacted as soon as possible.
The proposed Limited Partnership Act should also incorporate the law governing limited management partnerships. These rules should lay down the rights and obligations of the managers and the investors. Sine expertise would have to be sought from management companies overseas, the rules for the repatriation of their profits should also be spelt out.
6.57 Addressing the Credit Needs of Tiny Enterprises
As may be expected, among small scale enterprises the credit problems of tiny enterprises are even more acute and therefore require special attention. They particularly require exceptional assistance at the time of entry when the budding new entrepreneur may not have any credit history nor collateral. The various suggestions given above regarding the use of the National Equity Fund apply in particular providing support to tiny enterprises. The financial intermediaries in the formal sector (SIDBI) commercial banks, SFCs, Regional Rural Banks, Cooperative Banks) attempt to cater to the needs of small scale enterprises in an undifferentiated manner. The smaller among the small units have lost out to the relatively larger ones over the years in this process of transfer of credit from the formal system. This has resulted in this segment facing acute problems that arise mainly out of inadequate and delayed credit, procedural bottlenecks and institutional limitations as manifested in the insistence on collateral and a general lack of empathy with the needs and constraints of the tiny enterprises owners.
This is turn has contributed to high mortality rate, high incidence of default, shortage of funds and stunted growth in the tiny sector. these in fact are just symptoms of a systemic problem viz, the inability, both structural and attitudinal, of the formal system to reach out to the smaller clients on a sustained basis.
For ensuring that the tiny sector is not bypassed by the commercial banking system, the Committee proposes that it should earmark a minimum of 70 per cent of its priority lending allocated to the small scale sector to the tiny sector.
Considering these facts the Expert Group recommends that an alternative system of financial intermediation should be evolved for dealing exclusively with the needs of tiny sector. this may be done primarily through augmenting the existing system with active involvement of District Co-operative Banks, private sector Local Area Banks, and NGOs including business / industry associations. These institutions will be working at the district level confining their activities to not more than three districts. This would ensure better appreciation of local requirements and minimization of transactions (and costs) both for the intermediary as well as the borrower. These institutions need to be self-sustaining in the long run. They should also have access to the existing avenues of refinancing by NABARD and SIDBI.
Under the financial sector reforms the government is committed to revision of SLR and CRR in due course. A specified portion of the liquidity thus released into the system may be allocated for on lending either to tiny units directly or to the district level intermediaries as suggested above. However, whenever these ratios are increased as part of monetary regulations, the funds allocated to this sector should be insulated.
To help those enterpreneurs without sufficient collateral towards procuring bank loans, it is suggested that a Revolving Collateral Reserve be created at the intermediary level. In order to compensate the financial intermediary for the loss arising out of default for the first five years of their operation, the state governments should subsidise default upto 20 per cent of the total which would be brought to naught in the sixth year in a phased manner. The subsidy should be available on a matching basis to the intermediaries against their contribution for creating aforementioned Collateral Reserve by setting aside a share in profits. Income tax exemption to the extent of this provision may be made available as an additional incentive. The would be applicable only to district level intermediaries. The National Equity Fund may also be made generally accessible to the intermediaries to build this collateral reserve. Alternatively at the cluster level, the CSEA may be allowed to stand as community guarantor for securing loans from banks.
Composite loans (term loan plus working capital ) would be made available to tiny units from a single source with an enhanced limit of Rs. 10 lakh from the present limit of Rs. 50,000. However, while scheduling the repayment only the term loan component would be considered. The working capital component would be governed by the level of activity. For Financial assistance under this scheme, banks and financial institutions should not take any collateral from entreperneurs.
While deliberating on other issues in finance encountered by tiny enterprises, the Expert group felt that a perpetual problem is the delayed or non-payment of dues by large buyers to the small suppliers. The tiny units, especially are affected by this as it will cost them dearly if they estrange big customers. At the same time they are deprived of the benefits of inter-industry and inter-firm linkages due to their weak bargaining power as suppliers. As already noted the Delayed Payment Act, introduced as part of the 1991, policy statement has not been able to help the smaller entrepreneurs overcome this hurdle because it suffers from certain inherent lacuna. The proposed DEPA should be entrusted with the task of assisting tiny units in getting timely payment of their dues. Where legal action is required under the Delayed Payment Act the DEPA should be authorised to act on behalf of tiny units. Similarly, special efforts must be made by factoring service organisations to address the needs of tiny units.
Summary
To sum up, there is need in so far as credit dispensation is concerned, for a paradigm shift in favour of tiny enterprises. Adequate and timely credit under a single window arrangement woud enhance the productivity of assets already created in SSE sector and in the process increase the competitive strength of the small units. A time bound programme for investment in research and development, technology upgradation and technology transfer has assumed critical urgency in view of economic liberalisation. This issue is addressed below. Besides increasing the flow of term loans and working capital, there is also a strong case for easing legal constraints so as to encourage factoring services. It is equally important that institutional arrangement be made for meeting the shortfall in equity assistance both for new and existing ones. In so far as small credit needs of rural poor and more so women, are concerned, all encouragement should be provided to micro finance institutions with the help of specially created fund in NABARD / SIDBI.
6.6. Support Services For SSIs
Two major lessons can be drawn from successful experiences, worldwide, with small industry development of recent times. Firstly, access to a diverse range of sources of support services, whether it is government, private companies, consultancies, educational institutions, business associations, is necessary for individual small companies to identity the one most suitable for them. Therefore, the government’s role gets restricted to part financing of services without any bias for any particular source. Secondly, support services such as technical assistance, training, market development and information should be available as a single package for them to be effective. In India, however, government is the primary source of support services and a co-ordinated program for joint delivery does not exist.
6.61. Technology Development
Lately, the survival of enterprises in the large majority of natural clusters has been threatened by endemic technological obsolescence. When the exports of low quality products fell, the first alarm bells rang. In some product segments such as electronic components, Indian companies have braced themselves for competition from multinational corporations and have pressed their vendors to upgrade quality. In other cases such as diesel engines in Ludhiana, new opportunities for diversification into related products like electric generators and automotive components have been foregone due to technological limitations20.
The slow pace of technological progress is not necessarily inherent in the very nature of small scale enterprise in India. Admittedly, these companies catered to a price sensitive home market disinterested in quality. Correspondingly, most household enterprises have been promoted by poorly educated entrepreneurs unable to absorb new information. Many of them also manufactureproducts like furniture or crude tobacco based products where technology is stagnant.
The critical barriers to technological development, however, are decidedly policies and regulatory practices governing factors markets in India. For one, labour laws have driven proprietors to contract work to numerous household enterprises equipped with primitive techniques. In some cases, biased allocation of government subsidy has favoured obsolete products such as diesel engines and has driven modern lightweight and fuel-efficient engine using aluminum alloys out of the market. In an industry like food processing, the Prevention of Food Adulteration Act has vested the monopoly of food testing with the government. Not only are these antiquated government owned laboratories unable to undertake tests required by a modern food processing industry they also deny access to information about the requited standards particularly to small scale enterprise. The Expert Group, therefore, recommends that urgent action to amend or repeal laws that are a barrier to technological progress.
The atrophy in complementary infrastructure and institutions has proved to be a fetter on technological progress. Thus the Bureau of Industrial Standards played a catalytic role in stimulating technological improvements in the past but is not reportedly doing so now21. In the electronics industry, an acute need for common infrastructure for development of instrumentation, calibration and precision tools has been felt but has not been forthcoming. The crafts and textile enterprises have expressed an urgent need for design facilities that is not being met. Similarly, training and quality control facilities need to be refurbished in consonance with emerging demands. The Expert Group recommends that government share the costs or providing these services in collaboration with the private sector and voluntary orgnisations.
The enforcement of industrial standards has been used in many countries as a means of raising the technology used by SSEs and the quality of their products. The Bureau of Industrial Standards therefore must transform itself into an activist organisation and initiate an outreach programme for SSEs. once again, this could best be done in the basis of SSE clusters which have some degree of industrial sector specialisation. The Expert Group recommends that the government should provide funds to the BIS in the Ninth Plan to fund such an exercise. The seed funding With BIS would have to be complemented by funds from SIDBI, commercial banks and the proposal BABs for this purpose. Moreover, the transitional fund proposed in the context of the removal of SSI reservations should devote a portion of its resources for this purpose in the case of currently reservations should devote a portion of its resources for this purpose in the case of currently reserved products. This assistance would be particularly relevant to tiny units.
20 The information for this section has been drawn from "Restructuring and Modernization of SME clusters in India ", UNIDO, November 1996.
Technological assistance as well as the institutional mechanisms for its delivery will have to be tailored to the distinctive needs of the household enterprises and small and medium scale enterprises. Tiny craft enterprises have achieved huge productivity gains from incremental improvements in their toos22. Voluntary organisations are predisposed towards the welfare of household enterprises and more likely to take a keen interest in the delivery of technical assistance to them
Small and medium scale enterprises located in few metropolitan areas like Bangalore, Pune, Bombay and Hyerabad have shown promise in some high-tech industries. Specifically, they have demonstrated innovation potential in specialty chemicals, pharmaceuticals, information technology, bio-technology and machine design23. However, the yield of commercially successful technology has been small due the absence of intermediaries, i.e., counselors, research associations and technology centres engineering consultancies, between research institutions and the development centers in enterprises. Governments in developed countries have focused their efforts at assisting the growth of such intermediaries and India should also learn from these experiences and emulate them24.
As has been detailed in Chapter III the Small Industries Development Organisation (MSME-DO) has over the years set up a wide range of technology support institutions to help small scale industries in improving their access to technologies in different ways. As noted earlier, although these institutions have performed a very useful role in the past they need to be restructured as proposed earlier to become much more commercially oriented in order to provide higher level of services that are now required by small scale industries.
Financing for Technology Upgradation
The upgradation of technology which is the key to any programme of modernisation of small scale units, requires an integrated approach encompassing identification, adaptation, absorption, transfer of technology including energy conservation, waste management, quality certification. Such technology upgradation has to be taken up on sector-specific requirements by providing some measure of concessional financial assistance. Presently SIDBI operates a Rs. 200 crore Technology Development and Modernisation Fund (TDMF). State Bank of India and some of the nationalised banks also operate schemes for sector-specific technology upgradation.
Keeping in view the interdependence of the SSE sector vis-à-vis the large undertakings and need for the SSE sector to improve its capabilities to produce quality products, components/intermediates technology upgradation of the SSE sector must be strongly promoted in the coming years. To achieve this, the Expert Group proposes that the scope of the existing TDMF Scheme of SIDBI which is presently linked to 25% export obligation be enlarged to cove all modernisation proposals including those which involve the improvements of capabilities and competitiveness in the domestic market. Further assistance should be provided out of this fund to support service institutions / enterprises engaged in technology transfer, technology-oriented research and development and the like. To encourage increased availment by SSEs under the scheme, the assistance under TDMF could be provided at a concessional rate of interest. SIDBI and other financial / banking institutions which opt to take up this scheme may be compensated for such soft lending under a Special Revamped Scheme for Technology Development and Modernisation of SSEs. Such a scheme could operate much better if specific sectors and clusters are identified and then targeted for technology upgradation. The specialised commercial bank branches (and Local Area Banks as they come into operation) would have to devise and administer such schemes, with refinancing being obtained from SIDBI. It is likely that soft resources for such a scheme could be sought from soft funds available from foreign aid agencies.
Support for Research and Development
The technology support required by small scale industries includes research and development support, testing and calibration, assistance in environmental technology, assistance in pollution control mechanisms, and assistance in improving quality, particularly through the achievement of designated industrial standards. In each of these areas of assistance it is necessary to provide new technology support institutions which could provide these services effectively. Once again, the Expert Group is of the view that such services could be provided most effectively through institutions based around clusters of similar industries so that they are able to specialise as well as reap economies of scale. These new technology support institutions should basically be run by the cluster industry associations (CSEAs) in response to the felt needs of the industries based in these clusters. Further since there are clear externalities in the provision of such support, there is full justification for participation of the government in the establishment and funding of such institutions. The Expert Group recommends that the government should establish fund(s) at both central and state level in order to design schemes which provide matching funds as incentives to clusters industry associations to establish the required technology support institutions. Such institutions could be formed as registered societies with appropriate participation from both government and cluster institutions.
Research and development needs are more specialised than the other technology supports that have been mentioned. Although a great amount of innovation is observed in small scale industry, they are clearly not equipped to perform R&D functions. What is needed is cooperation between small scale units in the same industry to identify common technical problems which require R&D assistance. Different countries have experimented with different ideas to provide such R&D associations and through project funds. Such R&D associations however, are seldom seen to succeed without matching support from government funding sources. The Expert Group recommends that the Department of Science and Technology initiates a new scheme in the 9th five-year plan to from R&D associations based around identified clusters of industries which may be identified as those which are in urgent need of technology upgradation. At least 10 such clusters should be identified within the first year and the aim should be to establish at least 50 such industrial R&D associations for assisting SSEs, within 5 years.
There is at present very little interaction between regional engineering college and other industrial training institutions and small scale industries within their areas of operation. The above scheme for technology support and R&D would be much more practical if the proposed technology support institutions and R&D associations are formed with close links with existing engineering and other institutions at the local level. There must be much greater provision for sandwich courses, fellowships etc, for students to get industry level experience and for teachers in these institutions to get industry experience. However, these institutions should be encouraged to specialise in those industries which are concentrated in clusters in the areas where regional engineering college are located. The Expert Group recommends that these links between these existing technical institutions and existing industries on the one hand, and with the new proposed technology support institutions could best be forged by the national level industry associations through their regional members. The Ministry of Industry should approach these organisations to launch special programmes to forge these linkages.
In recognition of the great requirement of technology upgradation of SSEs for competing in the increasingly open economic environment. SIDBI and some commercial banks such as the State Bank of India have already organised special technology upgradation programmes in industry clusters such as Coimbators. This experience should be used to form similar programmes in other industry clusters through the proposed specialised branches suggested above and the new local area banks. The existing technology development scheme of SIDBI could be expanded for promoting this scheme.
In summary, the existence of small scale industry clusters can be profitably used to found a new approach to technology support for small scale enterprises. Whereas, as has been recommended, such technology support should come on commercialised basis from autonomous institutions, the government has a very important role in initiating action to encourage these institutions and to provide matching funds for their establishment and operation. This should be the new promotional approach of the government towards small scale enterprises.
In order to provide a focus and to promote the various schemes suggested above for assisting In technology upgradation and R&D for SSEs, the Expert Group recommends that a National Research Institute for Small Scale Enterprises be established. This institute would be expected to operate as a networking institution and a clearing house for policy studies and technology issues that get raised by small scale industries. It would promote the establishment of R&D networks on a clusters wise or sector wise basis, depending on where demand for technology appears to be most urgent; it would find funding mechanism for promoting R&D networks on a clusters wise or sector wise basis, depending on where demand for technology appears to be most urgent; it would find funding mechanisms for promoting R&D relevant for SSEs; it would promote the establishment of institutional mechanisms to achieve these purposes. It is proposed that this institutes should be promoted jointly by the central government and apex industry associations.
6.62. Training
Human capability is observed to be a prerequisite for absorption of technological developments25. Besides traditional sources of learning such as training institutes and universities, informal sources of knowledge acquired from the tacit knowledge of firms, machine suppliers, consultants, feedback from markets and quality control organisations are known to be more valuable. Indian enterprises, however, are not able to conveniently tap a diversity of sources of information and learning. Indian industryin general needs to upgrade its technical capability in order to be able to compete internationally. With increasing foreign investment and free new entry of domestic firms, existing firms also have to upgrade their technological levels. The onset of information technology in almost all sectors of industryand services is another contributor to technological change. For all these reasons it is becoming increasingly necessary to improve the training of new workers and to organise continuous retraining of workers already in service. Whereas many large firms have their own in-house training mechanisms small firms do not have such facilities. Thus there is a great need to initiate a vigorous new programme for industrial training of workers both for the industrial sector and service sector. some hints can be taken from the experience of other countries.
Some East Asian countries have forged new institutions to act as conduits for channeling information from large firs and other institutions to small and medium scale enterprises. In particular, Malaysia and Singapure report remarkable success with institutions which draw on the expertise of large MNEs and other organizations. The Standards and Industrial Research Institute of Malaysia (SIRIM), for example, has entered into an agreement with Hewlett Packard to train local industries in computer aided manufacturing 26. Its Quality Improvement Practice Program involves large companies to help small firms in meeting quality standards. Similarly, the Penang Skills Development Centre is a joint venture of the private and public sector for meeting training needs of Malaysian industry. The state government provided the premises and grant for eight years and the corporate members contributed the seed money and other donations. A double deduction tax incentive is available to the private sector against the expenditure incurred for human development. Similarly, Singapore’s Local Industry Upgrading program is a joint effort of resident MNEs, its Economic Development Board and the local industry27.
Among the best known vocational training programmes is the long standing system prevalent in Germany. This system is a unique example of widespread public private partnerships, as well as cooperation between their federal and state governments. Most German school leavers who do not go on for higher studies go through such a apprenticeship programmes. The government has identified a large number of distinct technical vocations for both the industrial and service sectors. A base curriculum is prescribed for each of these vocations by the federal government. The state governments finance and run training schools which each apprentice attends for one or two days a week. Firms, both large and small, employ these apprentices who work and receive on the job training for the remaining three or four days a week. Finally, the qualifying examinations are conducted by local commercial and industry associations. Thus there is effective participationa by federal and state governments, industry associations and firms. Apprentices are funded by their firm employers, though these wages are lower than those for fully qualified technicians.
The Expert Group recommends that the central government initiate a special exercise to start a training programme for technicians in both the industry and services sectors. A mechanism should be evolved to obtain participation in this activity by companies, industry associations, state governments and the central government. The Ministries Industry, Labour and Education should set up a special Task Force to work out the modalities for such a scheme and provision should be made in the Ninth Five Year Plan for the provision of seed capital. The Task Force should have adequate representation from state governments and industry associations. Once again, this idea should be initiated in selected clusters to begin with where the felt needs for such training are obvious, and where firms are willing to contribute. The Malaysian example quoted above could also be used to found skills development centres in clusters for ongoing training for mid-career workers. The Expert Group recommends that state governments should make provision for matching funds to be provided for establishing such skills development centres.
India needs to emulate such programs as this would be the quickest way to acquire expertise especially in manufacturing processes, quality control and standardisation. Suitable tax incentives should also be devised to make this possible.
In the area of enterprenurship development, inspite of having a number of national and state level entrepreneurhip training institutions, only around 10% of the potential target could be accessed through new enterpreneurship training facilities, the Committee feels that efforts to create and develop entrepreneurship training institutions are highly imperative in every state. Simultaneously, the performance of the existing state level institutions must be reviewed and strengthened. The NEDB can shoulder this responsibility with the help of national resource institutions in the field of entrepreneurship.
Through the provision of appropriate training, a cadre of ‘Professional Management Assistants" (thus replacing the currently used inappropriate term ‘Barefoot Managers’) needs to be created for effectively facilitating the functioning of the tiny sector. the managerial deficiencies now rempant in units in the lower size categories of investment could be removed to a significant extent by making the services of this cadre available to them.
6.63. Marketing Assistance
Marketing is the core strength of a successful enterprise. SSE enterprise by sheer size of the organisation has not been able to have resilience or wherewithal to incur expenditure on marketing activities, many of which being intangibles were not financed by formal sources. Identifying ‘marketing’ one of its trust areas, SIDBI has initiated action in providing assistance for tangible marketing activities like setting up of a show rooms, warehouse, organising trade fairs / exhibitions both in India and abroad and permanent exhibition centres. The finance for meeting intangible expenses of SSE such as cataloguing, advertising, branding and participation in trade fare and exhibition in also provided by SIDBI. Similar facilities should be made available by commercial banks which can resort to guarantee from local community / industry associations. In the post-liberalised environment, patenting and branding are to be increasingly encouraged for which there is need to set up separate fund. The Expert Group suggests that, on the lines of Marketing Development Assistance Fund set up earlier in EXIM Bank with World Bank assistance, a fund be created and operated through SIDBI for assisting a targeted SSE exporting units numbering around 5000 in the 9th plan period. The India Brand Equity Fund (IBEF) of the central government may also be suitably enlarged in order to enable the SSEs to have a share in the assistance from the IBEF.
Market Development for the Tiny Sector
Marketing is another area that poses challenges to the tiny sector. Strengthening the links of the tiny sector with the rest of industry is one aspect of ensuring markets for the former, especially in the capital and intermediate goods sector. The Expert Group recommends that a suitable mechanism be evolved to promote marketing outlets specialising in marketing the products manufactured by the tiny sector. Efforts may also be made to develop common brand names for such products. We do, in fact, have a few such successful initiatives in India by NGOs LIKE Sarya Shanti Ayog (SASA), Calcutta and Orissa Rural and Urban Producers’ Association (ORUPA).
Franchising
The marketing of SSI products and services can also be promoted by a more widespread adoption of the system of franchising. We have already recommended the removal of the 24 percent limit on equity holding in SSEs by large companies and foreign investors. This removal would make it easier for franchising companies to take equity positions in SSEs which become their franchisees. This would be applicable for both manufacturing and service SSEs. The restoration of the excise duty exemption for branded goods as also recommended would also help in the promotion of franchising as a concept in India.
6.64 Government Procurement And Market Promotion
Government currently procures 409 products from the small scale sector on a preferential basis and pays a premium of 15 percent on them. Data from the Directorate General of Supplies and Disposal, however, showed that in 1982-83 purchases from small companies accounted for only a small fraction of less than 12 percent of its total buying for such products. Moreover, the buying was mainly from the larger units among the small companies 28. The reasons for procuring from the larger companies seems to be the relatively lower transaction costs of dealing with the larger companies.
The old system of preferential procurement by the government is in obvious need of change. Involuntary purchase by the government is against the basic principles of free markets. Such a system also perpetuates technological obsolescence in small companies since it does not demand improvements in quality. In any case, government procurement will not be a significant factor unless means are found to loer the transaction costs of purchases from the small scale sector. Moreover, small companies lose interest due to long delays in payments to small companies.
The effectiveness of government procurement can be enhanced by co-operation with cluster associations. Transaction costs can be lowered if orders are placed with cluster associations and they distribute the work to individual companies. These cluster associations can also mediate with the government for prompt payment of bills. Collaboration with cluster associations can also enable the government to procure goods of superior quality without a proportionate increase in price. This will be possible if technical assistance is dovetailed with procurement.
Experience in other countries confirm that procurement coupled with technical assistance is an all win approach 29. A striking example is that of the Brazilian state of Ceara where the Industry and Commerce Department organized such a program in collaboration with the Brazilian SME assistance agency and associations of small producers. The Education Department of the state agreed to voluntarily purchase wood products from associations of small companies if the price and quality was competitive. The Association agreed to guarantee the quality and product warranties and would take back the fault products returned by the Education department. The only subsidy in the entire program was a down payment of half the amount which the association had to repay incase of a default. In turn, the association lobbied with the government for technical training of the workers. The results are reported to be starting.
Marketing development is another activity where the government can play a catalytic role to elicit interest from private buyers. The government cannot play a useful direct role since a diverse range of marketing channels exits and not all of them are useful for all companies. Current research indicates that government intervention has been most useful in organising trade fairs where private distributors are invited to gain an exposure to the products of unknown companeis30. Also research has concluded that government can play a useful role in financing specific needs, such as marketing consultants, for market development.
Research done in India uncovers an unsatisfactory situation in marketing of small industry products. In general, small companies do not have a good reputation for quality and delivery31. In turn, small companies are harried by problems of prompt payment and uncertainty about their outlets. The most important channel is the wholesaler who offers relatively low prices but a stable outlet. On the other hand, prices are higher closer to the final consumer where the prospects of a brand presence improves.
Clearly, linkages with markets have to be strengthened if small enterprises are to grow. The emergence of department stores in the country opens a new and a promising opportunity for small firms which can be realized with adequate attention on quality improvement. It is well known that department stores are keen on direct links with manufacturers but are unable to achieve this because large companies have established relationships with traditional distribution channels. Small firms do not have such loyalties and would be willing to sell to department stores. However, consistency in quality and prompt delivery would be absolutely important before department stores agree to by from small companies.
The Expert Group recommends that an effort be made in collaboration with clusters associations to build links with department stores. A program be undertaken for greater exposure to high quality products available with small companies. Technical assistance should be made available through BIS for small companies to meet the desired standards of quality. The cluster associations should stand guarantee to the quality of the product. A market development fund should finance a diverse range of activities to improve access to markets.
6.65. Information Services
The Expert Group is dismayed by the reported paucity of information available to entrepreneurs and that it is not disseminated in an organised from by reputed data base companies. It is also disturbed by the fact that the pioneering effort of NISIET in Hyderabad to develop a specialised data base, SENDOC, for small companies has tottered due to budgetary cuts. This is an extremely regrettable situation particularly because the Internet has created a new environment for an explosion of information services greatly adding to the convenience of doing business in the small scale sector.
The recent survey of the Friedrick-Naumann Stiftung and NCAER fund that information services are either neglected or there is no systematic way to collate and disseminate them. Thus forty nine percent of the DICs, which are potentially the links with information sources, report that there is no accepted way to regularly source information from the SISIs NSICs, etc. Another 21 percent report that information is exchanged only on request32. Similarly, thirty nine percent of DICs did not carry out a any area development survey and 45 percent had not undertaken any industry potential surveys33.
A great deal of stress is laid on information services in clusters that have succeeded overseas. This is well illustrated by an example from Italy. CIRER34, located in Modena in Third Italy, specialises in knitwear and keeps artisans informed about prices and nature of yarns, technological developments, fashion and market trends. CITER was initially financed with public funds when it was created in 1980 but government’s share declined to 30 percent of the budget a decade later. The remaining budget is financed by subscriptions from members or from earnings. The regional development agency of Emilia-Romagna, ERVET in Bologna has inspired other such sector specific centers for shoes, farm machinery etc.
The upshot of this very revealing background is that considerable effort is required to create a data base industry in India. This would mean that data base vendors should have access to sources of information in the various government departments. Conversely, the government should have a policy to price information. In the absence of legislation on freedom of access to information, a policy for preservation and sharing of information does not exist in the country.
The Expert Group has already recommended cluster based organisation for providing technical support to small scale enterprises. One of their specific functions should be to provide Internet based information services to their constituents. It would be easier to do this on the basis of clusters since there would be specilisation in the kinds of industries located there. With technical and trade opening of the economy, SSEs can benefit greatly from the ready availability of information on sources of raw materials, intermediate goods, capital goods and technology. Similarly, SSEs can build up on line relationships with customers as well as suppliers. The availability of such information will enable SSEs to source their need from the best suppliers and sell to the best customers, thereby making them more competitive.
A great amount of technical marketing and other information is now available on Internet. Most of the enterprises that are entering this information service segment around the world are small scale enterprises. In India also we are witnessing many small technocratic entrepreneurs entering this business. The Expert Group recommends that the provision of such information services be recognised as eligible SSE activity and be made eligible for commercial bank and SIDBI funding.
The Expert Group recommends that the Ministry of Industry should set up a Task Force with the participation of the apex industry associations to set up such information systems at the cluster level. Issues of secretary, sale and dissemination should be examined as well as a beneficial law governing the information industry. The proposed committee should also examine the implications of VSNL’s monopoly in the Internet and NIC over information services.
6.7. Infrastructure Development
Historically, the State Industrial Development Corporations (SIDCs) were conferred the authority to acquire land, develop it as industrial estates and sell sheds and plota to enterpreneurs. Their mandate did not include the development of related infrastructure such as effluent treatment, power, etc. The central government scheme of Integrated Infrastructure Development and the SIDBI scheme of "development of Industrial Areas" have not really taken off so far35. In the future, industrial parks should develop all the distinct components of infrastructure and not just land.
The clusters of small industry, spontaneously formed, have expanded to a level where their further growth will not be possible without rapid development of their infrastructure. The private sector will find it attractive to invest in such regions because their residents have a high willingness to pay for public services. In some cases, such as in Tiruppur, the local associations have already taken the initiative to persuade financial institutions to invest in infrastructure development and a scheme for the integrated development of infrastructure is already under way.
As has been documented elsewhere, most of the existing SSE clusters have developed spontaneously with minimal organised governmental support, though there are some which have been developed by government agencies. A great deal of productivity improvement can take place in these clusters if the infrastructure environment is enhanced in these places. The provision of basic services such as water supply sanitation, roads, reliable power supply and labour welfare. The Expert Group therefore recommends that both central and state governments redirect their existing growth centre and other infrastructure development schemes to the infrastuctural development of existing SSE clusters.
The available information suggests that the progress in the construction of large infrastructure projects is impeded by the low level of participation by the government. The state needs to share some of the risks and subsidies some components of projects especially where social benefits are higher than the private gain. Furthermore, the government can play an important role as a guarantor. In the interest of speedy development of infrastructure, the government may have to also share some commercial risks, in the initial stages, to attract greater interest from the private sector.
Several considerations have a bearing on the success of industrial estates and the interest they elicit from entrepreneurs. Above all, intangibles such as services contribute to the convenience of doing business in an industrial estate. A coherent design of the estate and its appropriate location is essential to attract investment from a single industry. Considerable expertise and ingenuity goes into developing a property that satisfies the users and this is best done by specialists.
India, moreover, needs expertise to cater the emerging demand for science and incubation parks as seedbeds of technological innovation. These parks have burgeoned in developed and some newly industrialising countries to commercialise technology transferred from universities. Indian educational institutions have evinced interest in science parks as a means to commercialise their intellectual property36. One of the projects for technology incubation at Pune has succeeded and the experience can be reproduced in other cities such as Bangalore37.
The Expert Group, therefore, recommends that private sector investment be encouraged for the development of industrial parks. State governments have invested significantly in existing industrial estates and growth centres. Some have functioned very well and others have not. The existing estates provide a good opportunity for state governments to invite private sector participation in their upgradation and management. This could raise resources for state governments to invest elsewhere, while improving the functioning of existing estates. But a clear framework for these activities would be require, and rules of the game regarding rights, responsibilities and duties of industrial park companies would have to be made transparent. In countries such as Thailand and Indonesia, the private sector plays a key role in the development of industrial estates.38 As also proposed by the Expert Group on Commercialisation of Infrastructure Projects, we also recommend that state governments set up State Industrial Parks Promotion Authorities (SIPAs) which will regulate the setting up of industrial parks and assist and negotiate with the private sector for their participation. SIPAs will prepare a database of enterprise, regional dispersion of industry, etc, to identify locations for industrial estates and the timing for their construction. They will also review policy periodically based on the experience gained.
Many of the older industrial cities suffer from the existence of old decayed industrial areas, usually located in what is now the central city. A coordinated approach to these areas could help in regenerating these decaying areas while providing a new thrust to SSE development: these areas, being in the central city, are ideal for the development of SSEs, both industrial as well as service enterprises. The re-use of the land would provide enough resources to help in liquidation of the existing sick enterprises, usually large enterprises, which are currently located on this land. These sites are ideal locations for science and incubation parks referred to above. Information intensive, non polluting, labour using SSEs could profitably be encouraged to come up in these areas. The Expert Group recommends that state governments identify such areas and initiate action to initiate these industrial (science and incubation) parks in such cities.
As mentioned, a policy framework will have to be created to attract investment in industrial parks. For one, industrial parks should be defined as infrastructure to distinguish them from real estate business. The state governments or the proposed SIPAs should prepare guidelines that will from the basis of investment in industrial parks. In particular, they should enunciate the terms for land use conversion and transfer land. Presently, the rules should spell out whether foreign direct investment is possible in companies’ formed to develop and operate industrial parks. Finally, a decision has to be taken on whether profits from land sale can be repatriated. We recommend that only the dividends of the special purpose vehicle be allowed to be taken back.
Similarly, the participation of the private sector will entail writing rules governing the relationships between the estate developer and the residents. Most companies hosted in the parks will prefer lease contracts as a means to reduce their risks. It is unlikely that the developers will be at ease with the existing rent control acts skewed in favour of the tenants. Private developers offering maintenance services, including the interface with civic bodies would expect adequate authority to penalise defaulters. Field studies have indicated that tiny enterprises show a marked reluctance to relocate in industrial estates. Household enterprises economise their overhead costs by undertaking work at their dwellings. It is, therefore, recommended that the craft enterprises be allowed to exchange their present houses for properties in industrial estates where they can work and live.
In recent times, land acquisition by the government has bogged down in innumerable legal disputes as landlords have learnt to defend their rights in the courts. The conflicts arise when the landlords have to involuntarily part with their titles to conform to public purpose clause, under the Land Acquisitions Act, 1895, that the government typically invokes. Landlords make their own assessments of the future value of the land an contest the acquisition when their compensation is less than their estimated present value of the property. In the courts, landlords take recourse to one of a variety of injuries an damages clauses since the law protects the original owners from them. Appropriate action has to be taken to resolve the current impasse in acquisition of land.
One way to overcome the problem is to offer landlords tradable rights in exchange for their land. At the outset, a modest down payment is paid by the landlords in order that the viability of the project is not jeopardised by high fixed costs. However, landlords will benefit from the upside potential of the project. Such tradable rights, called development rights, have been successfully implemented in New Bombay39. However, widespread use of this method will also requite the development of a secondary market for land rights.
Secondly, the government often possesses land which it is unable to sell to the private sector due to restrictions on transfer decreed by the Land Acquisition Act. Under the circumstances, the option of contributing government owned land in lieu of equity in a private sector should be explored. The law should not prove to be a barrier especially if a project is structured as a BOT vehicle.
The emerging situation allows recourse to alternative means of development of infrastructure, viable at the regional level, such as co-generation and sale of captive power. The supply of electricity can be increased by trading electricity generated by co-generation and captive power. Since companies specialising in small power stations such as Bechtel Energy Works, GEC Alsthom and ABB have set base in India and free import of small size turbines is now possible, the potential of co-generation can be realized. However, rules for the sale of power to the grid have to be laid down before full capacity utilisation of cogeneration and captive power will be possible.
Telecommunications infrastructure is another crucial ingredient of the quality of services that private industrial parks would want to offer. In services export industries, teleports from the bedrock of the transport infrastructure and have been utilised with telling success in Jamaica 40. Moreover, the internet offers an indispensable and cheap means to communicate with the world for small and medium scale enterprises. In India, the software technology parks have had a privileged access to advanced telecommunications facilities courtesy the Department of Electronics. Other parks should also have access to comparable telecom facilities on the same terms as those available to the software industry.
Speed of delivery has become the decisive instrument of competition in world markets offsetting the labor cost advantage of exports by small and medium scale enterprises in India. The transportation infrastructure is not able to cope due to a variety of administrative barriers. The first step towards accelerating delivery time has been taken by the installation of inland container facilities, including custom clearance, at some of the clusters and have been unanimously well reveived41. This can be extended to all other centres. The linchpin of speedy delivery, however, is a system of electronic commerce grounded in a national information infrastructure. A host of regulatory barriers, however, stand in the way of creating such an infrastructure that is becoming the standard in other countries.
Shifting of Polluting SSE Units to Conforming Area.
Some of the SSE clusters have happened to come up in certain urban and metropolitan areas and are now causing unacceptable levels of pollution. Courts are acting on citizen, NGO and government complaints to force such SSEs to relocate their units from non-conforming areas to conforming areas. Besides providing infrastructure in the conforming areas, a strategy has to be devised by the concerned state governments in co-ordination with institutions and banks for providing need-based facilities / finance to these polluting units for shifting their enterprises in the conforming areas. Installation of in-house effluent treatment plant and common effluent treatment plants in the clusters may also have to be supported by these agencies.
State governments should also have the latitude to decide on the terms for entering into partnerships with the private sector. A variety of mechanisms such as leasing of the estate, contracting of services, management contracts or special purpose vehicles can be designed in accordance with the objectives to be achieved and the peculiar characteristics of the regions. Moreover, feedback from cluster associations should be sought to avoid errors made in the past.
6.71 Role of Business Associations
Private business associations need to be brought centre stage to benefit from their counsel, sources of information and potential for supervision. The Expert Group has recommended the participation of business association in a whole host of activities. Subsequent of the economic reforms the national level business associations have got rejuvenated and are now undertaking many more promotional activities for their constituents than before. However, at the local level, business associations still function largely as lobbying groups. Historically, business associations have only clamoured for the indulgence of the government even if it was at the expense of the larger interests of the community. Lately, however, setbacks in some of the export markets, stringent implementation of environmental laws and congestion of the infrastructure has jolted a few of the associations into collective action for the improvement of the business environment. The government, particularly at the state level, must initiate action to activate the city / cluster level business associations so that they can participate actively in the many activities recommended in this report. Support to SSEs can bot be delivered by the government alone but it should actively participate in designing all the support mechanism indicated, particularly by way of providing matching funds. The central government should open a purposive with the national level business associations to help in this endeavour at the local level.
Some of the notable initiatives have come from clusters where the business community is not divided. The Mahratha Chamber of Commerce and Industry in Pune, for example, has promoted 6 institutions including an Institute for Business Research, the Pune Stock Exchange and is currently constructing an International exhibition complex 42. The Tiruppur Exporters Association has been boldest and has developed an industrial complex, it has a scheme for effluent treatment and has invested in a school. On the other hand, the cluster at Jaipur has a pressing need for an effluent treatment plant but is unable to raise resources. Government collaboration in such projects, by way of part funding or selective subsidisation, will send out clear signals to other associations to take similar initiatives.
Greater co-operation of business associations is essential, at this juncture, given the nature of the objectives to be accomplished. Private participation in infrastructure development raises several contentious issues of risk sharing and pricing of goods previously available free to consumers. Business associations can also be instrumental in dissemination of information and resolution of disputes.
Moreover, the design and location of industrial parks and other infrastructure projects will require feedback from the industry associations to ensure that the felt needs of their members are met.
A great deal of thinking and work is required to devise mechanisms for industry and business associations to act as promotional and extension agencies for SSEs. This may require the scanning of practices in different countries. The activist role of industry associations is perhaps most developed in European countries, and particularly in Germany. The Expert Group recommends that the Ministry of Industry should initiate a programme of technical assistance from the European Union or other bilateral sources to bring this about.
Naturally, participation in this programme must be sought from the industry associations themselves. A programme of partnering local level industry associations with their counterparts abroad should also be pursued.
6.8. Institutional And Legal Innovation
The Expert Group analysed the reasons for the tardy progress in the reform of the byzantine social legislation governing the small and medium scale industry. It came to the conclusion that alternatives to the antediluvian systems for insurance and social security, currently in practice, have not been found to substitute existing systems. Earlier attempts at reform have been mired in the conflicting perceptions of individual ministries supervising the diverse laws. The nuisance of corrupt inspectors goes unchecked due to low liability for negligent and arbitrary implementation of the low. Finally, the implementation of environmental laws could be simpler and more effective if recourse to deterrence mechanisms is taken instead of administrative methods.
Presently, the idea and definition of small enterprise stems from the Industries (Development and Regulation) Act, 1951. It is quite clear that this legislation does not adequately reflect the concerns of the small enterprise sector. the I (D&R) Act is basically structured to regulate large industries through mechanisms such as licensing, and the like. For that reason, it applies only to scheduled industries. Rightly, the administration of small industries is a state subject. Typically the state governments could have their own laws to support small enterprise development. However, a uniform promotional framework is desirable to service the overall interests of promoting the small enterprises with a view to equitable growth and development. The uniform framework will also enable compatible structure vis-à-vis banking institutions, corporate bodies and issues of national concern such as employment, rural development and social welfare.
The Expert Group, therefore, recommends a separate law for small enterprises. The objective of the law would be to define the small enterprise sector and outline the broad framework for the promotion of the sector. A single law for small enterprises will be a superior instrument for governing these enterprises. Among other things, the law could provide for:
- Definition of small enterprises
- Constituting the All India Small Enterprises Board under the law.
- Aspects of small scale enterprise promotion.
- Involvement of the industry associations in regulation an promotion activities. Constitution of appropriate "Industry facilitation councils" to resolve disputes and various concerns using techniques of mediation and arbitration.
- Voluntary registration of small scale enterprises.
- Provision for labour welfare measures for all small enterprises. Provisioning also for all clearances and approvals through a single agency.
Such a single business law called the "Basic Law for Small Enterprises" will be a superior instrument for governing small enterprises. This will obviate the need for a host of ministries administering diverse laws such as the minimum Wages Act, the Shops and Establishments Act. Workmen’s Compensation Act, as applicable to SSEs etc. Such a law can be implemented by the normal judicial process.
The Employee State Insurance Act, as it is administered, inflicts immense costs to the employer as well as to the workers. The utility of ESI to workers is low since government doctors attend to them after a considerable lapse of time and usually medicines are often not available in stock. As a result, the poorer households have shown a marked preference for private hospitals and nursing homes. Employers suffer productivity loses due to the time spent in dealing with officials. It is, therefore, suggested that employers should be allowed to meet their obligations by paying for medical insurance under the Workmen Insurance Scheme.
Similarly, the Provident Fund Act is implemented at high costs to the employers as well as the employees. Ideally, the alternative of paid systems of social security will be more beneficial since higher returns can be realised in the capital markets. However, it will be a while before private pension funds are allowed to enter Indian capital markets. In the interim, the employers should be allowed to mark contributions to the Public Provident Fund. This will relieve them of intrusive government inspectors.
For the protection of the rights of workers, suitable provisions can be made in the Basic Law for Small Enterprises. the state can meet its obligations towards workmen by creating a fund for legal aid. A part of the finance of the fund should be sought from the employers.
The working of labor laws has been a thorny issue for the small and medium scale enterprises. labor laws have little utility since they are evaded by the simple expedient of keeping employment below the threshold level, specified by the IDR Act, for the enforcement of labor legislation. It is recommended that the threshold level for the application of the labor laws is raised to 50 for units using power and 100 without power. The interests of workmen can be taken care of by instituting a system of unemployment insurance paid for jointly by employers and employees.
Finally, the survival of small and medium scale enterprises has been threatened by environmental laws. In some regions in Tirrupur, Madras and Jaipur, business associations have risen to the occasion and have organised common effluent plants. However, the Jaipur cluster has been unable to raise the capital required for such a plant. The initiatives of provate business associations should be supported by capital subsidies.
Moreover, aggregate pollution levels for each cluster can be set and the precise means to achieve them should be left to the local association. The units unable to lower pollution cost-effectively should have the option to pay others to do so. These aggregate pollution levels are implemented equally effectively by deterrence mechanisms such as imposition of fines when chear evidence of violation of laws is found.
The issue of inspector raj is a thorny one. As long as there are laws which govern different aspects of regulation – labour welfare, labour safety, labour social security, equipment safety, statistical reporting, environmental laws and the lime-systems have to be devised for their compliance, the main system being used currently is that of inspection by inspectors, and the result is "inspector raj" the ills of the system are acknowledged by all industry and government representatives alike, but solutions offered so far have been few. The Expert Group offers the following suggestions:
- Review and Modernisation of Laws: There is now adequate identification of all the laws effecting the functioning of SSEs (e.g. the Mahapatra Commttee Report. The Report of the Committee to Suggest Simplification of Procedures of Various Approvals of Industrial Projects at the State Level" (1994) constituted by the Ministry of Industry, and many reports compiled by business association). We can scarcely improve on their suggestions, We can only recommend that governments at both the state and central levels review these reports and act on them. Our generic suggestion is that modernisation of outdated laws, repeal of obsolete ones and greater transparency will do much to mitigate the tyranny of the arbitrary inspector raj.
- "Clustring" Inspectors: while the government acts to simplify and modernise laws, it is necessary to act immediately to reduce or eliminate the harassment of SSEs. Governments at both central and state levels must "cluster" inspectors to eliminate repeated inspections by inspectors from different departments. Different departments must be made to cooperate so that inspection where necessary is done on a consolidated basis. Further, the recommended cluster associations should participate in this activity in order to eliminate harassment and corruption.
- Random Selection: A move must be made towards self certification in the compliance with the different laws that govern SSE operation. SSEs could be asked to specifically certify that they are complying with the regulations that affect them. Beyond that inspection could done periodically on a random basis. This can be made transparent by an open drawing of lots on a monthly basis through a random number generator in defined special jurisdictions. Once again business associations can assist in this activity to promote transparency.
Institutional Innovation
In the vision for the structure of promotional institutions recommended, government funding bodies will play a key role. It is suggested that autonomous Enterprises Business Services Funds be created at the state level to finance a variety of projects in collaboration with the private sector. They would be able to garner funs from multilateral funding bodies as well international and national donor would be able to garner funds from multilateral funding bodies as well international and national donor organisations if they are governed by an independent board outside the government. A guiding principle of such funds would be that disbursements will be made only against specific projects suggested by state governments or by business associations. The funds should be staffed by experienced professionals with proven ability to judge the value of schemes proposed for financing.
The central government should take the initiative and provide the seed money for creating such funds in a few states. States should be made to compete for the seed money and those contributing the highest matching funds, including contributions from their private sector, should be selected. This will ensure that adequate commitment is forthcoming for such projects.
Finally, the need for a restructuring of MSME-DO has been indicated in order to make it much more functional. The Expert Group recommends that the Industry Ministry appoints professional management consultants to assist in this restructuring.
In order to act on the many suggestions made in this report the Expert Group recommends that the ministry of Industry set up a Steering Committee under the chairmanship of the Industry Minister to oversee the evolution of the new policy approach suggested. This Steering Committee should consists of representatives of the key government departments concerned, of business associations, of the banking system and of state governments. The Industry Ministry should recommend to state governments to set up similar Steering Committees at the state Level. This Steering Committee should compile regular progress reports on the actions taken in support of small scale enterprise development on a quarterly basis and issue them for public information.
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