It has been reported that the government will soon change the way it defines the micro, small and medium enterprises (MSMEs). "We will have one meeting and then finalise it (changes to MSME definition)," Union Minister Nitin Gadkari told news agency PTI, adding that extensive changes will be made soon. In August, Finance Minister Nirmala Sitharaman had said that the government would consider shifting to a “single definition” of MSMEs. The change in definition would require an amendment to the MSME Development Act. In February last year, the Union Cabinet had approved amendments to the MSMED Act and had decided to choose shift from a criterion of classifying MSMEs based on 'investment in plant and machinery' to a criterion based on 'annual turnover'.
What is the importance of the MSME sector?
According to a Reserve Bank of India report, the MSMEs are amongst the strongest drivers of economic development, innovation and employment. Looking back at data since 2000-01, MSME sector growth has almost every year outstripped overall industrial growth in the country.
“The MSME sector also contributes in a significant way to the growth of the Indian economy with a vast network of about 63.38 million enterprises. The sector contributes about 45% to manufacturing output, more than 40% of exports, over 28% of the GDP while creating employment for about 111 million people, which in terms of volume stands next to agricultural sector,” stated the report.
However, the RBI report also noted that at present the sector is “exceedingly heterogeneous in terms of size of the enterprises and variety of products and services, and levels of technology employed” and that it has the potential to grow at a much faster rate. One of the key attractions of this sector is that it huge employment generation potential at relatively lower capital investment.
How are MSMEs defined at present?
There has been no uniformity over the years about the definition of what exactly one means by “small scale industries” in India. Moreover, the definition also changes from one country to another.
In India, for instance, under the Industrial Development and Regulation (IDR) Act, 1951, small industries were conceived in terms of “number of employees”. But it was found that obtaining reliable data on the number of employees was difficult. As such, a proxy was found – and this was to look at the investments in plant and machinery; it was relatively easy to reliably ascertain and verify this data. So at present, the classification of MSMEs is done based on investment in plant & machinery/equipment (see table) in accordance with the provision of Section 7 of the MSMED Act, 2006.
Classification of MSMEs in India at present
How do others define MSMEs?
According to the World Bank, a business is classified as an MSME when it meets two of the three following criteria: employee strength, assets size, or annual sales. According to a 2014 report, as many as 267 definitions were used by different institutions in 155 economies. But the most widely used variable for defining an MSME was the number of employees -- 92% of the institutions use this. Other definitions were based on turnover as well as the value of assets (49% and 36%, respectively).
Around 11% used other variables like loan size, formality, years of experience, type of technology, size of the manufacturing space, and initial investment amount etc.
The crucial thing, however, is that most of the countries used only one variable to define MSMEs.
How does a change in definition help?
Definitions based on investment limits in plant and machinery/ equipment were decided when the Act was formulated in 2006. But such a definition “does not reflect the current increase in price index of plant and machinery/equipment,” stated the RBI report. Moreover, MSMEs, thanks to their small scale of operations and informal organisation, MSMEs don't always maintain proper books of accounts. This essentially results in their not being classified as MSMEs.
The change of definition is likely to improve the ease of doing business for MSMEs, and in the process, make it easier for them to pay taxes, attract investments and create more jobs. Gadkari said that MSMEs have created 11 crore jobs till now, but "now, the mission for five years is that we need to create more than five crore jobs in five years, particularly in tribal, rural and agricultural areas".
The clear and unambiguous definition – that is also in consonance with global norms and learns from the best practices across countries – is the starting point to reforming this crucial sector of the economy.