A Model Comprehensive MSME Policy for Indian States

Executive Summary

Small businesses are the job-creating engines of any healthy economy. Having a supportive policy environment can help high-potential businesses accelerate. Creating such an environment is a shared responsibility of both the central government and India’s 28 states.

Many state governments in India have piecemeal policies and programs to support micro, small, and medium enterprises (MSMEs). About one-third of India’s states have worked to craft multifaceted and supportive policies and practices to encourage MSME growth. This paper reviews the ideas already enacted in different Indian states, as well as in national and subnational governments around the world.

Developing a single comprehensive MSME policy is an effective approach for a state-level government to consider. It allows small firms to find policy incentives and programs in a single place, and perhaps most importantly, it allows a state to directly consider a range of intertwined incentives that can work together. This will maximize the positive impact to small firms that are poised for growth.

Facilitating the growth of MSMEs will have a much wider impact on India’s job growth overall. The large multinational manufacturers that India hopes to lure to invest through programs like Make in India require a diverse and efficient network of suppliers. Supporting MSME growth can create a multiplier effect—driving new investment and employment generation by larger firms. The central government has affirmed a 25 percent target of gross domestic product (GDP) for manufacturing, up from around 14 percent today. 

This white paper provides leading international examples in the promotion of small businesses, while also enumerating best practices from Indian states’ MSME policies. The final section lays out the 30 elements commonly utilized by Indian states to offer targeted assistance to MSMEs as a roadmap for other states that want to provide best-in-class policy interventions.

This white paper is the third in a series of four white papers focused on Indian state-level business reforms. The first paper focused on small business procurement policies. The second paper looked at cluster development policies.

Note: In some instances, in this paper, the term small and medium enterprises (SME) is used instead of MSME. SME removes the “micro” sized firms which often have particular needs and are too small to avail of some support programs.

Elements and Impacts of Comprehensive MSME Policies

The Importance of Small Businesses

Small business policies are considered an important part of most countries’ industrial policy due to MSMEs’ job generation capacity. The Indian government estimates the nation hosts around 60 million MSMEs, which collectively employ 111 million people—around 25 percent of total national employment. MSMEs contribute 28 percent of GDP and 40 percent of India’s exports. Of these categories, “micro” firms (less than 600,000 USD in turnover) make up around 95 percent of the market.

Job creation is crucial as India slowly undertakes agricultural reforms. Today, India’s agriculture sector employs around 43 percent of workers, yet produces less than 17 percent of GDP. While the Indian government backed down from a package of agriculture reforms in 2021, smaller reforms continue to provide space for Indian farmers to expand and improve productivity. This would likely cause further reductions in farm workers—and a widening pool of semi-skilled and unskilled laborers that must be absorbed by other parts of the economy. Some initial reports about “post-Covid-19” economic shifts indicate that seasonal workers are finding lower-paying roles than in previous off-seasons.

The world is in the middle of a substantial realignment of global supply chains. Rising labor costs, trade imbalances, and security concerns have all collided to force companies to consider supply hubs outside of China. Often, Indian officials seek to court large manufacturers to consider new investments. They note the steady liberalization of foreign direct investment (FDI) policies, India’s improved rankings in global business indices, and the growing domestic market. However, another element large manufacturers must consider is the health of the supplier ecosystem. For example, Ford Motor Company notes that they have around 1,200 Tier 1 production suppliers. Boeing has over 11,000 Tier 1 suppliers globally. Lockheed Martin notes a network of 15,800 active suppliers. Procter & Gamble boasts of a network of more than 60,000 suppliers. For firms like these, having a network of suppliers ready to grow commensurately can improve Indian states’ overall attractiveness as a manufacturing hub.

India’s state governments should also carefully consider policies that support young MSMEs but do not create constraints to continued growth. Globally, older small firms have less impact on job creation than either young firms or larger firms, so governments should choose policy options that avoid creating a “growth trap.” Policies should be framed in a manner as to encourage continued growth instead of stagnation.

The Specialized Needs of Smaller Firms

Even after 30 years of liberalization, firms of every size in India can list off a range of issues that preclude their growth to some extent. Some of these are policy issues, while others are operational issues, such as the low quality of infrastructure. While much of this list is shared with larger firms, some of these factors have a more acute impact on smaller firms.

Some key examples of the operational barriers that often have an outsized impact on smaller firms include:

• Weak electric power grids: Larger firms may have the capacity to invest in redundant or independent electric power sources. Smaller firms are less likely to be able to invest in such capacity.
• Water systems: Many industries require purified water as part of their manufacturing processes. Larger firms may have the capacity to invest in improved water sources or in improving the quality of municipal water, while smaller firms are less likely to be able to do so. This is also true for the treatment of effluent discharge.
• Legal restitution of business disputes: As business disputes occur, larger firms have more negotiating clout and may be able to resolve disputes before going to court. If they do go to court, larger firms have the capacity to hire the best legal counsel and wait longer periods for decisions. For smaller firms, securing legal restitution through the courts can cause tremendous hardship.
• Access to information: Indian state policies can be difficult to find, even online. Smaller firms may not be aware of government policies and programs meant to accelerate their growth and improve operations.
• State compliances: Larger firms are more likely to have a focused team that can complete state compliances in areas such as taxation, labor, and environmental regulation. For smaller firms, such compliances place a real burden on management, distracting from other critical operational issues.
• Access to resources or inputs: Larger firms will have a greater capacity to negotiate with resource and input providers. Larger firms may offer advantages to a supplier such as pricing, transparency, size of supply contract, length of supply contract, and other factors.
• Climate change mitigation: As governments increase actions to combat the sources of climate change, firms may be asked to bear short-term expenses to reduce emissions. This could deeply impact smaller firms.

This list is far from exhaustive but provides some idea of how the business environment impacts firms of different sizes differently. Some surveys of MSMEs expand this list much further—studying topics such as labor unrest, availability of raw materials, and other issues where supportive government policies will need to be more creative and nuanced. Government policymakers should bear this in mind when looking for ways to boost job creation. Compared to large firms, smaller firms may not have the capacity to regularly petition the government on business affairs, so it will take greater effort to learn about the constraints smaller firms face—and how interventions can help.

Some recent surveys of small businesses in various geographies point to the difficulties faced by small firms and the effectiveness of various government interventions. Naturally, recent surveys must take into account the unusual factor of the Covid-19 pandemic. But across geographies and national income levels, it is striking—despite different types of questions, firms, and more—that similar issues are prioritized by MSMEs.

Existing Policy Interventions of Indian States

Ten of India’s 28 states have overarching MSME policies, either as standalone policies or as a focus section in the state’s larger industrial policy framework. Of these 10, four are expired and others were drafted by previous governments. The five states with “live” policies drafted by the incumbent governments are Andhra Pradesh, Gujarat, Haryana, Madhya Pradesh, and Tamil Nadu. The Andhra Pradesh and Gujarat MSME policy incentives are included in these states’ wider industrial policies.

Of course, every Indian state offers programmatic and policy support to nurture MSMEs, but such policies are rarely developed as part of an overarching MSME policy.

Source: CSIS research and analysis.

Five common themes are commonly found in existing states’ MSME policies:

• Financial Support: Assisting with MSME finances through funding support, reimbursements, and financial incentives.
• Compliance and Regulatory Support: Offering measures to reduce the burden and cost of compliance. This often takes the forms of reduced paperwork or subsidies related to costs like registrations, certifications, power charges, state taxes, and more.
• Infrastructure Support: Improving MSME infrastructure access through MSME cluster or park development. Also, offering concessions for availing infrastructure or providing a seat in existing state infrastructure.
• Marketing Support: Improving MSME’s marketing efforts through state procurement and market linkages.
• Boosting Central Government MSME Programs: Strengthening MSME development institutes and facilitating central MSME schemes, including funding schemes and distressed asset schemes specifically. Also includes establishing or strengthening MSME facilitation councils in the state.

Highlights of Select Indian States’ MSME Policies

Existing Policy Interventions: Global Examples

Creating policies to support small firms is not unique to India. Many national and subnational governments around the world have targeted support programs to help smaller firms accelerate growth.

Examples of MSME Intervention Successes

Policies and programs require regular monitoring and impact assessments to ensure that they are being carried out successfully at the envisioned scale and positively impacting the desired groups. The ultimate goal is facilitating business survival, business expansion, and job creation.

The best programs and administrators ensure that monitoring mechanisms require relatively low effort beyond the initial setup. For instance, several U.S. states integrate public procurement portals with small business targeting programs so that progress dashboards are easy to track, and course corrections can be made, such as the Statewide Procurement Data Dashboards from California—which is made publicly available to improve accountability. Another example is the COSTARS program in Pennsylvania, which connects buyers and sellers and has built-in tools to track the types of firms that are winning contracts.

Below are some country-wide examples of policy and programmatic interventions that have been linked to positive outcomes for small businesses.

Brazil

• SMEs receiving credit support experienced a 15 percent increase in their number of workers (three jobs per establishment on average).
• SMEs participating in a credit program observed a 2.4 percent increase in wages and an increase in the value of exports and trademark registrations. For every 1,000 firms receiving credit support, on average, about two of them registered a trademark.
• SMEs receiving export support increased employees by 11 percent on average and created an average of 2.6 jobs per establishment.
• Further, export support led to six additional trademarks registered for every 1,000 establishments.

Argentina

• Argentine SME support programs increased employment, real wages, and the probability of exporting by 14.3 percent, 1.4 percent, and 1.8 percent respectively.

Turkey

• SME policies on innovation found that access to capital, regional innovation programs, and institution-industry collaboration led to greater innovation.

Nigeria

• A 2015 World Bank report notes the many successes of Nigeria’s Youth Enterprise with Innovation (YouWiN) program for start-ups with a $50,000 prize. Existing firms that have won the contest have a 20 percent higher likelihood that the firm is still operational three years later, a 21 percent higher chance that the firm crosses the 10-employee threshold, and a 25 percent increase in profits.

Sri Lanka

• A 2012 study published in Science indicates one-time transfers to microenterprises in the nation is linked to higher survival rates and higher profits.

Policy Recommendations: Key Elements of a State MSME Policy

Main recommendation: The state should survey small firms to gauge the primary areas where policy reform and programmatic support will have the biggest impact. The states should further build a framework that incorporates accountability tools to track implementation and create a review mechanism to assess the impact of the policy on business survival, business growth, and job creation. The state should also consider appropriate methods for educating the public about these initiatives so that they are taken up by small businesses.

MSME model policy constituents: The model MSME policy contains various elements emanating from the six policy pillars outlined earlier in this report. Indian states are highly encouraged to implement a comprehensive policy encompassing all 30 elements listed below, prioritizing areas that are recognized as particularly crucial in individual states. Within a state, some policies may be reserved or augmented for targeted classes of individuals or less-developed regions.

Financial Support

1. Reduce fees for initial company registration.
2. Offer direct subsidies for new investments in plants, property, and equipment.
3. Offer rebates on state taxes, such as stamp duty and state GST.
4. Provide subsidies or rebates on interest costs.
5. Establish mandatory procurement preferences for MSMEs. This can include a target percentage and other incentives outlined in an earlier report.
6. Reimburse employers’ contributions to the Employee Provident Fund (EPF).
7. Have state agencies prioritize payments to MSME suppliers and partners.

Compliance and Regulatory Support

8. Allow self-declaration to a single state agency to allow a firm to start operations.
9. Provide a “graduated system” of reporting—micro firms have the fewest document submissions, followed by small firms, medium firms, and so on.
10. Create a digital land bank with incentives for MSMEs to acquire or lease land.
11. Remove less critical compliances for the first three years of operations.
12. Provide subsidies or reimbursements for domestic and international certifications.
13. Provide subsidies or reimbursements for submitting domestic and international patent applications.
14. Provide subsidies or reimbursements for the acquisition of equipment related to required product testing.
15. Create district-level “facilitation cells” that help local MSMEs through their approval processes.

Infrastructure Support

16. Create “clusters” with common infrastructure, especially for related industries, with key features covered in an earlier report.
17. Reimburse some percentage of the cost of electricity for business operations.
18. Reimburse or subsidize costs with securing additional sources of electric power, including rooftop solar panels and generators.
19. Reimburse or subsidize land costs.
20. Reimburse or subsidize land conversion fees.
21. Provide subsidies or reimbursements for the cost of upgrading information and communications technology platforms.
22. Provide subsidies or reimbursements for energy and water audits that can help the company save costs and increase productivity.
23. Provide subsidies or reimbursements for the costs of equipment related to energy and water audits.

Marketing Support

24. Provide subsidies or reimbursements for renting a stall at a trade fair or exhibition. This can be for both domestic and international shows.
25. Tutor MSMEs on the central government MSME procurement mandate, helping them win orders.
26. Create programs to teach MSMEs how to get online.

Boosting Central Government MSME Programs

27. Subsidize the cost for MSMEs to list on SME exchanges.
28. Create a targeted plan with the National Skills Development Corporation (NSDC) to link states’ needs with central government training.

Other Ideas

29. Raw Materials: Many MSMEs highlight the lack of availability of raw materials. The state can look at information tools to help link MSMEs with available stocks of raw materials.
30. Skilling: As with Haryana, the state can cover some of the costs MSMEs incur in training and skilling employees.

Richard M. Rossow is a senior adviser and holds the Wadhwani Chair in U.S.-India Policy Studies at the Center for Strategic and International Studies in Washington, D.C.

The author would like to thank Kriti Upadhyaya for her assistance with this paper.

This report is made possible through the generous support of the Wadhwani Foundation.

This report is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).
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