Sizing up the new MSME definition: a case for MSE within MSME

The Government recently announced a decision to change the definition of MSMEs. The old definition was based on investment in plant & machinery (for manufacturing) OR investment in equipments (for services). The step is broadly a step in the right direction and has potential to make the process of MSME benefit administration easier and transparent. However, there are caveats and the Government needs to come out with more details to assure smaller businesses.

Let us examine the issue in greater detail.

The old definition and the new definition are as below:

As is evident, the changes have the following effect:

1. The new definition does not distinguish between Manufacturing & Services
2. The new definition is based on turnover rather than investment
3. The cut-off thresholds for turnover seem to be set higher (e.g. assuming a reasonably good asset turnover ratio of say 4, the turnover cap for medium business should have been around 40 crores)

Now, let us consider these changes for their potential impact. The first two changes would have a broadly positive impact – especially from the perspective of administrative ease. In the GST world, the difference between manufacturing and services (includes trade) has become less meaningful. Further, linking the MSME definition to turnover now allows (as the Government has itself stated) – to monitor businesses for MSME qualification based on their GST returns.

This will significantly reduce the hassles involved in identifying “who are MSMEs” and enable Government to assist and monitor the sector systematically. In doing this, Government has put the first big step towards generating regular MSME statistics. Government needs to follow this up by making the process of MSME registration easier and streamlined. The idea of Udyog Aadhaar is great, but it needs to be implemented in full earnest. Finance Minister referred to MSME identity in his budget speech – so it does seem this issue will now get due attention.

Now, let us look at the revised thresholds put out in the new definition of MSMEs. The new thresholds are clearly pegged much higher than the old thresholds. As I have earlier indicated, a fixed asset turnover ratio of 4 (most businesses would be in 1 to 5 ratio range) would have given a cap of INR 40 crores on medium businesses (against the INR 250 crore given in the new definition).

Even on the micro business side, the new definition puts an INR 5 crore business to be a micro business. This can be contrasted with INR 1.5 crore as the cap for composition scheme. Clearly, the caps in the MSME definition are on the higher side.

So should small businesses be worried at this definition? Perhaps Yes.

The new definition will allow much larger firms that were NOT a part of the MSME criteria earlier, to now possess the MSME tag. In the real world, where government budgets are constrained, it is important that only those who truly deserve help, get state benefits.

I am listing down a partial-list of benefits that MSMEs currently avail. For each of these benefits, the Government needs to clarify, whether the budgets will be increased (unlikely) or if the MSME definition will be applied “restrictively”.

1) Priority Sector Lending by Banks: Currently, banks are required to allocate 40% to priority sector of which MSMEs is one part. There is a sub-allocation to micro businesses to the extent of 7.5% and this allocation could potentially move away from the “very micro” firms to the “newly tagged micro” firms. This needs to be clarified / revisited by RBI / Government.

2) PSU procurement policy: As per policy, PSUs are required to purchase about 20% of their requirements from MSMEs. They are currently struggling to do so and are estimated to procure only about 10% from MSMEs. With the new definition, with supplier firms in the range of 200-250 crore (which were likely NOT MSMEs earlier) would count as MSMEs, and PSUs may be able to meet the policy requirement without really changing anything on ground. Hence, in real terms, the smaller businesses may not benefit. Perhaps, PSU should have a sub-limit for micro and small supplier firms.

3) Technology Upgradation Fund schemes: similar to above, one needs to review whether a medium size firm of turnover 200 crore should get capital subsidy from the Government?

4) Prompt Payments: Government has protected the rights of MSMEs by requiring larger companies to pay MSMEs within 45 days. This law has not been utilized effectively by MSMEs yet. One wonders if the law will now automatically enable “medium” firms i.e. firms upto INR 250 crore to demand prompt payments. Perhaps, the focus of this law should be limited to micro and small firms.

5) NPA reporting: In a recent notification, RBI has allowed 180 days delay before reporting MSME loans as NPA. Again, it makes sense to extend this benefit to only micro and small firms.

The new definition has rightly brought renewed focus on the subject of MSMEs.

But there is now, more than before, need to move beyond broad-brush term of MSME – a term which equalizes say a vegetable seller with a monthly business of INR 50,000 with a “medium” manufacturing unit which clocks say an annual turnover of INR 200 crore, and say profits of INR 20 crore. This equivalence could potentially lead to ill-targeted MSME assistance. The problem could be worse unless there are clarifying provisions to discourage large firms from setting up fully owned smaller subsidiaries to corner MSME benefits.

In my view, with new definition at hand, the portfolio of MSME benefits should be carefully focused towards independent micro and small businesses (and within the segment – on micro!).

 Accordingly, we should start using a new terminology – micro and small business “MSEs”. (and by consequence, the balance business universe is medium & large businesses – the MLEs).

The Government should direct a bulk of their attention and assistance to MSEs and monitor the progress of MSEs (through GST returns). With the right encouragement, MSEs would grow to become future medium & large businesses.

More power to MSEs!!!