Protection to small-scale industries (SSIs) in India was historically provided through two sets of policy instruments. The policy of reservation provided that a certain number of products could only be manufactured by SSIs. That was to protect them from large Indian companies. The reservation process began in 1967 with 47 items and peaked to 873 in 1984. The tide has turned since 1997, however, and the number of reserved products today stands at 114.
The second policy was through trade: quantitative restrictions (QRs) on imports, high import duties and restrictive FDI limits. This was targeted at foreign companies to protect the Indian SSI sector. QRs have been removed and import duties brought down systematically since 1991. But the FDI clause remained. The FDI limit was an integral part of the classical definition of an SSI.
Another development in the meantime has been that the sector was re-christened the micro, small & medium enterprises (MSME) sector with the enactment of the MSME Development Act, 2006. The definition of an MSME now falls in the domain of this Act, which ostensibly includes the FDI limit as well.
But on practical grounds, what does that mean for small-scale units, which are in either non-reserved or reserved categories? Let?s examine what happens if a foreign or domestic company invests more than 24% in a small unit not in the reserved category. This is the scenario for a bulk of the sector, which churns out 8,000 products of which only 114 are reserved. If more than 24% is invested in the small unit, it will cease to be a registered SME.
What do you lose? There are two major benefits that one can claim when registered as an SME: the option of excise exemption up to a turnover of Rs 1 crore and coverage under priority sector lending. Firstly, no progressive company can really do without CenVat from the beginning and excise exemption is hardly an incentive.
Secondly, which large Indian or foreign company would really be interested in a company whose size is intended to be less than Rs 1 crore, just for the excise exemption? Thirdly, a tie-up with a large company or investment by a foreign company acts as a great comfort factor for most bankers. Most of them are more than willing to finance such ventures, priority sector lending notwithstanding. Other benefits for registered SMEs are insignificant and amount to mere tokenism. Therefore, for non-reserved categories and a bulk of the sector, FDI has always been open.
If we turn to reserved categories, for equity participation in excess of 24% or in cases where a non-SSI unit wants to manufacture a reserved item, an industrial licence is required and a minimum export obligation of half the production.
What is rather surprising is the way some industry bodies raised this issue and included it in their reforms wish list, as if it was of critical importance. Also, the way the government touted it as an initiative to help technology upgrades.
What pro-reservation lobbies might note, however, is that the de-reservation process is effectively complete now with removal of QRs as well as allowing a higher investment limit by large companies. The increase in the limit, therefore, is at best a political statement and at worst inconsequential. The current debate, nevertheless, highlights the growing disconnect between what policymakers perceive SMEs need and what is actually happening on the ground.
The author is secretary-general, Federation of Indian Micro, Small & Medium Enterprises