There is a lot of accepted wisdom about the Indian economy that guides policy in still archaic modes. A good example is the issue of financing small and medium enterprises (SMEs). Every political party is pretty clear we need to do a lot to help this sector. There is little to argue about on that front. It is on the policy prescriptions which follow that conventional wisdom leads us astray. SMEs face tough competitive markets. So, we need to ensure that banks and development institutions make funds available at concessional rates. But is that necessary? Most probably, the answer is no.
Statistics culled from the ministry of SMEs show total cumulative investment in the small-scale sector, as on March 31, 2006, at about $48 billion. Who are the chief financiers of that level of investment in SMEs? To get an answer, one has to look at a different set of statistics. In the same period, reports from analysts say that venture capital (VC) and private equity (PE) firms have pumped in almost $9.5 billion of funds into the Indian economy. This includes both foreign and domestic VC and PE firms. For instance, in just six months of 2007, these firms have pushed in about $5.6 billion from abroad.
To get a sense of comparative flows, one has to look at the figures of SME financing by Indian banking and other developmental institutions. We know that in the same period, domestic banks and developmental finance institutions have provided about Rs 22,000 crore to this sector. That works out to about $4.5 billion, at last year?s exchange rate. This figure is incidentally quite different from the RBI?s figure of Rs 90,239 crore, or $20 billion, which is the gross sum outstanding of banks vis-a-vis the SSI sector.
What about VC and PE funding? Typically, a large part of their finance gets pumped into startups and medium-level enterprises, instead of large enterprises. PE, too, chases smaller firms. In India, there has, of course, been a trend of their investing in big firms. Even if we discount that, it is not unreasonable to suppose that at the very least, 50% of their finance has gone into SMEs.
Putting a number to that would mean that a staggering $4.75 billion has been provided to this sector by private capital last year. We are not quibbling about who has nosed ahead. The point to ponder is that non-institutional sources?PE and VC?have financed at least half, if not more, of the total SME investment in this period. This represents a big paradigm shift in the arena of business finance that is hardly ever factored into calculations made by the political establishment.
This immediately gives a new perspective to the debate on the role of VC and PE firms in the Indian economy. Foreign capital, it is clear, is not the preserve of the big boys of Indian industry. It has begun acting as a critical lubricant for companies that people may not even have heard of, by and large. It follows that any move to restrict that flow of capital would be bad news for the economy. This is a sector that often outpaces big industry in growth rates and definitely in terms of employment.
What about the argument for concessional finance? Since large tracts of this sector are doing pretty well even under the tougher terms of VC and PE firms, there is certainly no point in wasting breath on arranging soft finance for them. By most accounts, the sector seems to have got over its traditional sobs over lack of finance.
A logical corollary to this train of thought is to make it easy for the enterprises to corporatise themselves for the present trend of new investment avenues to deepen. Even now, a large percentage of the SSI sector is structured as partnership firms, but that again is the product of a mindset that refused to accept the changing ways of the economy.
