A coupon for innovation: Why India’s small firms need a boost

By Shivani Singh and Farheen Yousuf

India’s small and medium enterprises (SMEs) are often described as the backbone of the economy. They contribute to almost 30% of India’s GDP and employ well over 250 million individuals. However, when it comes to innovation, a decisive component of productivity and sustainable competitiveness, SMEs are all but invisible. This paradox lies at the heart of India’s industrial and economic challenge: how to empower small firms not only to survive, but to innovate, compete and grow.

The 2025-26 Union Budget marked a significant step in recognising this challenge. It increased allocation to the SME sector and delivered a dramatic 800% rise in funding for research and development (R&D), primarily through a ₹ 20,000 crore capital infusion into the Department of Science and Technology. But here lies the catch, these investments risk bypassing the very players who need them most unless they are supported by mechanisms that actively link small firms with the innovation ecosystem.

One such mechanism, tested globally and piloted in parts of India, is the Innovation Voucher. A small value, co funded grant that enables SMEs to tap into the knowledge and technical expertise of accredited labs, and universities. Think of it as a government-subsidised “problem-solving credit,” which a firm can use to tackle a technical bottleneck, build a prototype, or test a new process in collaboration with a knowledge partner. Unlike traditional grants or loans, innovation vouchers do not require firms to undertake large projects or commit to major risk. Instead, they focus on solving one problem at a time. In a country like India, local problems sometimes need local solution which makes grassroot innovation and community driven approaches essential for meaningful impact.

Why SMEs Struggle to Innovate

Innovation in India is heavily skewed toward the public sector and large corporations. The government accounts for half of the country’s gross R&D expenditure, with business enterprises contributing 41%, and educational institutions a meagre 9%. At the firm level, the disparity is even more pronounced: 96% of companies report having no dedicated R&D unit. For SMEs operating on thin margins, investing in innovation is risky, expensive, and slow to deliver returns, three factors that make it unattractive for cash-constrained entrepreneurs.

Innovation often suffers from market failure, firms underinvest because they can’t capture all the benefits. Spillovers in productivity and skills rarely translate into profits, especially for SMEs with limited capacity or access to expertise. What they need isn’t more capital, but smarter tools that make innovation accessible.

Lessons from Abroad and Home

Globally, innovation vouchers have proven to be an effective tool for this purpose. Between 2016 and 2019, more than 40,000 vouchers were issued across the European Union. Austria awarded over 4,400 in a single year, while Finland distributed more than 2,500 since 2016. Lithuania and the Czech Republic have also reported strong uptake. In Ireland, the scheme demonstrated impressive returns: for every €1 invested by the state, recipient firms saw an increase in sales of €8.29 and a net economic value added of €2.95 and generated €31.1 million in net economic value added. A later survey showed even higher returns, €11.83 per €1, with 97% of firms recommending the programme. China, too had adopted this model and a study of 1,700 firms found it boosted patents, finances, and helped those with few industry ties most.

A Practical Proposal for National Scale

The moment is right to scale up these trials to a national innovation voucher program. In contrast to investments in big R&D programs that take decades to yield results, these vouchers provide an instant and straightforward means to bring SMEs into the world of innovation. The plan is simple, provide ₹ 3-5 lakh co-funded grants, where SMEs put in 20-50% of the funding, to address targeted technical problems. The benefits are numerous. SMEs gain access to technical skills, universities develop closer industry connections, and the state encourages bottom-up innovation with minimal bureaucratic burden. Above all, by reducing the barrier to entry, vouchers have the potential to introduce new players, especially those from underserved regions or sectors, to the R&D.

From Capital to Capability

There is another side to this story. A disproportionate share of innovation comes from a small number of large firms and a small number of publicly funded institutions. The rest, which includes SMEs with low capabilities and universities with no incentives or funding, sit idle due to a structural mismatch. Traditionally, innovation policy in India has focused on these small number of firms and institutions to fund capital investments in institutions and run large research projects. However, simply funding research is insufficient; it must also address deeper structural issues. To make this work, research institutions must be better integrated into the needs of small firms. India’s vast network of colleges, polytechnics, and public labs already exists, it now needs to be made accessible and relevant to the everyday challenges of productivity, process design, and product quality faced by SMEs. Innovation vouchers can do just that. They can complement existing efforts by extending the frontier, into the workshops, factories, and start-ups where India’s economic future is being quietly shaped.