Growth Hurdles: Tackling India’s core structural vulnerability

March 31, 2021 5:00 AM

The bulk of the units in agriculture and industry being sub-scale is a major problem. Need to ‘mimic scale’ through clusters/FPOs and ensure access to formal credit

As a comparison, the average net income of large farmers is about Rs 27,000 which translates to nearly 6x the per hectare productivity of a small farmer.As a comparison, the average net income of large farmers is about Rs 27,000 which translates to nearly 6x the per hectare productivity of a small farmer.

By Arindam Bhattacharya & Aparna Bijapurkar

The last two years have been deeply troubled for the Indian economy. The economic shock from Covid-19 lockdown was a big reason. Stories of hardships faced by millions of people who were rendered jobless when large number of MSMEs were forced to close operation dominated the front pages of news publications. And, then, before the industry could fully recover, the farmers’ agitation against the new farm Acts 2020 brought by the Union government to reform agricultural marketing brought in new uncertainty to the agricultural sector.

These two disconnected crises— one caused by a natural disaster and other a man-made one—highlight a fundamental structural vulnerability at the core of the Indian economy, which is that the vast majority of economic ‘units’ in both industrial and agricultural sectors are sub-scale, have low productivity, and, in a good year, create just enough surplus to sustain for another year. Any crisis, natural or man-made, can bring them to their knees, and thus creates an ever-present fear-factor for the people engaged in them.

Let us revisit the numbers. It is estimated that 99% of the approximately 60 million MSMEs that employ about 110 million workers and contribute to ~25% of the GDP are sub-scale micro-enterprises, operating at low productivity levels. While there is no robust data for India, data from MSMEs in OECD show that productivity of medium firms (50-250 people) could be as much as 2x higher (this could be still higher in India) than that of micro firms (<9 employees). Clearly, for these micro units, building scale is critical to enhance productivity and become more competitive.

Similarly, in the agriculture sector, 86% of the farmers in India are small and marginal (less than 2 hectares); the share of this category of farmers has only increased (70% in 1970-71) while the share of large farmers (more than 10 hectares) has come down from 4% to 1% during the same period. As per NSS 70th round data, the average monthly net income of small farmers is estimated to be about Rs 900, which means there is practically no surplus left to tide over any crisis. As a comparison, the average net income of large farmers is about Rs 27,000 which translates to nearly 6x the per hectare productivity of a small farmer.

These units are caught in a vicious cycle that leaves them small and unproductive—low productivity leads to subsistence net income, little/ no surplus to invest in new skills and technologies or capacity expansion, poor financials and high risk (and few assets to mortgage) result in lack of access to financing, which perpetuates low scale and low productivity. Over the years, every government has enacted laws and policies to help these sectors—but this problem of sub-scale structure has remained intractable and presents a huge ‘productivity penalty’ for the economy.

So, what can be done to address this core issue of sub-scale structure?

Not surprisingly, the three thematic policy interventions for both sectors are the same. The first solution is to ‘mimic scale’ which can overcome such a high level of fragmentation by building and strengthening industrial clusters and Farmer Production Organisations (FPOs). A good example of an FPO in agriculture is the Sahyadri Farmers Producer Company Limited from Nashik, Maharashtra. Starting as a small FPO, today, it has more than 8,000 marginal farmers as members and exports more than 16,000 tonnes of grapes each year.

A bad example of non-competitive clusters are the 59 textile parks in India under the Scheme for Integrated Textile Park, of which 70% are of less than 75 acres, compared with competitive the clusters in China or Vietnam where the average park is of an area larger 350 acres. Successive governments have spoken about the importance of both clusters and FPOs, but progress on the ground has been patchy at best. The present government has brought renewed urgency on both with its ‘mega park’ approach and focus on FPOs in the new farm Acts. We must get the execution right this time.

Second, we must get MSMEs and small & marginal farmers into the formal credit system. To do this, we have to look at innovative approaches which can help banks and NBFCs move away from asset-backed lending to some form of cash-flow-based lending. For example, small retailers, most of whom are micro-units, are outside the formal credit system, unable to invest, modernise and grow, lacking fixed ‘assets’.

But, all of them are linked to and sell brands of well-known and large companies. Can our banks and NBFCs work with these companies and use anonymised data on sales and credit performance to develop credit scores for lending to them? There could be similar innovative ways to cover other segments of micro-units. For example, we are starting to see an increase in the number of pledge finance models offering credit against storage of farm produce. As agri-tech penetration increases, could we see more farmer credit and lending based on estimates of production data, or transaction data on e-NAM and other e-marketplaces.

Finally, we must reduce the cost of operations and risks for MSMEs and small & marginal farmers, which, in turn, can improve their compliance with regulations. The growth of digital technology and emergence of ‘platforms’ as an organisational innovation can reduce transaction costs, increase traceability, improve data-based decision-making to improve profitability, reduce regulatory burden while improving compliance, etc.

A recent Omidyar Network India-BCG study titled The Potential of Open Digital Ecosystems shows the huge value-unlock in creating such multi-stakeholder, shared technology infrastructure with use-cases ranging from marketplaces, credit/ lending, insurance, to micro-skilling and regulatory services. The recent announcements by the agriculture ministry to develop an agri-stack is a welcome first step in this direction.

It is rather unfortunate that it takes a crisis to trigger an urgency to address this core structural weakness of both sectors. With the passing of the crisis, we lose the urgency and go back to band-aid solutions that only address some of the immediate symptoms. Perhaps, the current challenges faced by both sectors, albeit for different reasons, will spur us to work in mission mode to finally address this long-standing Achilles heel of our economy.

Bhattacharya is managing director and senior partner, and Bijapurkar is principal, BCG India
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