The polarised economy

While celebrating its 105 unicorns, India should spare a thought for the 64 million MSMEs.

Startup Unicorns
Let thousands of startups bloom, but MSMEs must also be given the seeds of progress.

Less than a week from now, India will complete its 75th year of Independence. There are, of course, a lot of things to be proud of on this momentous occasion, but, as with most realities of our country, there are a lot of paradoxes, too. For proof, take just two basic facts together.

One, India has emerged as the third-largest ecosystem for startups globally, with 105 unicorns having a total valuation of around $340 billion. Half of these were born in the last two years. That is a superlative achievement by India’s young entrepreneurs, who deserve to be complimented for their ability to dream big and attract big capital.

Now, let us look at the second fact: there is another set of entrepreneurs—64 million of them—who also took big financial risks and set up businesses. But unlike their luckier counterparts in the first category, they are mostly struggling to survive and do not have the resources to scale, despite a few interventions by the government. 

To get more clarity, let’s look at some of the numbers in detail. According to Invest India, the Indian startup ecosystem has seen exponential growth since 2015—15 times increase in total funding of startups; nine times increase in the number of investors, and seven times increase in the number of incubators.

Till 2016-17, approximately one unicorn was being added every year. Over the past four years, this number has been galloping, with a whopping 66% year-on-year growth in the number of unicorns added every year. Out of the total number of unicorns, 44 with a total valuation of $93 billion were born in 2021, and 19 with a total valuation of $24.70 billion have been born so far in 2022. Most of them operate in sectors such as e-commerce, payments systems, fintech, education, etc.

While every startup has its unique journey to becoming a unicorn, the minimum and maximum time taken by a startup to become a unicorn are six months and 26 years, respectively, according to Invest India. The country is now gradually transitioning to the age of decacorns (those with valuation of more than $10 billion). India has four of them—Flipkart, BYJU’s, Nykaa, and Swiggy.

So far, so good. Now, let’s look at the second category of entrepreneurs operating in manufacturing. They contribute close to 30% of India’s GDP and employ an estimated 11 million people. Known as MSMEs (micro, small and medium enterprises), they contribute 45% of manufacturing output, but most of them are gasping for breath due to lack of access to resources and markets. 

What weighs them down are the troubles relating to accessing loans even as the government has implemented measures to make credit for businesses readily available to foster entrepreneurship.A large number of MSMEs often require regular sources of working capital to stay afloat. The ticket size of the loans they require is normally small, ranging from `50,000 to `1 lakh. Yet, the formal banking system can meet only a fraction of the demand from the sector as they are unable to carry out standard underwriting processes to assess their credit-worthiness. According to a report by the International Finance Corporation, India’s formal banking system can only supply about Rs 11 trillion of the credit that MSMEs need, which is less than one-third of the demand from the sector.

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Experts say micro-SMEs should have a separate set of underwriting standards. Banks operate with a certain level of risk appetite to generate a return. So, from a financial parameter point of view, it is very difficult to make any of the micro-enterprises creditworthy. There is an urgent need to bring new growth parameters for this sub-sector.

One of the reasons why firms stay small in India is because of the law and policies that discourage businesses from growing. Out of the 64 million registered units, there are just about 1,000 medium enterprises in India. These medium-sized units are all in nowhere land as they become disqualified for special schemes. As a result, MSMEs feel no need for scaling up their operations, thus creating a vicious cycle. As most MSMEs are micro with low assets, over 90% of them are outside the formal credit system, unable to access funds to improve capabilities and grow. Unable to invest and improve productivity, they remain uncompetitive, able to survive only by remaining outside the formal tax structure, perpetuating the cycle of being sub-scale, with poor productivity and low competitiveness.

Take, for instance, Tirupur, India’s largest textile cluster. More than 70% of the units in Tirupur remain micro-enterprises with less than 10 employees, compared to only 20% such units in Bangladesh’s largest textile cluster, Narayanganj.

MSMEs face other problems, too, regarding enforcing contracts and dealing with construction permits. In fact, the time taken by businesses to enforce a contract remains longer, at 1,445 days, than it was 15 years ago (1,420 days). There have been significant changes in terms of registering a new business—down to 30 days from 127 days—but MSMEs still have to wait and clear 12 procedures to start a business in a city like Mumbai, whereas, globally, it takes just five procedures on an average.  Also, MSMEs face legacy issues such as information asymmetry, non-registration of firms, inadequate and untimely credit, delayed receivables, technological obsolescence, negligible market linkages, absence of exit policy, etc.As startups prosper and MSMEs languish, the so-called K-factor playing out in the economy is widening. This needs to be corrected. Policymakers must ensure that the economy doesn’t get more and more polarised into a globally competitive formal sector and a struggling “other” sector, which is responsible for employing 85% of people.

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Let thousands of startups bloom, but MSMEs must also be given the seeds of progress. That’s the best way to celebrate India’s Independence Day.

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