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India’s reforms under Ease of Doing Business will still take a few years to be felt: World Bank


The World Bank has been focused on a slew of initiatives that can help to create an enabling environment to overhaul the MSME sector. Offering technical assistance to financial institutions for them to scale up their outreach to MSMEs, helping the sector adopt new technologies and creating an ecosystem which has innovation at its very core has been central to their ethos. In a freewheeling chat, Siddharth Sharma, Senior Economist, World Bank, spoke to ET on how, besides ease of doing business, a range of external and internal drivers can pave an unprecedented growth path for SMEs in the country. Excerpts:

The Economic Times (ET): As per World Bank’s ratings, India’s ease of doing business ranking improved by 23 spots in 2019. In what way did this have a bearing on small businesses?
Siddharth Sharma (SS):
Empirical evidence shows us that SMEs tend to suffer the most from onerous regulatory compliance requirements imposed by governments. The Doing Business methodology of the World Bank focuses on the regulatory experience of SMEs, and so the improvement in ranking indicates that the time and cost burdens faced by SMEs to comply with government regulations has gone down over the past four years due to a large number of reforms implemented by the central government and governments of Maharashtra and Delhi. But like any global study, the Doing Business methodology cannot comprehensively cover the entire regulatory burden of an SME in India. Compliance inspections and licensing under a number of laws are some examples of the areas that are not covered. Therefore the effort of the central government to drive much broader reforms at the state level, through a process of competitive and cooperative federalism, is particularly commendable. This helps broaden the impact on SMEs of reform. But there is still much to be done to truly unleash the potential of SMEs by reducing the regulatory burden they face. We look forward to supporting the government in further broadening and deepening the impact of reforms.

ET: Did the improvement in ranking help the SME and MSME sector do better business and attain prominence with the various industry stakeholders?
SS:
The rankings are important primarily to signal to investors that India is now open for business. The full impact of reforms implemented till now will still take a few years to be felt. But what is evident is what the reforms mean for business. Companies can now incorporate their businesses faster and at less cost than they were able to four years ago. They can now obtain construction approvals and electricity connections much faster than they were able to before. GST has helped them reduce the compliance burden associated with VAT, and has made it easier to operate across states and transport goods between states. And finally, the insolvency code means it will be easier for entrepreneurs to exit unprofitable business and start anew. We have learned over the past four years that it takes time for the private sector to become comfortable with and adopt new reforms, especially those as ambitious as the ones India has been able to enact. And so we are hopeful that the process of unleashing entrepreneurial energy through the elimination of regulatory burdens will continue to flourish, and will unleash greater investment, entrepreneurship and job creation across the country.

ET: Besides access to finance, what are some of the other challenges that plague the SMEs’ growth potential and hinder their development in India?
SS:
Well, we can’t underestimate the access to finance gap, as in India we estimate it to be over $230 billion. Indian SMEs vary substantially in terms of dimensions such as size, sector, technological intensity, main market and growth-orientation, so it is difficult to give specific constraints, as it depends on the nature of the underlying market failure and the type of SME. However, in addition to credit gaps, SMEs need support with accessing domestic and international markets, increasing firm capability in terms of both, management and skilled labor, an enabling business environment, and on-time payments from buyers and suppliers. Better infrastructure will also add to firms’ productivity.

ET: What are some of the other initiatives led by World Bank in India to uplift the MSME sector?
SS:
The World Bank is very much focused on supporting central government ministries and state governments alike in the design and implementation of policies conducive to MSME growth. This support has been reinforced in the Country Partnership Strategy between GoI and World Bank India, which will span until 2022.

The World Bank Group (WBG, The World Bank and the International Finance Corporation) have been providing support to the MSME sector through a number of initiatives that have supported access to financial services for MSMEs over the past decade. The World Bank provides lending, offers technical assistance, and undertakes research on MSMEs, while the IFC advises and invests in financial institutions to promote the growth of SMEs. We provide technical assistance to many financial institutions to assist them scale up their outreach to MSMEs, including how to better use financial technologies (fintech) to identify, assess, and monitor MSMEs for lending. We also work on the enabling environment for MSMEs.

For example, support for credit infrastructure, strengthening the bankruptcy framework, and facilitating payments mechanisms are a core part of our support for India’s MSMEs. We help MSMEs adopt new technologies through the expansion and upgrading of technology centers and we are reinforcing the innovation ecosystem for some specific sectors, such as in the health and pharmaceutical sectors. Finally, we have been undertaking a breadth of research and analytical work to better understand factors driving job creation, firm productivity, access to financial services, among other issues.

ET: What are some of the key drivers that should be adopted to boost the growth of MSMEs in emerging markets?
SS:
There are both external and internal drivers of the growth of SMEs. The key factors in the external environment of SMEs are the ease of doing business and efficient access to capital and inputs. For example, credit market inefficiencies due to informational asymmetries and high transaction costs constrain SME access to capital. Hence, it is important to strengthen the underlying financial infrastructure and existing credit schemes on market-based principles so that they improve the efficiency of credit allocation to SMEs. Financial market innovations using Fintech could also help SMEs. Further broadening and deepening of the ease of doing business reforms is also important.

Access to markets is another key external factor for SMEs, often overlooked. Many SMEs find it too costly to access bigger markets (domestic or international), which constrains their opportunities for growth and reduces their incentives for investing in new products and processes. Access to export markets where there is a premium on quality can be especially impactful for SMEs. For example, in a study conducted in Egypt, researchers provided a subset of small rug producers the opportunity to export handmade carpets to high-income markets. They found that the opportunity to export raised firm profits by between 15 and 25%, and that these increases in profits were accompanied by large improvements in product quality, possibly due to “learning-by-exporting”.

Improving the internal “capabilities” of SMEs also matters for their growth. Firm capabilities are those elements of the production process that a firm cannot readily buy in the market and must therefore learn. Innovation and managerial competencies are the most common examples of firm capabilities. Research shows a string positive correlation between good management practices, productivity and innovation in firms. Worryingly, the average quality of management practices followed by emerging economy firms, including Indian SMEs, appears to be well below that in countries like the US and Germany.

There exists a wide range of potential instruments to support SMEs in developing their managerial, technical and innovative capabilities. These instruments address underlying market failures related to informational asymmetries and coordination. They include:

  • Improving the depth of the financial sector so that SMEs can access financial services that are needed to manage liquidity and to also invest long term
  • Financial instruments such as matching grants to help finance specific types of investments and receivable financing so firms can better manage cash flows
  • Supply-driven approaches such as technology and business advisory extension services
  • Accelerators and incubators targeting high-growth potential firms
  • “Demand-pull” instruments that connect firms to markets where higher capabilities are more desirable, or those that combine market linkages with capability strengthening.

ET: How can Indian SMEs try to be a part of Global Value Chains (GVCs) to improve their business potential and profitability?
SS:
Most SMEs in middle and high-income countries are plugged in GVCs as suppliers of exporters. SMEs are vastly under-represented in GVCs when looking at direct exports only. Those that participate in GVCs largely do not participate as direct exporters, but as suppliers to other domestic exporting companies. They are most frequently active in either in low value-added activities where entry costs are lower and not capital intensive, or in high-skilled and specialized activities.

Achieving the objective of integrating SMEs in GVCs can be supported by policies and an industrial strategy that seeks to strengthen firm linkages and the absorption potential of local SMEs. The primary areas of focus involve improving inter-industry collaboration, including domestic firms and SMEs, modifying foreign investor incentives and requirements, and developing affordable training opportunities and opportunities for international exposure. SMEs ability to comply with international standards (product, environmental, social and governance), as well as access to ICT and finance are also important factors.

The World Bank report
Inclusive Global Value Chains discussed policy options for connecting SMEs to GVCs in depth.

ET: What lessons can India take from SMEs in international markets such as US and China?
SS:
There is a huge learning curve as far as the quality of management of Indian SMEs is concerned. For example, India was in the bottom rung among the 35 countries covered in the 2012 firm-level World Management Surveys (WMS) (Bloom and others, 2012). At the top were countries like the US, Japan and Germany. Although India had some firms with the highest quality of management practices, most firms were at the low end.

This is worrying as it lowers productivity, competitiveness and their capacity to create good jobs. Incidentally, the WMS surveys found that while Chinese firms are better managed than Indian ones, the gap is not as large as that with the US. This is one area in which Indian SMEs can catch up to their Chinese counterparts.

It is not possible to ascribe the weak management of Indian SMEs to any single factor. It is probably related to institutional factors like the prevalence of family owned-managed firms. It is also due to information and coordination-related market failures that constrain SMEs from improving their management.

For instance, SMEs could think of paying business consultants to get advice on improving management practices, but may not be able to distinguish between low and high-quality consultants. Many SMEs are not even aware that they have a problem with the quality of their management practices. Hence, it may be worthwhile for the government to support and subsidize consulting services to SMEs. There is evidence from countries such as Mexico that management consulting programs have positive impacts on the productivity and growth of SMEs.

ET: Going forward, what are some of the collaborations that one can expect from World Bank with the industry / government that can give a fillip to this sector?
SS:
The dialogue with Indian stakeholders in the MSME space is very dynamic, since MSMEs are a priority for both GoI and the WBG. We are currently exploring potential interventions in an array of policy areas that are deemed critical for MSME competitiveness and growth. Namely, we are engaging with government partners on issues around access to finance, women entrepreneurship, start-ups, cluster development and improving both managerial capabilities and access to markets of Indian MSMEs. There are no silver bullet solutions to these instrumental issues so we are advocating for holistic approaches that consolidate effort and try to trigger systemic change in the economy, which we believe we will manage to do working very closely with Indian states and ministries.

ET: In what way do you feel should the new government line up initiatives and reforms for the MSME sector to gain further momentum in the economy?
SS:
At the World Bank Group, we have shifted our thinking around SMEs, really focusing on identifying and supporting high growth firms and productivity. Identifying policies to stimulate productivity is critical for India’s growth, as firm productivity accounts for half of the differences in GDP per capital across countries. High growth and young firms are the primary job creators in India, so we aim to bring our knowledge of how to increase productivity growth at the firm level, while facilitating a better enabling and policy environment to level the playing field for all firms. Finally, the innovation and fintech agendas remain high on our priority list, as new innovative solutions for firms can help India leapfrog the growth trajectory for firm productivity and job creation.





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