Reclassifying MSMEs

Turnover definition causes more confusion

Definition of MSMEs - Contentious

The outdated definitions of MSMEs are set to change. Union Ministry of MSME introduced an Amendment to the MSME Development Act 2006 to redefine the sector basing on annual turnover as the single criterion.

While change in the definition from the sole criterion of investment in plant and machinery that has facilitated Inspection Raj is long overdue, again moving to single criterion of turnover is fraught with greater risks than before for the MSMEs.

Globally,they are the backbone of the economy with some definitions showing their contribution accounting for 95% of the world’s GDP.

The term "SME" encompasses a broad spectrum of definitions. The definition varies from country to country. Generally these guidelines are based upon either headcount or sales or assets or a combination of any two or all of them. Some are backed by law while others are by practice and policy.

Indian MSMEs that significantly contribute to economic growth are already suffering several disabilities and while resolving one, leading to many more would be disastrous. The objective of change in definition of the sector should be providing jobs, wealth and innovation.

When the economy is set to be the third largest in the world with increase in WB rankings of Ease of Doing Business, it is important to ensure that each segment of the economy, more so the sector that has the largest potential for employment creation and enterprise promotion, moves in tune with the developed economies. Definitions vary across the multilateral institutions like the World Bank, UNIDO, OECD etc.

World Bank defined SMEs based on Employment and Assets. Out of 18 countries in Asia, Caribbean, East Africa, West Africa, South Africa, Latin America, North America, Eastern Europe six countries defined in terms of Assets, Employment and Turnover. 9 countries defined in terms of two of the three criteria – either assets and employment or employment and turnover. Only four countries including India defined in terms of a single criterion – assets or employment. Philippines, Thailand Bolivia, Mozambique and Rwanda defined in terms of employment as single criterion, employment.

or example the Inter-American Development Bank defines SMEs as having a maximum of 100 employees and less than $3 million in revenue. In Europe, they are defined as having manpower fewer than 250 employees and United States define them with employees less than 500. As general guidelines, the World Bank defines SMEs as those enterprises with a maximum of 300 employees, $15 million in annual revenue, and $15 million in assets. In Kenya, there are different definitions of SMEs which are yet to be consolidated. For example, a national baseline survey of MSEs carried out in 1999 defines a small enterprise as one which employs 6-10 people while a medium one is expected to have 11-100 employees.

Employment as a criterion to define the sector has widely been prevailing. Number of employees by itself is no indicator for efficiency of the enterprise. It is also no guarantee for growth. In fact, there would be a positive effect of economic growth on jobs. This criterion applied singly has again the consequence of services sector like the IT getting undue advantage as even 10 employees can contribute to a turnover of Rs.500cr annually.

Turnover as a single criterion has the deleterious consequences of over-flexibility. It also has the immediate consequence of picking up NPA status with the turnover threshold of Rs.75cr annually for the small and Rs.500cr for the medium. Presently the gross NPAs of the MSME sector stand at around 7-8 percent.  

Depending on trade cycles, the turnover may increase or decrease the redefined thresholds. Whenever such change occurs, it would be well-nigh impossible to reclassify and extend or withdraw the entitlements of incentives, wherever available for this sector. It will be preposterous to presume that GST would resolve the moving turnover thresholds for qualifying the enterprise in a particular category. Obtaining credit would become more difficult.

Any two criteria defining the sector would be more rational and lead to better growth of the sector. Doing away with investment in plant and machinery is welcome but replace them with employment and turnover. It will also be possible to attract more global investments into the sector. This would help MSMEs engaging labour on more competitive terms than now and also measuring their contribution to the turnover.

Modified version of the article has been published in the Hindu Business Line Today.