Need a machete, not a memo: NITI Aayog's Arvind Virmani on why MSME reform needs more than new laws

Economic Times

5 hours ago

Arvind Virmani says that one of the roles of NITI Aayog is to get information that the ecosystem is completely unaware of and therefore not searching for.
Arvind Virmani, Senior Economist and NITI Aayog Member, uses the analogy of a jungle to explain that the 'jungle of control' cannot beeliminated just by changing the laws for the MSME (micro, small and medium enterprise) sector. Although the governments have made efforts to reduce the time and cost of compliance, there is still a long journey ahead, he notes. In an exclusive interaction with ET Digital, Virmani talks about the crucial role of states, the advancement made by Southeast Asian countries, the future path for Indian MSMEs to become global champions, and more. Edited excerpts:
Economic Times Digital (ET): The MSME sector in India plays a crucial role in the country's economic growth. Despite various government schemes, why do Indian MSMEs continue to face challenges in scaling their operations?
Arvind Virmani (AV): There are two sub-segments in the SME segment. There are SMEs, which are basically 10 or more workers, and there are household and micro enterprises. We call them micro, but within them, the household part is much larger at 80-90%, which are just one-person enterprises.In terms of the issues that they face, one is basic infrastructure, which applies to both these two categories. The general point is that just the basic infrastructure in industrial areas is not up to the mark.When we think of urban development and cleanliness, we think of residential areas, but to get enterprises of high quality and functioning at the levels we expect, the basic infrastructure has to exist. They cannot be worrying about overflowing sewage pipes every other day if they are getting people from outside to buy things or getting an export order. The second is land use laws. For example, the conversion of agricultural land into industrial land: how will you get entrepreneurs in rural areas if that process is very difficult? The third is demand risk; a lot of small enterprises are single products, single buyer profiles. So, the risk is higher. So, when we say—why can't they get credit easily it is because they are riskier; due to their small scale, they are restricted.
And finally, the critical one which is overlooked is the level of skills. The skill part has been neglected for decades, but I think it's getting more attention now, and one of my efforts has been to make sure the quality of that is improved.
ET: A large portion of small businesses in India operate informally. Do you see the informality as a symptom of over-regulation, or is it more due to a lack of incentives to formalise?AV: So, this links us back to those two sub-segments: 10 or more workers versus 10 or less; so less than 10 is informal. So again, if laws, rules, and regulations are more complicated, procedures also reflect that. But efforts have been made to simplify the laws and rules, digitise the forms, and comply. But as I have asserted many times in the last several decades, the jungle of control, which was built up, just doesn't go away by changing the law.We have to dig into every little thing. There's a whole structure that was built over 30 years of wrong policies, which is very hard to reverse. It's not just a matter of laws and rules; it's also how the whole system operates. So, with the analogy of a jungle, one has to go through every area and cut the jungle. And that's difficult.Smaller companies are more effective, and that is where the below 10 and more than 10 divide actually works; the compliances are lower for less than 10. That has the perverse effect of not wanting to grow. So, in that threshold, they just divide into two units. If they are going to go eleven, they will just divide up. In the longer term, this prevents you from attaining scale.The second type of cost primarily involves owner-managers, including SMEs, except for the highest, which we call the medium. They are owner-managers. So, their time is limited. If they spend more time on compliance, they will have less time for other things, including innovation, etc. So, there is a challenge, and the only way, and perhaps the best way, to do it is to reduce that time and other costs of compliance.That has been the effort of the government, but it's a long road. And it also has to stretch it down to the states. Every state has to do its bit because much of this appliance actually happens at the ground level, at the local level, actually. That is the state's purview.
ET: What steps is NITI Aayog considering to facilitate the transition from informal to formal structures for micro and small enterprises? AV: It is one of the roles of NITI Aayog to get information that the ecosystem is completely unaware of and therefore not searching for. So that is one, but also that applies to information to states and officials. One state may be doing better, but the other state is not aware of how it is done. Obviously, it depends on their own willingness and motivation as well.We have independent states. So, supporting states and providing them with information is crucial. The other thing that we are doing is to build an index for investment. One of the initiatives that NITI is doing is to see how we can define the strengths and weaknesses of different states in attracting investment, infrastructure, and manufacturing. So that index is now in phase two and will be completed in the coming months. Once that index is ready, a state that is not doing well will have a roadmap to follow. They have a chance then to improve and, therefore, attract more investment and FDI.The role of states is 100% integral. The ease of doing business, or what used to be called 'Inspector Raj', occurs at the local level, with those inspectors being responsible to the state government, not to the central government. So, clearly the role of the states is critical in attracting FDI in producing and exporting quality goods. To be in the international market, you must produce international-quality goods.
ET: NITI Aayog's latest report on medium-sized enterprises highlights their vital contribution to India's GDP, particularly within the manufacturing sector. How can their potential be fully harnessed? AV: This is important because medium-sized enterprises are capable of advancing to the next level. That means the materials, equipment, tools, skill levels of those who run these things, knowledge and information of the owner manager—all that is of a certain quality. The medium-sized enterprises are the ones who are operating at a much higher quality and, in principle, have the potential to compete globally. For example, recently, we did a report at the NITI Aayog on hand tools. There were a whole bunch of hand tool manufacturers. They are in a whole different category. And those are the ones which will be this new medium sector. They have the capability to upgrade the quality chain because the gap is not so large.So, one would look at this medium sector in that context, that they are both labour-intensive and have the potential quality and competitiveness to compete globally.Those are the ones who are capable of scaling. And then, of course, there is the 10 barrier, as well as the 100/300 worker barrier, among others. All these need to be simplified and made less onerous.
ET: India's spending on R&D is among the lowest compared to its international counterparts. This is also applicable to medium enterprises. How can we bridge these gaps to foster the growth of MSMEs in general and medium units in particular? AV: The competitive system and export competitiveness are critical for R&D to happen. So, if there is too much protection in an industry, I would not expect anybody to do R&D. So, the first thing is, what is the incentive from their side to do R&D? Why do you do R&D? If you feel that a competitor is going to get something better, a product or a process, which will reduce the cost, and he'll be able to wipe you out. Or he'll produce a new product and get all the market away from you. So that is the basic driver of private sector R&D.The issue is, what can the government do to facilitate it? This is indeed a controversial issue. I believe that we should bring back the R&D subsidy and give a focused subsidy to encourage it. I think it is still very important. Many countries across the world give incentives for R&D. We withdrew it because of a bad experience. I think we need to re-evaluate.
ET: Many Asian countries have successfully scaled their SME sectors. What lessons can India learn from countries like Vietnam, Indonesia, or China? AV: This is a very important question. If you look at Southeast Asia in general, the big lesson is they went all out there to attract FDI. They laid out the red carpet for them to set up the supply chain. They didn't do this in one or two years; first they attracted the FDI, and when a large company with US supply chains came in, they rolled out the red carpet to help them build that supply chain.That is what has transformed them. That is what enabled them to surpass our per capita income. So, all the Southeast Asian countries who did that and did it successfully now exhibit a much higher gap in per capita income than us. So the big lesson is—FDI and supply chains; if you can get them even now, when things are so bad, it's a different world. That will be a huge driver for the medium and small sectors.If there are 100 companies engaged in this activity nationwide, that means we have representation in 28 states. If every state brings in one anchor investor, it will transform manufacturing in every state in the next 10 years. We are progressing towards Atmanirbhar Manufacturing. So that is the lesson, a very clear lesson.
ET: India was unable to capitalise as much as it had hoped in the China-Plus-One strategy. How can there be a turnaround for India, especially with some inherent strengths, such as a large market and demographic dividend on its side? AV: It is not true that we have not benefited. India is in the top three or five gainers, as per some studies. Some studies show we are third; others show we are fifth. In simple terms, the US imports from China have gone down; they have gone up from other countries, including Taiwan and Vietnam, which is always mentioned. Clearly all these studies indicate that we are the third-largest gainer.Now, the question is, how can we gain more?Given our size, we should be gaining 10 times what we are now. So, that is the real issue, and that is connected to what I said about FDI and supply chains. But what is the policy we are pursuing? The policy is having FTAs with countries that are the source of FDI and demand for manufacturers. That is what the supply chain is all about. So, the FTA with the UK is done; the UK is one of the largest importers of manufactured goods in the world. The US and the EU are the top two if you treat the EU as a single entity.Therefore, the FTAs are part of our strategy to achieve this comprehensive and much bigger shift in the next 5-10 years; [we should] not just be satisfied with being number three or five; we should be number one by a big stretch.
India's 64 million MSMEs are vital to India's goals as an economic powerhouse. However they are often constrained by issues relating to scale, diversification and digital infrastructure. Elevating their stature and empowering such businesses is crucial, especially in the context of unpredictable global trade dynamics at play. In this interaction, Niti Aayog member and senior economist Arvind Virmani tells ET Digital how MSMEs can learn from international peers, the role of medium enterprises in unlocking growth and what needs to change for small businesses to become global champions of the future. Watch this video for more.
ET: What should the MSME sector's strategy be in the backdrop of recent tariff and trade developments, and how can they safeguard themselves in light of such an unpredictable economic landscape?AV: So, as we know, the tariff was suspended. And based on all the information that came in the next couple of weeks—a month or so after that—a lot of US companies were desperately looking for Indian suppliers of the same products. So, I think the opportunity is much greater than the threat. So, in engineering goods, in household items, and in many others, there were reports, textiles, and many other things; they were looking for suppliers in India. So, I think the advice is very clear. MSMEs should be out there. This is the time. Look for buyers. They are looking. Find them. The MSMEs who feel they want to expand—this is an opportunity.
ET: What is your vision for Indian MSMEs over the next decade, and what must change for them to become global champions? AV: The spirit of the MSME sector is very clear. One is that we must not think only of the current situation that there is x demand and we will meet that demand; we must think of the future where we want to be and build for the future.
Second is that the future means we are going to be Viksit. So, you must build for a Viksit quality. We cannot be satisfied with where we are today. If I am producing something which is 30% inferior to, say, a German or Japanese product in machinery, a machinery manufacturer must think that in five years, we must be at that quality, and they have to start doing that now. That applies to MSMEs. That applies to start-ups. The vision is that start-ups will drive this push for higher quality, the frontier of the MSME sector. They are going to be the new MSMEs. And they are the ones who will transform productivity and growth. And which is why so much emphasis has been placed on start-up infrastructure, funding, the fund of funds, etc. It's just a matter of connecting them to the system.And that is the vision, actually. That is the future.