My Publications-New Vistas

CHANGING PRIORITIES OF SSI SECTOR IN THE CONTEXT OF ECONOMIC REFORMS

This article attempts to examine the future growth potential and structure of the small scale industry sector as it emerges with the changes brought about and challenges posed as a result of the changed emphasis and new directions necessitated by the economic liberalisation policies initiated in this country a few necessitated by the economic liberalisation policies initiated in this country a few years ago. While the new economic reforms introduced were a clear watershed in the country’s economic management, the policies for SSI sector also signalled a departure with the past policies but continued with the basic thrust of the SSI. The ramifications, however, are to be assessed but, prima facie, it appears to have withstood the changes because of its innate resilience. In any case, there is a need for reorientation of the past policies to render the sector viable in the light of the new imperatives. – Author

Background

The SSI sector has an indispensable role in the industrial development of India has been its vibrant and growing component. It is expected to play a vital role in future as well and remain a permanent component of the industrial structure. The SSI sector’s primary objectives of promoting gainful employment at relatively low capital cost, creating and sustaining a strong entrepreneurial base, inducing regional dispersal of industrialisation in rural and backward regions of the country have been realised to a great extent but the last one was only partially fulfilled. Other objectives of the SSI sector were reducing the economic disparities between various sections of the society and between regions, equitable distribution of income and wealth. Besides, establishing and reinforcing strong linkages between SSI and large industries was also sought to be realised through promotion of ancillarisation for close integration between the two sectors. This kind of symbiosis was expected to provide the much needed impetus to the SSI sector to upgrade its technology. All these goals were to be realised by a well conceived strategy to provide key inputs through governmental patronage in the form of institutional support, package of incentives and tax concessions particularly in excise and sales tax, and preferential credit at lower rates of interest. Market support was also offered by reserving certain items for exclusive production in SSI and also reservation of items for purchase from the SSI sector on preferential basis. Other facilities provided for SSI were supply of machinery on hire purchase, provision of common facility services, industrial accommodation and other infrastructural facilities. Critical examination of these supportive policies pursued so far would lead to the inevitable conclusion that they were no longer valid in the original form in the market oriented economy. More importantly, these policies themselves led to the vitiation of the functioning of certain institutions as in the case of financial system. As will be examined later, the subsidised credit led to the inefficient functioning of the banking system itself. A number of the governmental institutions, which have come into existence to discharge certain promotional functions, were ill-equipped and have become anachronisms in the changed economic environment. The measures enumerated above, however, contributed to the growth of the sector significantly as can be seen from the table below.

No. of units Production Exports Employment

Average growth rate

1985-90 7.98 13.79 17.29 6.04

1990-92 6.87 3.66 20.47 4.18

1992-95 6.96 7.63 17.19 4.13

1985-95 7.46 9.91 17.90 5.18

Compound growth rate

1985-95 7.42 9.82 17.50 5.00

It may be mentioned that while the SSI has recorded impressive gain in number of units, production and employment, in range and type of products and also in the value added by manufacture it essentially remained a sector in which there was neither continuous technological improvement nor the incentive to achieve it particularly because of the protective umbrella it enjoyed. Further the inherent weakness -- for example, the lack of sufficient resources at the individual unit level or group of units -- compounded the situation. The absence of automatic flow of advances in technology through a well established agency for the delivery of information on improvement in technology, the lack of sufficient financial resources to introduce new machinery and equipment have resulted in tardy technological upgradation. This led to the sub-optimal level of utilisation of resources.

Economic reforms and New Small Enterprise Policy (NSEP) - their impact on SSI sector

Ever since the new economic policy (NEP) was announced in 1991 several changes have been introduced in the policy of SSI sector as well. Since the basic thrust of the NEP was to tackle the deep-rooted macro economic malaise and restore the economy to an even keel through liberalisation, the SSI sector could not remain untouched. A separate policy (NSEP) was thus announced for the first time for SSE rather than for the SSI, which in reality means now the scope of the sector has been expanded to include business and services rather than manufacturing alone. The policy for SSEs contained several significant departures from the earlier conviction unhindered growth. It may be noted that in spite of all the support there has been incipient sickness in the SSI sector. The new policy for SSE aimed to competitive survival as a necessity. There is a renewed emphasis on growth impetus and vitality and thus concentrates more on efficient growth of SSE and productivity. As a corollary it may be pointed out that employment generation was no longer to main concern of SSI, assigned now to the tiny and the village industries the objective being to develop a technologically viable SSE sector, even if it means increased capital intensity. It would be interesting to note that growth in SSI was lower than the increase in the number of SSI in 1991-92. As against a growth of around 7 percent in SSI units in the eighties, employment grew by 3 percent. This reflects the changed character of SSI in the regime of liberalisation.

It is realised that protective policies yield to positive promotional measures. Preferential credit and directed credit programmes are no longer valid in the changed context of fiscal discipline and stablization as a macro economic requirement, to be enforced to prune expenditure on government departments. These new measures of liberalisation in the areas of financial sector, trade, investment policy and structure of taxation are bound to have pervasive repercussions on SSE sector unless countervailing measures are taken to devise new ways of lending support. The new industrial policy for the SSE sector has taken cognizance of this and introduced two measures to enhance the flow of funds: the first measure is equity participation upto 24 percent by other SSE units. Since such participation is expected to come from large units, this measure was expected to reinforce the integration of small and large sectors. The second measure introduced new legal form of restricted/limited partnership which again expected to attract equity funds from friends and relatives.

The likely changes to be faced by the SSE sector as a consequence of free market policies and the changes brought about may be examined to assess the likely impact on the SSE. Although it cannot be firmly concluded at this juncture, there is an apprehension that the reforms may not be to the advantage of SSEs at least during transition, on the contrary they may favour the large companies. Even the policy of SSE announced is clearly slanted towards the larger of the SSEs. The recent announcement to enhance the ceiling up to Rs. 3 crore for SSI, with the explicit objective of facilitating their expansion, diversification and technological viability is a step in this direction. But this would also mean that in the intentions of the policy makers the SSI have to fend for themselves while the smaller of the units including tiny sector may still be eligible for some kind of support on a continuing basis. Thus in the short run at least there is a dis-orientation in the SSE sector but in the long run it is expected to experience accelerated growth.

The core areas of economic reforms contemplated the deregulation and debureaucratisation of the hitherto overregulated system, financial sector reforms including the capital market and financial institutions, deregulation of interest rates, trade liberalisation and technology which will encompass the macro economic functioning with implications for industrial production. While these will purportedly transform the economy they have a direct bearing on large companies and SSEs as well, with the latter bearing the brunt of the unintended consequence.

The earlier regime of regulatory mechanism with its concomitant and meaningless restrictions resulted in higher costs even for large industries but were more adverse for the SSEs because of the several permissions to be obtained and formalities to be fulfilled in procuring a licence to do business. The costs were generally high and the resources at their command were low with the result there were long delays. With the removal of endless restrictions SSEs found entry easy. The licence permit era gave way to simplifying procedures and served the SSEs. Debureaucratisation however is still to be achieved.

Nevertheless in other respects such as the changes in the financial system and the availability of credit there has been a marked adverse impact. The new policy had introduced an element of unequal competition among large and small companies. There was a gap in the supply of term loan as well as working capital from the traditional sources and the banks were yet to evolve a system thereby increasing requirements of the sector could be met. In this context it may be worthwhile to bear in mind an important conclusion arrived at by a study conducted by the UNIDO:* “Formal credit did not seem to play a promotional role and in fact the inference drawn is that very little reliance should be placed on the pro-active credit in any general strategy or programme for upgrading and developing SSI clusters”. Even the Abid Hussain Expert Committee felt that adequacy of credit flow and timely supply were more important than concessional finance. These aspects would have to be taken into consideration while evolving the new strategies.

Financial sector – reforms

Basically there are two sources of funds for the industrial sector: firstly, the open market where the companies could raise the equity funds through open listing, and secondly, the developmental financial institutions.

Changes in capital markets

There was an inherent limitation on the SSEs to borrow directly from the market because of their size. The deregulation of capital markets provided the large companies greater access to national and international capital markets to raise equity capital, but small companies did not have a similar advantage. The reforms in the capital market generally benefited the large companies only. With the abolition of controls of capital issues the formula based pricing of new issues of capital by companies need not be followed. They are now free to price their new capital issues based on market conditions. However, the small and medium companies had no such facilities and even alternative sources of financing like venture capital were not yet developed. Even the access to the traditional stock markets is limited since companies with investment of Rs. 5 crore alone are eligible for listing on stock exchanges. These companies could be quoted on over the counter exchange but this exchange itself is facing problems. Perhaps it is necessary to relax the stringent requirements for listing on the exchanges. Foreign, private equity funds which have entered into the capital markets effectively to assist the unlisted companies for flotation in stock markets have also not developed to the desired extent. In such a situation venture capital can play a very useful role but ours is one of the smallest venture capital industries in the world. Basically small companies need support to facilitate their access to capital markets and one of the ways is to enable them to communicate their worth to the capital markets after a systematic assessment of their project. But this is yet to develop. It is therefore necessary that proper channelising of bank credit is introduced in order not to starve the SSEs of the much needed finance. Since the SSEs do not have access to the ioutside funds it is imperative that they are provided with term capital and working capital to facilitate their sustained growth. But a cursory examination of the scenario reveals that presently there is a difficult situation for the SSEs.

Financial institutions

The thrust of the proposed economic reforms is to develop a vibrant and competitive financial system. Thus financial sector reforms assumed significance. Over the years the banking and financial system has made significant progress, and the credit reach and geographical spread also have been quite impressive. However, certain factors like directed investment and directed credit programmes have contributed to the erosion of efficiency in the banking system itself. In order to infuse a new direction to the financial sector, steps were taken to introduce greater operational freedom and some of the controls were relaxed. Deregulation of interest rates was allowed so that financial institutions can modify the interest rate based on market conditions subject to a floor rate ceiling. These measures, while enhancing the efficiency of the banking sector, have resulted in higher rates of interest to SSEs. Steps like imposing obligations on the banks to make provision for bad and doubtful debts even to small loans, providing for non-performing assets of less than Rs. 25,000 up to 10 percent and similar other regulatory mechanisms have further affected the credit flow to the small sector. According to a study of clusters of SSEs done by the National Council of Applied Economic Research (NCAER), most of them have experienced a fall in the supply of credit. The only clusters unaffected were glass manufacture and woollen industry and knitted products sectors which have vastly improved their export performance. Overall the relative share of credit to the small sector has fallen from 13 percent of the incremental gross bank credit in 1994-95 to 11.4 percent in 1995-96. There is a problem of adequate supply of term loan component as well due to the drying up of sources of refinance to the SFCs and SIDC, which usually extend such facility. The state financial corporations themselves are in doldrums due to poor recovery of loans. Thus there is a great need to revamp the financial system to meet the growing needs of SSEs and evolve a viable system to be responsive to the requirements of SSEs. Attempts are being made in this direction firstly by enlarging the national equity fund, and secondly through restructuring the SFCs. There is also a suggestion that the term loan component and the working capital should be dispersed by a single agency to alleviate the difficult of a unit receiving the term loan from one agency and waiting for working capital to be sanctioned by another. A composite loan may be ideal in such a situation.

Trade reforms

The policies of trade liberalisation have again been an area of mixed blessing for the SSI sector. The liberalised import measures have opened the Indian market to many of the hitherto restricted items. In fact there is already a new thinking that the reservation policy has to be scrapped as it has only acted as a deterrent for small industry sector instead of giving it impetus. The SSI can also benefit by expanding exports, which are possible under the new policy of globalisation. Removal of non-tariff barriers would definitely open up many new markets and competition will also be stringent, unless the Indian small industry increases its efficiency and productivity.

There are other aspects which are very important in the liberalised economy and which have direct bearing on the performance of SSI sector. The increased pressures of infrastructure availability will add to the woes of the SSI. Other essential inputs required to support a growing SSE sector such as training of manpower, quality control, information and even skilled labour are, however, not strong points of many governmental institution, which are meant to supply these inputs to the SSI. The new economic environment presupposes the emergence of a free market where survival is not possible without technological upgradation. In the earlier schemes the establishment of inter-linkages between large and small industry were expected to take care of this aspect. But in reality, the ancillarisation programme and the subcontracting have always been a qualified success. The SSI sector has always treated the large unit as the exploiter. In short it has not been rewarding experience for the SSI. But the emerging need for a competitive survival thrust poses a challenge to SSIs to upgrade their technology and modernise, as otherwise the inescapable law of survival of the fittest will operate to the detriment of the SSE.

Further the restructuring of taxation resulted in dilution of the tasks of the protection offered by excise and the other tax concessions to SSEs. The relative advantage of change is no longer in its favour.

In brief it is apparent from the above analysis that the impact of NEP has brought to the fore certain basic premises which were the favourites of the academicians alone hitherto. But now the harsh realities of the new situation do not leave any scope for the dogma of protection. Instead of the focus has shifted to the problems of finding alternative solutions for providing a cushion to the SSE to make the change less painful. The suddenness of the reforms has added to the problems. A brief discussion is attempted in the following paragraphs of the new initiatives that are necessary to achieve a viable and growing SSE sector which should lead to policy prescription.

New directions of policy formulation

New policy directions essentially should focus on three major aspects: the need for a demarcation of the different sub-sectors of SSE, namely modern small industry, tiny and business enterprises; and the needs of each as also the possible policy support and strategy.

In the light of the new economic policy and its likely impact on SSE as analysed above, it may be concluded that the new scenario offers both challenges and opportunities for SSEs. As can be seen, in the immediate short run there is a threat to the growth of the SSE, posed by several factors already mentioned, but with a careful policy intervention the growth of the SSE can be accelerated. Needless to say even in the era of economic reforms there is a great potential for the SSE, provided the policy formulation attempts to eliminate the handicaps of the sector.

It would be worthwhile to mention some of the changes contemplated SSE sector and their implications for future. The hike in the ceiling on investment from the present Rs. 60 lakh to Rs. 3 crore, positive aspect in giving impetus to the technological upgradation and large (small) units to have easier access to the capital markets. ‘However, caution has to be exercised not to transform the labour intensive characteristic of this sector. Further with the higher ceiling in investment some of the medium scale units will now be categorised as SSE which will infringe upon the resources like bank credit. However, there is a need to bear in mind the fact that mere escalation of the ceiling will not lead to a larger share of SSI – as suggested by Sandesara [“New Small Enterprise Policy” (Economic & Political Weekly), October 19, 1991]. It was also pointed out by him that increased investment ceiling in the definition of small industry has by and large not increased the size of the small sector relative to the large; it has remained uncharged or shrunk. But the case for hike in ceiling on investment can be more on the basis of inflation and devaluation of the Rupee, which have lowered the real value of the investment limit.

The second important aspect on which there is rethinking is the reservation policy. The argument is that in a trade liberalised economy the reservations do not help the SSE as many of the hitherto protected items are importable freely now. Moreover this kind of negative measure is out of place in a liberalised economy and the efficiency of this measure in promoting SSE is of doubtful validity. Further, many of the items of the reserved category are already being produced by large and medium units. While the statistics show that the production of the reserved items amounts to 28.3 percent of the total production in SSE and 36 percent of the units fall into the reserved category, this policy of reservation acts as a deterrent to growth of the unit as well. Only about 60 items constituted 80 percent of the production in reserved items. The study of the National Institute of Public Finance & Policy revealed in terms of the size of the employment, capital output and also productivity of labour and the capital, unreserved items are better placed particularly unreserved items are better placed particularly those having an investment of Rs. 10 lakh in P & M. Even in terms of profitability, inventory burden and capacity utilisation, units producing unreserved items and with output levels greater that Rs. 30 lakh are superior to those producing several items. It was also found that reservation had an impact on the smallest of the units which probably cater to the local needs. Moreover, the reservation policy is based on the premise that large and small industries are competitors. However, in terms of quality of certain products of this category, e.g., sports goods, leather footwear, readymade garments, they are highly rated as suggested by the experts of these products. However, in the larger context of export potential it is necessary to remove any constraints on growth. But any dereservation should be gradual and not to cause difficulties for the existing units. The main thrust of the dereservation argument is to remove the inefficient use of capital.

Another area which requires attention is the need for rationalisation of tax concessions which the SSI sector has been receiving. Originally these benefits were introduced to give an artificial cost advantage to the SSI products vis-à-vis the large industry products. However, these measures have become counter productive in the sense such fiscal incentives have perpetrated inefficiency and acted as a dis-incentive for the units to grow in size. The consumer of these products is the eventual looser. The subsidisation of low level of technology combined with restrictions on size and investment led to technological stagnation. Nonetheless the importance of excise concessions cannot be minimised and hence there is a need for rationalisation of these measures particularly in regard to the tiny sector enterprises and the smaller units of the SSE sector.

Policy intervention, new focus and opportunities

The policy for SSE should be such that it creates an economic environment that would be essential for the realisation of full potential for the sector. Nonetheless it must be recognised that the successful growth of SSE is a by-product of the general economic growth. Policy is of limited importance when the demand is healthy but becomes more important when the demand is sluggish. In the Indian context with the historical accent on protective policies, the economic reforms do not warrant a complete withdrawal of governmental intervention, but a gradual transition is imperative to reach that goal. The new approach should therefore concentrate on measures enabling the SSE sector rather than invoking the dependence syndrome. In this context a new ambience has to be created and the much wanted programmes modified. Three broad areas should be considered for future strategy:

Reorientation of governmental institutional setup with the objective of transforming them into autonomous agencies with participation by private agencies,
Minimising the competitive role of SSE with large sector and promoting complementarity,
Technological advancement through ancillarisation.

Institutional reorganisation

In order to enable the SSEs to take full advantage of the new opportunities there is a need to focus attention on restructuring the government institutions. The elaborate network of state-owned/funded institutions is inadequate in the changed context to be of help to SSEs. The requirements of different kinds of units can be better served if the rigid government approach gives way to more flexible private and autonomous institutional framework. In fact, recent surveys have confirmed that the private sector companies have emerged as the prime sources of services for SSEs. A recent NCAER survey focussed that out of a total sample of 657 units, 136 units had utilised technical consultancy services in three consecutive years. Only 29 units utilised the services of the state-owned SISIs while 82 got it from private sources. 59 percent of the units have appreciated the services of the private sector.

It will also be relevant to mention that UNIDO study on Restructuring and Modernisation of Clusters has also found that together with larger private enterprises, with which they sometimes trade, SISIs are their most effective service providers. The SISIs primarily rely on themselves who are all other private firms for marketing, raw materials and equipment supply, training and skill acquisition, finance premises and even for specialised production and testing services. It was also found that public interventions and testing services. It was also found that public interventions and institutions are currently providing a wide variety for services in parallel with private commercial services. Better would be for the public intervention to encourage the private sector to fill up service gaps. Only where this does not succeed public intervention becomes necessary to develop such services. There is thus a need for restructuring SISIs and DICs equipping them to provide such services as technical assistance and management by separate companies. The present DICs may have to play a larger role in establishing linkages with other institutions like banks and training institutes. This new agency can be an autonomous one for speedy delivery of information, clearances, coordination and project planning. In reality many agencies of the government like SISIs are not in a position to provide for the requirements of SSI. At best they are capable of meeting the needs of low-tech industry.

There is therefore an urgent need to restructure these agencies as autonomous. In the emerging situation emphasis is on evolving a flexible and servicing oriented approach on the part of the institutions which is possible only if they are private rather than government owned. These could then serve the needs of the SSEs in the changing context.

There are two segments in the SSI: one consisting of units producing final consumer goods and therefore in competition with large units. In these units technology is low but employment is substantial vis-à-vis the capital employed. There is another segment comprising of units that are vertically linked to large sector units or their ancillaries. In the market friendly economy the latter will gain in importance and units not so linked may not be viable. Therefore the policy formulation for supporting the SSE should be based on the larger framework of growth and modernisation of the economy and the linkages that are established between the SSI and technological improvement of the production process itself. However, the tendency of promoting undesirable capital intensity of industry and the consequent decline in employment generation are the factors to be guarded against in the future policy.

The clear demarcation of the enterprises that are independent and complementary to large industries, and those which are in competition with large industries is essential to avoid confusion in policy formulation. Small enterprises can be vital in so far they are ancillaries to large industry and the later can infuse new technology into the former and thus the relationship can be mutually beneficial. The provision of equity participation not exceeding 24 per cent by other units will certainly reinforce the relationship between large and small enterprises and in a way establishes the stake of large units in the growth of SSEs.

As Sandesara points out, the problems of small industry arise mainly because of its size not being able to realise the economy of scale. It therefore becomes extremely difficult to turn the tide in favour of small units even when state assistance is comprehensive and substantial (EPW, October 1991). It is suggested that emphasis should be on units which are independent of and complementary to large units. Even the expert committee on small enterprises (Abid Hussain) concludes that the new policies designed to support SSEs must encouraged the interdependability of large and small enterprises.

Technological advancement through ancillarisation

Ancillarisation is one of the key areas of future growth of SSEs. The SSEs which have greatest scope for modernisation and technological upgradation are those which are ancillary to the large units. Establishing stronger links with large and multi-national companies have great potential for investment, as they do not compete with large industry products. Further if the new economic order has to succeed in ensuring that economic growth becomes broad based, SMEs must play a more positive role not only directly as sub-contractors, and ancillaries of large sectors in the domestic markets but also in the external markets. The provision of equity participation of 24 percent is a step in the direction of establishing such mutually beneficial relationship. The large units can also share research and management techniques and working capital needs which will make for a long term relationship.

Cluster approach

Of late considerable interest is visible in the cluster approach to small enterprise promotion. The idea of network or clusters of mainly small firms interacting among themselves through specialisation and sharing of services has led to the successful growth of many industrial areas in the world.

New initiatives are called for to meet the new challenges of competition from large sector within the country and imports from abroad. SMEs gain significantly in competitiveness by forgoing strong relation with other firms both small and large. They also gain from linkages with service institutions in clusters of enterprises based on groups of related products. Rather than the firms considered individually the enterprises together are better able to grow rapidly and upgrade the skills, improve their productivity and technology, develop product lines and gain access to distinct markets. This provides one new source of assistance capable of meeting the needs of such a very large section of SME sector.

However, it is found that most of the clusters are natural rather than government induced. The cluster development is linked to one or more of the factors like resources, market or infrastructure. While 99 of the 138 clusters studied are market based only six of them have come up primarily because of conducive infrastructure; rest of the 33 are resource based. The clusters are of different types: horizontal, large unit based, and vertical integrated. Though most of the clusters have come up naturally, for policy purpose it has to be examined whether they can also be induced. Some attempts were made in this direction by promoting infrastructure-based clusters, eg., electronic industry through establishment of software parts. The policy intervention should be aimed at strengthening the clusters by promoting new types of organisations, which in essence involves partnership between government and business associates in these clusters. However, the starting point of this exercise should be identifying the industry and potential clusters, and studying the needs of these clusters.

Conclusions

The SSI sector has grown in terms of number of units, employment and production over the years, with governmental policy protection offering a wide variety of facilities. However, certain distortions have crept in and as a result the sector remained stagnant in terms of technology upgradation, quality and productivity. A new urgency is felt for infusing a new direction with the advent of the economic liberalisation and free market policies. The reforms to rehabilitate the macro economic management envisaged financial sector reforms, trade liberalisation and restructuring of taxation which in turn have a bearing on the small scale sector. The artificial advantages available to the sector in the past can no longer be continued, with the removal of concessions in the rates of interest and excise taxation.

The scope of the SSI has been expanded by including the services and business also. The ceiling on investment for SSI has been raised to Rs. 3 crore to take care of the inflation and fall in the value of the rupee. This measure blurred the distinction between SSI and medium scale units. The reservation of items for exclusive production in SS sector is considered to have attained its purpose. The credit flow to the sector has not been adequate. The competition in the importable under the trade liberalisation posed a challenge to SSI sector.

In this context there is a need for more positive policy intervention and innovative approaches. The governmental institutions have to be reoriented by introducing an element of autonomy and participation of private agencies to be able to meet the changing requirements of SSI with regard to information, technology, etc. An effort should be made to promote clusters by inducing them through infrastructure development. Basic support for technology advancement is crucial in the changed context of growth and competitive survival. This would mean promoting a new class of entrepreneurs through training in managerial skills and technology advancement. While the SSE experienced problems due to the transition from the regulated economy to the market friendly economy in the long run, SSE can avail of the opportunities promised in the sector readjusting to the changing economic environment. Policy stipulations are crucial in enabling the SSE sector to effect readjustment at less cost. IT shall also prevent the channelising of funds into product lines, which are less competitive.