Speech on SMEs: The Way Forward

Speech | 29 July 2009

Speech by Cheolsu Kim, Principal Financial Sector Specialist of ADB's Public Management and Trade Division, South Asia Regional Department, at the "Global SMEs Summit: Business Partnership Meet - 2009", New Delhi, India

Introduction

Ms. Anita Sharma, distinguished guests, ladies and gentlemen: I am delighted to join you for this important Global SMEs Summit that comes amid the current global economic and financial crisis. First of all, I would like to thank the organizers for giving ADB the opportunity to share its experience in private-sector development, especially SMEs. I would also like to express my appreciation to the Ministry of Micro, Small and Medium Enterprises and FICCI for this worthy and timely initiative to discuss and deliberate on the important issues related to SMEs in India.

As has been discussed in the previous sessions, the SME sector in India plays a vital role in the growth of the country. It has been estimated that every one rupee of investment in fixed assets in the SME sector produces 4.6 rupees worth of goods and services with an approximate value addition of 10 percentage points. In addition to being a GDP earner, the SME sector is also instrumental in achieving inclusive growth which touches the lives of the most vulnerable and marginalized sections of society, including women, minorities, and other disadvantaged groups. Further, they also go a long way in checking rural-urban migration by providing villagers and people living in isolated areas with a sustainable source of local employment.

Key Advantages of Indian SMEs and Recent Policy Reform Measures

As a developmental strategy, the SME sector typically possesses key advantages in the Indian context of high labor availability and capital scarcity including (i) a relatively high labor-capital ratio, (ii) shorter gestation periods, (iii) lower investment requirements, and (iv) a focus on relatively smaller markets. These factors ensure a more equitable distribution of national income and ensure a more effective mobilization of resources of capital and skills which might otherwise remain unutilized.

In recent years, the Government has introduced a number of policy reforms and initiatives to promote and strengthen the SME sector including (i) the Micro, Small and Medium Enterprises Development Act 2006 (MSMED Act, 2006); (ii) the establishment of the National Manufacturing Competitiveness Council (NMCC); (iii) the introduction of the scheme to establish Small Enterprises Financial Centers (SEFCs) for strategic alliances between bank branches and the SIDBI (Small Industries Development Bank of India); (iv) launching a $2.27 billion SME fund; and (v) promotion and financial support for credit-cum-performance ratings in India's SME sector to facilitate a greater flow of credit from the banks.

A loss of investor confidence in the global financial markets has virtually dried up the flow of funds to SMEs. To address this credit squeeze, the RBI has slashed the repo rate by 350 basis points and the cash reserve ratio by 400 basis points since October 2008 to ease bank access to finance. Furthermore, the Government has indicated that the banks should increase their SME lending. The Planning Commission's working group on SMEs for the 11th FYP has estimated that smaller firms need approximately 61 billion dollars in working capital and term loans during the plan period. But while banks may accommodate the demands made on them, there are also disincentives to credit expansion across the portfolio spectrum.

Challenges Faced by SMEs in India

Despite the policy reforms and initiatives recently introduced by the Government, there are still several constraints to the growth and competitiveness of Indian SMEs. These include first, the problems that SMEs face in accessing adequate and timely financing on competitive terms, particularly longer tenor loans, which have been exacerbated by the current global financial crisis. Secondly, policy, legal/regulatory framework issues (in terms of recovery, bankruptcy, and contract enforcement), institutional weaknesses in the absence of good credit appraisal and risk management/monitoring tools, the absence of collateral arrangements and lack of reliable credit information on SMEs which has made it difficult for lenders to be able to assess risk premiums properly, creating differences in the perceived versus real risk profiles of SMEs. Thirdly, most SMEs have limited access to larger markets in terms of market linkages, transport, telecommunications, and information exchange which seriously undermine the demand for their products. Lastly, with opening up of the economy and as globalization intensifies, poor physical infrastructure hurts the productivity and the competitiveness of Indian SMEs vis-à-vis imports.

ADB's Role

As a regional institution focused on poverty reduction, ADB is committed to supporting the Government's efforts to promote sustainable and inclusive economic growth. In line with the Government's priorities, ADB has recently adopted a new long-term strategic framework called 'Strategy 2020' in which two of the five core areas of operations are infrastructure and finance sector development which emphasize inclusive growth through the creation of an enabling environment for SMEs, amongst others.

ADB commenced its operations in India in 1986. One of the first ADB operations in India was a loan to IDBI approved in 1987 by the ADB Board, for on-lending to SMEs through state financial corporations. Over the years, ADB has provided a series of technical assistances to build the capacity of domestic financial institutions and develop and deepen the capital markets which are vital for SME financing. ADB has also supported equity investments in SMEs through investments in private equity funds, which has fostered high-growth SMEs and catalyzed productive improvements in existing businesses.

Another ADB focus in India has been infrastructure development, which is not only in line with the Government's priority, but also eventually enhances SME productivity and competitiveness. In recent years, ADB's involvement with the Government in promoting public-private partnerships (PPPs) in infrastructure has deepened, with several ADB initiatives on mainstreaming PPPs at both the central and state level.

Currently, ADB is processing two SME projects in India. The first project consists of three components. The first component is a long tenor loan facility to the Government to be on-lent to eligible SMEs through participating commercial banks. The second component is a Partial Credit Guarantee facility to be provided to one or more Indian public-sector banks that would help the participating financial institutions raise long tenor financing from international markets at competitive rates to fund SMEs. The third component is a technical assistance that aims to strengthen the capacity of rural women entrepreneurs and associations to ensure more systematic access to financial resources which will be made available by the proposed ADB loan and partial credit guarantee facility.

The second proposed SME project, which is specifically targeted at export-oriented SMEs, comprises a loan to Exim Bank of India, together with a technical assistance, that is expected to serve as a catalyst to support Exim Bank's expansion program to promote SME exports and growth of SMEs in India.

We believe the proposed ADB interventions will support the Government's efforts to accelerate SME sector development in the country amidst the on-going global financial crisis as well as support the Government's inclusive growth strategy through employment and income generation.

The Way Forward

Functioning financial intermediation is of critical importance for SME development but it is useful to emphasize that the success of any financial intermediation depends on several factors. The good practices in financial intermediation, especially for SMEs, fall into three broad areas: First, the investment climate must improve through rational policies, better access to finance, and stronger institutions. Second, the financial sector needs to become more broad based, competitive, and efficient to provide entrepreneurs with alternative sources of investment capital, a diversified selection of new and innovative products, competitive rates, and efficient services to make their investments viable. Third, improving skills, trades, entrepreneurship, and other business development advisory services would ensure success and help strengthen financial intermediation for SMEs. Thus, a three-pronged program where the elements are mutually complementary needs to be adopted to build a strong foundation for an efficient and effective financial intermediation system that will support private-sector development and help accelerate economic growth.

Thank you very much.