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On June 1, 2020, the Cabinet Committee on Economic Affairs approved a revision in the definition of Micro, Small and Medium Enterprises (MSMEs).[1] In this blog, we discuss the change in the definition as approved by the Cabinet, and examine some of the common criteria used for classification of MSMEs.
Currently, MSMEs are defined under the Micro, Small and Medium Enterprises Development Act, 2006.[2] The Act classifies them as micro, small and medium enterprises based on: (i) investment in plant and machinery for enterprises engaged in manufacturing or production of goods, and (ii) investment in equipment for enterprises providing services. As per the Cabinet approval, the investment limits will be revised upwards and annual turnover of the enterprise will be used as additional criteria for the classification of MSMEs (Table 1).
Earlier attempts to amend the definition of MSMEs
The central government has sought to revise the definition of MSMEs in the Act on two earlier occasions. The government introduced the MSME Development (Amendment) Bill, 2015 which proposed to increase the investment limits for manufacturing and services MSMEs.[3] This Bill was withdrawn in July 2018 and another Bill was introduced. The MSME Development (Amendment) Bill, 2018 proposed to: (i) use annual turnover as criteria instead of investment for classification of MSMEs, (ii) remove the distinction between manufacturing and services, and (iii) provide the central government with the power to revise the turnover limits, through a notification.[4] The 2018 Bill lapsed with the dissolution of 16th Lok Sabha.
Global trends in criteria for the classification of MSMEs
While India will now be using investment and annual turnover as the criteria to classify MSMEs, globally, the number of employees is the most widely used criteria for classifying MSMEs. The Reserve Bank of India's Expert Committee on MSMEs (2019) cited a study by the International Finance Corporation in 2014 which analysed 267 definitions used by different institutions in 155 countries.[5],[6] According to the study, countries used a combination of criteria to classify MSMEs. 92% of the definitions used the number of employees as one of the criteria. Other frequently used criteria were: (i) turnover (49%), and (ii) value of assets (36%). 11% of the analysed definitions used alternative criteria such as: (i) loan size, (ii) years of experience, and (iii) initial investment.
Evaluation of common criteria used to define MSMEs
Investment: The 2006 Act uses investment in plant, machinery, and equipment to classify MSMEs. Some of the issues with the investment criteria include:
Due to their informal and small scale of operations, firms often do not maintain proper books of accounts and hence find it difficult to get classified as MSMEs as per the current definition.5
The investment-based classification incentivises promoters to keep the investment size restricted to retain the benefits associated with the micro or small category.7
Turnover: The 2018 Bill sought to replace the investment criteria with annual turnover as the sole criteria for the classification of MSMEs. The Standing Committee agreed with the proposal under the Bill to use annual turnover as the criteria instead of investment.7 It observed that this could overcome some of the shortcomings of classification based on investment. While turnover based criteria will also require verification, the Committee noted that the GST Network (GSTN) data can act as a reliable source of information for this purpose. However, it also observed that:7
With turnover as a criterion for classification, corporates may misuse the incentives meant for MSMEs. For instance, there is a possibility that a multi-national company may produce a large quantity of products worth a high turnover and then market it through various subsidiaries registered as Micro or Small enterprise under GSTN.
The turnover of some enterprises may fluctuate depending on their business, which may result in the change of classification of the enterprise during a year.
The Committee noted that there is a wide gap in turnover limits. For instance, an enterprise with a turnover of Rs 6 crore and an enterprise with a turnover of Rs 75 crore (as proposed in 2018 Bill) would both be classified as a small enterprise, which seems incongruous.
The Expert Committee (RBI) also recommended using annual turnover as the criteria for classification instead of investment.5 It observed that turnover based definition would be transparent, progressive, and easier to implement through the GSTN. It also recommended that the power to change the definition of MSMEs should be delegated to the executive as it will help in responding to changing economic scenarios.
Number of employees: The Standing Committee had highlighted that in a labour-intensive country like India, appropriate focus is required on employment generation and MSME sector is the most suitable platform for this.7 It had recommended that the central government should assess the number of persons employed in the MSME sector and also consider employment as a criterion while classifying MSMEs. However, the Expert Committee (RBI) stated that while the employment-based definition is an additional feature preferred in some countries, the definition would pose challenges in implementation.5 According to the Ministry of MSME, employment as a criterion has problems due to: (i) factors such as seasonality and informal nature of engagement, (ii) similar to investment criteria, this would also require physical verification and has associated cost overheads.7
Number of MSMEs
According to the National Sample Survey (2015-16), there were around 6.34 crore MSMEs in the country. The micro sector with 6.3 crore enterprises accounted for more than 99% of the total estimated number of MSMEs. The small and medium sectors accounted for only 0.52% and 0.01% of the estimated number of enterprises, respectively. Another dataset to understand the distribution of MSMEs is Udyog Aadhaar, a unique identity provided by the Unique Identification Authority of India (UIDAI) to MSME enterprises.[8] Udyog Aadhaar registration is based on self-declaration by enterprises. Between September 2015 and June 2020, 98.6 lakh enterprises have registered with UIDAI. According to this dataset, micro, small, and medium enterprises comprise 87.7%, 11.8% and 0.5% of the MSME sector respectively.
Employment in the MSME sector
The MSME sector employed nearly 11.1 crore people in 2015-16. The sector was the second largest employer after the agriculture sector. The highest number of employed persons were engaged in trade activity (35%), followed by persons engaged in manufacturing (32%).
Implications of change in the definition of MSMEs
The change in the definition of MSMEs may result in many enterprises which are currently classified as Small enterprises be reclassified as Micro, and those classified as Medium enterprises be reclassified as Small. Further, there may be many enterprises which are not currently classified as MSMEs, which may fall under the MSME classification as per the new definition. Such enterprises will also now benefit from the schemes related to MSMEs. The Ministry of MSME runs various schemes to provide for: (i) flow of credit to MSMEs, (ii) support for technology upgrade and modernisation, (iii) entrepreneurship and skill development, and (iv) cluster-wise measures to promote capacity-building and empowerment of MSME units. For instance, under the Credit Guarantee Fund Scheme for Micro and Small Enterprises, a credit guarantee cover of up to 75% of the credit is provided to micro and small enterprises.[9] Thus, the re-classification may require a significant increase in budgetary allocation for the MSME sector.
Other announcements related to MSMEs in the aftermath of COVID-19
MSME sector accounted for nearly 33.4% of the total manufacturing output in 2017-18.[10] During the same year, its share in the country’s total exports was around 49%. Between 2015 and 2017, the contribution of the sector in GDP has been around 30%. Due to the national lockdown induced by COVID-19, businesses including MSMEs have been badly hit. To provide immediate relief to the MSME sector, the government announced several measures in May 2020.[11] These include: (i) collateral-free loans for MSMEs with up to Rs 25 crore outstanding and up to Rs 100 crore turnover, (ii) Rs 20,000 crore as subordinate debt for stressed MSMEs, and (iii) Rs 50,000 crore of capital infusion into MSMEs. These measures have also been approved by the Union Cabinet.[12]
For more details on the announcements made under the Aatma Nirbhar Bharat Abhiyan, see here.
[1] “Cabinet approves Upward revision of MSME definition and modalities/ road map for implementing remaining two Packages for MSMEs (a)Rs 20000 crore package for Distressed MSMEs and (b) Rs 50,000 crore equity infusion through Fund of Funds”, Press Information Bureau, Cabinet Committee on Economic Affairs, June 1, 2020.
[2] The Micro, Small and Medium Enterprises Development Act, 2006, https://samadhaan.msme.gov.in/WriteReadData/DocumentFile/MSMED2006act.pdf.
[3] The Micro, Small and Medium Enterprises Development (Amendment) Bill, 2015, https://www.prsindia.org/sites/default/files/bill_files/MSME_bill%2C_2015_0.pdf.
[4] The Micro, Small and Medium Enterprises Development (Amendment) Bill, 2018, https://www.prsindia.org/sites/default/files/bill_files/The%20Micro%2C%20Small%20and%20Medium%20Enterprises%20Development%20%28Amendment%29%20Bill%2C%202018%20Bill%20Text.pdf.
[5] Report of the Expert Committee on Micro, Small and Medium Enterprises, The Reserve Bank of India, July 2019, https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/MSMES24062019465CF8CB30594AC29A7A010E8A2A034C.PDF.
[6] MSME Country Indicators 2014, International Finance Corporation, December 2014, https://www.smefinanceforum.org/sites/default/files/analysis%20note.pdf.
[7] 294th Report on Micro Small and Medium Enterprises Development (Amendment) Bill 2018, Standing Committee on Industry, Rajya Sabha, December 2018, https://rajyasabha.nic.in/rsnew/Committee_site/Committee_File/ReportFile/17/111/294_2019_3_15.pdf.
[8] Enterprises with Udyog Aadhaar Number, National Portal for Registration of Micro, Small & Medium Enterprises, Ministry of Micro, Small and Medium Enterprises, https://udyogaadhaar.gov.in/UA/Reports/StateBasedReport_R3.aspx.
[9] Credit Guarantee Fund Scheme for Micro and Small Enterprises, Ministry of Micro, Small and Medium Enterprises, http://www.dcmsme.gov.in/schemes/sccrguarn.htm.
[10] Annual Report 2018-19, Ministry of Micro, Small and Medium Enterprises, https://msme.gov.in/sites/default/files/Annualrprt.pdf.
[11] "Finance Minister announce measures for relief and credit support related to businesses, especially MSMEs to support Indian Economy’s fight against COVID-19", Press Information Bureau, Ministry of Finance, May 13, 2020.
[12] "Cabinet approves additional funding of up to Rupees three lakh crore through introduction of Emergency Credit Line Guarantee Scheme (ECLGS)", Press Information Bureau, Ministry of Finance, May 20, 2020.
Recently, the central government launched the Pradhan Mantri Sahaj Bijli Har Ghar Yojana (or Saubhagya).[i],[ii] The scheme seeks to ensure universal household electrification (in both rural and urban areas) by providing last mile connectivity. The scheme is expected to cover three crore households. Note that currently about four crore households are un-electrified. A rural electrification scheme has also been under implementation since 2005. In light of this, we discuss the current situation of, and key issues related to rural electrification in the country.
Regulatory and policy framework
Under the Electricity Act, 2003, the central and state governments have the joint responsibility of providing electricity to rural areas. The 2003 Act also mandates that the central government should, in consultation with the state governments, provide for a national policy on (i) stand-alone power systems for rural areas (systems that are not connected to the electricity grid), and (ii) electrification and local distribution in rural areas. Consequently, the Rural Electrification Policy was notified in August 2006.[iii]
The Rajiv Gandhi Grameen Vidyutikaran Yojana (RGGVY), launched in 2005, was the first scheme on rural electrification. In December 2014, Ministry of Power launched the Deendayal Upadhyaya Gram Jyoti Yojana (DDUGJY), which subsumed the RGGVY.[iv] Components of DDUGJY include: (i) separation of agricultural and non-agricultural electricity feeders to improve supply for consumers in rural areas, (ii) improving sub-transmission and distribution infrastructure in rural areas, and (iii) rural electrification by carrying forward targets specified under the RGGVY.
The total financial outlay for DDUGJY over the implementation period (until 2021-22) is Rs 82,300 crore which includes budgetary support of Rs 68,900 crore. The central government provides 60% of the project cost as grant, the state power distribution companies (discoms) raise 10% of the funds, and 30% is borrowed from financial institutions and banks.
Status of rural electrification
As of August 2017, about 1% of the villages in India remain un-electrified (3,146 villages). However, with regard to households, around 23% (4.1 crore households) are yet to be electrified. Table 1 at the end of this post shows the status of rural electrification across all states.
Issues with rural electrification
Definition of an electrified village
An electrified village is defined as one that has the following: (i) provision of basic infrastructure such as distribution transformers and lines in the inhabited locality, (ii) provision of electricity in public places like schools, panchayat office, health centers, dispensaries, and community centers, and (iii) at least 10% of the total number of households in the village are electrified.[iv]
Therefore, a village is considered to be electrified if 10% of the total number of households in the village have been electrified. This is apart from the basic infrastructure and electrification of certain public centers in the village. The Standing Committee on Energy (2013) had observed that according to this definition, a village would be called electrified even if up to 90% of households in it do not have an electricity connection.[v] It also noted that the infrastructure being provided under the scheme is highly inadequate, unreliable and unsustainable. The Committee recommended that the actual electrification requirement of villages must be assessed, and it should be ensured that the state discoms provide electricity to the remaining households in the village.
Supply of electricity
The Standing Committee had also noted that while the rural electrification scheme looks at creating infrastructure, the actual supply of electricity to households rests with the state discoms.[v] These discoms are already facing huge financial losses and hence are unable to supply electricity to the villages. Discoms continue to supply subsidised power to agricultural and residential consumers, resulting in revenue losses. Further, the average technical and commercial losses (theft and pilferage of electricity) (AT&C losses) are at around 25%. While the Ujjwal Discom Assurance Yojana (UDAY) has eased off some of the financial losses of the discoms, it remains to be seen whether discoms are able to reduce the cost-tariff gap and AT&C losses in the future.
It has been recommended that generation capacity should be augmented so that states can meet the additional demand under the rural electrification schemes. Further, the assistance to financially weaker states should be increased so that they can better implement the scheme.[v]
Electricity to below poverty line (BPL) households
Under the rural electrification scheme, the cost for providing free electricity connection per BPL household is Rs 3,000. It has been observed that this cost per household may be inadequate.[v] Due to the low cost, the quantity and the quality of work has been getting compromised leading to poor implementation of the scheme. It has been recommended that the Ministry should revisit the cost provided under the scheme.[v]
The new electrification scheme: Pradhan Mantri Sahaj Bijli Har Ghar Yojana (or Saubhagya)
The new scheme, Saubhagya, seeks to ensure universal household electrification, that is, in both rural and urban areas. Under Saubhagya, beneficiaries will be identified using the Socio Economic and Caste Census (SECC) 2011 data. The identified poor households will get free electricity connections. Other households not covered under the SECC, will be provided electricity connections at a cost of Rs 500. This amount will be collected by the electricity distribution companies in 10 instalments.
The total outlay of the scheme will be Rs 16,320 crore, of which the central government will provide Rs 12,320 crore. The outlay for the rural households will be Rs 14,025 crore, of which the centre will provide Rs 10,588 crore. For urban households the outlay will be Rs 2,295 crore of which the centre will provide Rs. 1,733 crore.
The state discoms will execute the electrification works through contractors or other suitable agencies. Information technology (mobile apps, web portals) will be used to organise camps in villages to identify beneficiaries. In order to accelerate the process, applications for electricity connections will be completed on the spot.
So far the focus of electrification schemes has been on rural areas, where typically last mile connectivity has been difficult to provide. Saubhagya extends the ambit of electrification projects to urban areas as well. While DDUGJY has focused on the village as the principal unit to measure electrification, the new scheme shifts the targets to household electrification. While the target for ensuring electricity connection in each household will be a significant step towards ensuring 24×7 power, the question of continuous and quality supply to these households will still rest on the ability of the discoms to provide electricity. Further, while the scheme provides for free connections, the ability of these households to pay for the electricity they consume may be a concern.
Table 1: Status of rural electrification across states (as of August 2017)
[i] “PM launches Pradhan Mantri Sahaj Bijli Har Ghar Yojana “Saubhagya””, Press Information Bureau, Ministry of Power, September 25, 2017.
[ii] “FAQs on Pradhan Mantri Sahaj Bijli Har Ghar Yojana “Saubhagya””, Press Information Bureau, Ministry of Power, September 27, 2017.
[iii]. Rural Electrification Policy, Ministry of Power, August 23, 2006, http://powermin.nic.in/sites/default/files/uploads/RE%20Policy_1.pdf.
[iv]. “Office memorandum: Deendayal Upadhyaya Gram Jyoti Yojana”, Ministry of Power, December 3, 2014, http://powermin.nic.in/rural_electrification/pdf/Deendayal_Upadhyaya_Gram_Jyoti_Yojana.pdf.
[v]. “41st Report: Implementation of Rajiv Gandhi Grameen Vidyutikaran Yojana”, Standing Committee on Energy, December 13, 2013, http://164.100.47.134/lsscommittee/Energy/15_Energy_41.pdf.
