MSME manufacturers oppose bill that redefines their classification based on turnover

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30 November, 2019

Anju Bajaj first became an entrepreneur in 1990. She took of a loan of Rs 10 lakh under the Mahila Udyam Nidhi scheme, a government scheme for women entrepreneurs, and invested in land, a building and plant and machinery. She set up her business, PnA Industries, in Bahadurgarh, an industrial area neighbouring Delhi, manufacturing electrical conduits, pipes, fittings and junction boxes. Her initial customers were government agencies such as defence establishments and the Indian Railways, and she slowly expanded to the private sector as her business flourished. PnA industries is classified as a micro enterprise, defined as such based on the amount of money Bajaj has invested in plant and machinery.

Like several other manufacturers, Bajaj is now worried about the Micro, Small and Medium Enterprises Development (Amendment) Bill, 2019, which redefines the criteria for what qualify as micro, small and medium enterprises. Instead of the earlier criterion, based on the amount invested in plant and machinery, the bill proposes to classify MSME’s based on their annual turnover. The bill is listed for introduction, consideration and passage in the current session of Parliament that will end on 13 December. If this bill is passed into law, Bajaj feared she may be unable to continue in the manufacturing business.

The Micro, Small, and Medium Enterprises Act, 2006, currently defines the criteria under which businesses can be classified as MSMEs. The act applies to businesses manufacturing goods or providing services. It defines MSMEs engaged in manufacturing on the basis of their investment in plant and machinery, which are the fixed assets—such as machines and tools—that a firm uses to manufacture goods. According to the act, a micro enterprise is one where the investment does not exceed Rs 25 lakh, a small enterprise is one where the investment is between Rs 25 lakh and Rs 5 crore and a medium enterprise has an investment of between Rs 5 crore to Rs 10 crore.

In the case of a business providing a service, it can qualify as a micro enterprise if it has investment of up to Rs 10 lakh in equipment, as a small enterprise with investment of between Rs 10 lakh and Rs 2 crore and as a medium enterprise with investment ranging from Rs 2 crore to Rs 5 crore.

MSMEs receive a number of benefits such as compulsory government procurement and priority lending from banks. According to the government’s procurement policy, 25 percent of procurement by the central government—which includes ministries, departments and public sector undertakings—must be from micro and small units, with some exceptions for the defence sector. In 2016–17, the contribution by MSMEs in India’s GDP stood at 29 percent.

The new MSME bill seeks to reclassify MSMEs based on their turnover, which is the total sales during an accounting period, usually a year. According to the proposal, a micro unit would be an enterprise with a turnover of up to Rs 5 crore, a small unit would be one with a turnover ranging from Rs 5 crore to Rs 75 crore while a medium enterprise would have a turnover of between Rs 75 crore and Rs 250 crore. In its statement of objects and reasons, the bill states, “It has been considered appropriate that if the annual turnover is taken as a criterion for classification, the information available with goods and services tax network and other sources can be used for determination of the category of the enterprises. Overall, the turnover based classification will promote the ease of doing business and will put in place a non-discretionary, transparent and objective classification system.”

However, manufacturers are worried that the new turnover-based classification will allow traders to enter the MSME space. Since investment in plant, machinery and equipment will no longer be the defining criterion, the new classification may make it simpler for traders to pass themselves off as manufacturers, simply by importing cheaper goods from abroad rather than manufacturing them in India. This could increase the competition for government benefits and crowd out the market.

Manufacturers have argued that it will take away the incentive for manufacturing in India and encourage imports. “If this bill goes through I’ll probably have to shut my firm,” Bajaj told me. “Manufacturing in India will become uncompetitive and it will be cheaper to import from China and pass it off as made in India. Whatever little manufacturing base that India has will also be wiped out.”

Several industry associations representing MSMEs have come out against the government plan. The Laghu Udyog Bharati, a Sangh Parivar organisation that represents MSMEs, has also opposed the bill. “Our stand is that the bill is illogical and unnecessary and we are trying to convince the government that MSMEs should not be defined as per turnover,” Govind Lele, the all-India general secretary of LUB told me in a phone interview. Echoing Bajaj’s views, he added, “Manufacturing is the backbone of any industrialised country and the purpose of the current definition is to promote micro and small industries by Indian entrepreneurs. Changing the definition to turnover would mean that traders would prefer to import manufactured items from abroad and pass it off as made in India, wiping out what little manufacturing there is in India.”

The LUB is also opposing the bill because of the employment generated by the MSME sector. “The main driver of employment after agriculture is MSME,” Lele said. “An average MSME unit employs seven people, so what will happen if traders also get into the game? They don’t require much man power, so employment will go down. It will be damaging for economy and society.” When I asked Lele how they planned to oppose the government he said, “We will fight it out logically and on the basis of facts, not hit the streets or call a bandh like a Left trade union.”

Government statistics partially support Lele’s arguments. In its 2018–19 annual report, the ministry for micro, small and medium enterprises stated that MSMEs had created 11.10 crore jobs during the period 2015-16.

“Manufacturing is shrinking and the statistics bear this out,” Virendra Kumar Singh, the northern-region chairman of the All India Manufacturers’ Organisation, an industry body, told me. “Manufacturing in India is uncompetitive and the shift to trade is already happening. If this bill goes through it will accelerate the process.” Singh added, “India was once a global hub for textiles, but now Bangladesh and Vietnam have overtaken us.” Singh cited terrible infrastructure in the form of bad roads, and inadequate facilities such as water and electricity, to explain the manufacturing sector’s uncompetitiveness.

I also spoke to Pronab Sen, a former secretary at the ministry of statistics and programme implementation and currently the programme director for the India programme at the International Growth Centre, an economic research centre. He told me that classifying MSMEs on the basis of turnover is “not a particularly desirable way of doing it” because there would be an incentive to under-report turnover to evade the Goods and Services Tax. In addition, he said, a turnover-based system would skew the incentives in favour of traders rather than manufacturers.

“A trader’s value addition is smaller than a manufacturer’s,” Sen told me. “He buys a good, transports it, and resells for a slightly higher price. If the value of the items he trades in is high then his turnover is high, but the value addition, or the difference between the cost price and selling price, is low.” Referring to the investment a manufacturer makes in factory costs, plant and machinery, Sen added, “A manufacturer on the other hand is adding much more value through the production process and hence has to invest more money than a trader.” However, if turnover was the basis used to classify MSMEs, Sen said both the trader and manufacturer would be evaluated by the same measure, and getting the same incentives. “But whatever the margin, it goes straight into the trader’s pocket, whereas the manufacturer has to use part of his margin to repay his bank loan and other costs.” Sen said that it is possible that manufacturing would be further eroded if a turnover basis was adopted for MSMEs.

However, some industry bodies have supported the changes proposed in the bill. Harish Pal Kumar is a former chairperson of the National Small Scale Industries Corporation and currently the co-chair of the MSME vertical at the Federation of Indian Chambers of Commerce and Industry. “Reclassification of MSMEs on the basis of turnover would be better because it will make it easier to identify an MSM unit and bring it into the tax net,” Kumar told me. “Earlier one had to look at the original balance sheet to figure out what was invested in plant and machinery, which is a depreciating asset and this is difficult.” When I asked him about the concerns that traders would enter the market and replace manufacturers, he said that the onus was on the MSME ministry to make sure that only genuine manufacturers got the benefits. “If you are a trader in Chandni Chowk and are availing the benefits meant for manufacturers, then it’s the mistake of the registering authorities, they are supposed to check if there is a manufacturing unit,” Kumar said. “But if someone gets the registration through misrepresentation, they may get away with it.”

In January 2019, the Reserve Bank of India constituted a committee on micro, small and medium enterprises. It submitted a report in June stating that it had deliberated on the proposed definitional change and found it “rational, transparent, progressive and easier to implement with the introduction and operationalization of Goods and Services Tax.”

Piyush Agarwal, a deputy director of MSME policy with the MSME ministry told me that the government was changing the classification because of problems with the investment criteria. “Firms were under reporting their investment in plant and machinery, so they would continue to reap the benefits of being a micro or small unit, which is basically participation in the mandatory 25-percent government procurement from MSMEs,” Agarwal said. “With turnover, the figure will automatically be captured by the GST network and it will be easy to figure out which firms are small and micro and which firms are medium.”

Agarwal said that traders cannot register on the Udyog Aadhar portal, a government platform meant for the online registration of MSMEs, but conceded that some traders could resort to online manipulation and get their firms registered as an MSME unit. “But that is unlawful,” he said.

The MSME bill was first introduced in the Lok Sabha in July last year. Since it was not passed, the bill had lapsed when the term of the sixteenth Lok Sabha ended. It remains to be seen what the fate of the bill will be in the ongoing session of Parliament.