A seminal decision taken by the Union Cabinet in early February 2018 to change the basis of classification of the Micro, Small and Medium Enterprises (MSMEs) bodes well for this important segment of India’s industrial base.1 The decision will become effective after the bill to amend the Micro, Small and Medium Enterprises Development Act, 2006 (MSMED Act 2006) is approved by Parliament and assented to by the President of India.
According to the Committee of Experts set up by the Ministry of Defence (MoD) in 2015, MSMEs contributed 7.04 per cent to the Gross Domestic Product (GDP) in 2012-13, with a gross value of output of Rs 1,09,976 crore. In the defence sector alone, as many as 6,000 MSME units have been supplying components and sub-assemblies to the public and private sector companies, out of which 800 are engaged with the Defence Research and Development Organisation (DRDO).2
Presently, enterprises qualify as micro, small or medium enterprises if their investment in plant and machinery (for manufacturing units) and equipment (for service providers) is within the limits laid down in Section 7 of the MSMED Act 2006,3 which are as follows:
Although Section 7(8) of the Act provides for the Advisory Committee constituted under the Act to make recommendations regarding the need for higher investment by MSMEs in plant and machinery or equipment for technological upgradation, employment generation and enhanced competitiveness, the investment limits have remained unchanged since the commencement of the MSMED Act 2006. These limits are too low in the contemporary context.
Classification of enterprises based on fixed monetary limits also places newer units at a disadvantage vis-a-vis those set up in earlier years as the former have to invest more for the same type of plant and machinery or equipment. More importantly, self-declaration by enterprises as regards the cost of investment at the time of registration with the authorities concerned entails verification, if deemed necessary by them, adding to the transaction cost.
All this is set to change with the Union Cabinet’s decision to withdraw the MSMED (Amendment) Bill, 2015, pending in the Lok Sabha, which simply sought to increase the existing monetary limits two to three times,4 and to change the basis of classification from investment in plant and machinery or equipment to annual turnover without making a distinction between manufacturing enterprises and service providers.
The revised classification and eligibility thresholds will be as follows:
An enabling provision will be also be made in the MSED Act 2006 to permit the Central Government to vary these limits in future by simply issuing a notification but the revised limits shall not be more than thrice the limits mentioned above. This will ensure that the monetary limits remain contemporaneous at all times as changing these limits will not require a formal amendment to the MSED Act 2006, which is a time-consuming and cumbersome process.
The new system of classifying enterprises based on annual turnover will be more reliable, transparent and objective as the qualifying criteria will be verifiable with reference to the data available in the Goods and Services Tax network. This will also reduce transaction costs as it will no more be necessary to carry out any inspection.
With the replacement of the restrictive criteria for classification of MSMEs based on cost of investment in plant and machinery or equipment with a more realistic criterion linked with annual turnover, many enterprises that presently do not qualify should come within the ambit of the MSMED Act, 2006 and benefit from a large number of schemes promulgated by the government for this sector from time to time.5 Existing MSMEs should also be able to invest more in plant and machinery and equipment without losing out on the benefits available to them. While the main driving force behind the promotion of MSMEs is the Ministry of Micro, Small and Medium Enterprises, the Ministry of Defence also has a lot to offer them specifically in the area of defence offsets as well as projects under the ‘Make’ procedure and Defence Technology Fund. Foreign vendors are permitted the multiplier of 1.5 if they discharge their offset obligation through an Indian Offset Partner (IOP) from the MSME sector. The proposed limits on annual turnover will enable a larger number of companies to qualify as MSMEs and benefit from the offset policy while at the same time providing a wider base for foreign companies to choose from.
This will also improve the prospects of a larger number of ‘Make’ projects presently on offer6 being taken up as the number of MSMEs should increase on account of the change in the basis of classification. It may be recalled that ‘Make’ projects entail design, development and manufacture of equipment, systems, sub-systems, assemblies, sub-assemblies, major components, and upgrades by Indian companies.
There are two sub-categories of ‘Make’ projects: Make-I, which entails MoD funding of the cost of development; and, Make-II, comprising industry-funded projects. Projects with development cost of up to Rs 10 crore and Rs 3 crore are reserved for the MSME under these two sub-categories respectively. The change in the basis of classification should enable MSMEs to enhance their capabilities without having to bother about investment in plant and machinery and be in a better position to undertake these projects.
The expanded MSME base also improves the prospects for projects funded from the ‘Technology Development Fund (TDF)’ for development of defence and dual use technologies. These are currently not available with Indian defence industry or have not been developed with objective of creating eco-system for enhancing cutting edge technology capability for defence application.
The scheme envisages funding of projects through the provision of grants to public and private sector industry, especially MSMEs that may work in collaboration with academia or research institutions.7 MSMEs are ideally suited for undertaking such projects to develop niche technologies.