GST woes, Covid pandemic leave MSMEs gasping

Five years after GST's implementation, MSMEs struggle to stay afloat due to labour shortage, credit gap and unfavourable policies

After working as a labourer for a decade, Saravanan (42) donned the cap of an entrepreneur in 2006. With many aspirations supported by hard work, he set up a micro-scale job work engineering unit in Tamil Nadu's Coimbatore, popular as South India’s Manchester.

A technically-sound person, who over the years, developed the ability to clear doubts about machines over the phone, Saravanan expanded his unit that made automobile parts, textiles, and hydraulic spares by employing 10 people.

The first decade as an entrepreneur felt seamless. Things went downhill when the Union government introduced the Goods and Services Tax Act (GST Act) in 2017. The regime brought job units and micro enterprises into the tax ambit, but the move came when the largely cash-dependent industry was already suffering due to liquidity issues due to the demonetisation in November 2016.

Read | A silver lining amid the crisis

Units, like the one Saravanan owned, came under the higher 18% tax bracket making the going difficult for job work units and micro-enterprises. The job units, which largely consist of five to 10 people, form an integral part of India's industrial ecosystem. They couldn’t take the shock.

The differential tax slabs — lower tax slabs for finished goods and higher slabs for the raw materials used in them — was a major cause of the chaos. The government did course correct later, like bringing the tax bracket to 12%, but it was already too late.

Five years down the line, Saravanan has shut his unit and sold his machinery. "The surmounting losses reached the peak during the Covid-19 lockdown," he says.

“From zero debt in 2006 to a loan outstanding of Rs 18 lakh in 2022, didn’t I come a long way in just 16 years?” asked Saravanan. “And this, after having sold everything that I had. I hardly make Rs 20,000 a month now,” he told DH.

Despite the losses, many units did fight back and were on their feet by 2019. That is when the global economic slowdown snatched orders from them — they hoped this too would pass.

Covid-19 lockdowns and their impact

Then there was the Covid-19 pandemic-induced lockdown. The subsequent increase in prices of raw materials was perhaps the final nail in the coffin. These consecutive issues put Micro, Small, and Medium Enterprises (MSMEs), known as the backbone of the Indian economy, in deep distress.

Saravanan’s story is just the tip of an iceberg. There is no dearth of stories of suffering across the country – be it Kanpur, Tiruppur, or such hubs in Gujarat and Karnataka -- with several thousand micro units going out of business silently over the past few years, more so after the Covid-19 lockdown.

R Raju, past president of Karnataka Small Scale Industries Association, owns Ven-Gree Metal Punch Pvt Ltd in Bengaluru says the past five years have been the most challenging since he launched his business in 2006. He complains that the government continues to bring changes to tax slabs even five years after the GST regime was introduced.

Raju expressed dissatisfaction that there was no leniency extended to micro and small enterprises in the GST regime. “Come what may, we have to file returns on the 20th of every month. And we are being charged interest on penalties,” he says.

Though the government exempted job manufacturing units with less than Rs 40 lakh turnover from the tax ambit, large companies that issue orders insist on a GST number. These firms still take 90 to 120 days to make payments despite the government asking them to stick to a 45-day period.

Also read | Coimbatore, the MSME hub, struggling to find its feet

“We usually survive on a hand-to-mouth basis. When the government asked us to pay GST every month, we had no choice but to borrow money and pay taxes to avoid complications. The borrowings have only increased over the months,” C Sivakumar of Coimbatore Tiruppur Districts Micro and Cottage Entrepreneurs Association, tells DH.

Economic mismanagement

Human development economist Santosh Mehrotra attributes “economic mismanagement” by the Union government to the mess that MSMEs find themselves in today.

“Note ban was the disaster that sent clusters like Tiruppur and Coimbatore essentially of MSMEs and unorganized sector down in the dumps. It was followed by GST, slowdown, and repeated Covid-19 induced lockdowns,” Mehrotra, Visiting Professor, Centre for Development Studies, University of Bath, UK, told DH.

Take the case of Coimbatore, one of the major MSME hubs in the country, known for the excellent ecosystem it provides to manufacturing and automotive industries.

M V Ramesh Babu, who heads the influential Coimbatore District Small Scale Industries Association (CODISSIA), says around 30 per cent of the micro units in the city have gone out of business silently in the past few years.

“They could not simply stay in the business. Flawed implementation of GST, the differential tax regime, and the high number of compliances made many units unsustainable even before Covid. And the pandemic just washed them away,” Babu said.

Sivakumar added, “we will never know the number of units that have shut shop. We realise many have closed down only when we invite them for our meetings.” In the Economic Survey tabled by Union Finance Minister Nirmala Sitharaman this year, the government said the Udyam portal registered 66 lakh MSMEs of which 63 lakhs were micro enterprises, 3 lakh (small), and 34,355 (medium) as of January 17, 2022.

Many entrepreneurs whom DH spoke to complained of problems in the GST regime that need to be sorted out. Take the case of Manjunath Rao from Karnataka, who filed GST in the wrong category for a product his firm bought.

“We filed in the wrong category for six months, paid penalty and applied for the refund. I did get the refund. However, after five years I got a notification that I had to pay interest for those six months for delay of payment. In fact, now I have to pay interest for five years. Can we afford to keep paying penalties?” Rao asks.

Read | Why MNCs are quitting India

Though GST has brought many into the tax net, the higher slabs, insiders say, have forced many to evade the system. On this, Babu of CODISSIA says the Centre should take a cue from then Finance Minister Arun Jaitley’s promise that the tax rates will be reduced when GST collections increase.

“The country keeps posting record GST collections and this is the time to reduce the tax slabs. This will not just come as a reprieve to micro and small enterprises but encourage many to comply,” Babu adds.

Aftermath of Covid

While Covid-19 washed out the working capital of the MSMEs which had to run the show despite units being shut for months together, the prices of raw materials – iron, steel, cotton, and yarn among many others -- which is on an upswing since October 2020 pushed many of them to the brink.

Jaimin Vasa of the Gujarat Chemical Association says raw materials witnessed a 200% to 300% hike and demand is also not picking up.

“Nearly 60 per cent of MSMEs in the sector in Gujarat have turned sick post Covid-19 and require a lot of hand holding and support from the government. The chances of revival are bleak due to technological constraints faced by local players. Besides, the demand is also not picking up,” he said.

Besides working on capital issues, the MSMEs had to incur huge expenditures on maintaining machinery that was idle for about 10 months in two years.

K Mariappan, President, Tamil Nadu Small and Tiny Industries Association, warned many businesses will go down the drain if the prices of raw materials were not controlled.

Skilled labour is another major problem that MSMEs are facing. “Wherever you go, there is an acute shortage of labour. What will we do without labourers,” Mariappan asks.

Raju concurs with Mariappan. “We have a 30% to 40% shortage of labour. Many workers who had returned to their villages during the lockdown never came back. We barely manage to complete orders on time,” Raju adds.

Mehrotra feels the Union Government could have addressed the labour shortage issue effectively by announcing an urban employment guarantee scheme that would have achieved the twin objectives of stimulating growth and keeping the migrant labourers in their places of work.

“Such a scheme would have also substituted the government’s expenditure on rural MNREGA as it would have kept workers in cities. Many MSMEs died because they had no workers,” he says.

Labour shortage

Mehrotra feels the Union Government could have addressed the labour shortage issue effectively by announcing an urban employment guarantee scheme that would have achieved the twin objectives of stimulating growth and keeping the migrant labourers in their places of work.

“Such a scheme would have also substituted the government’s expenditure on rural MNREGA as it would have kept workers in cities. Many MSMEs died because they had no workers,” he said, adding joblessness grew on a mass scale as demand collapsed during Covid.

The leading economist said the government should supplement its supply-side actions with stimulating demand in a variety of ways to ensure that MSMEs don’t die.

“Many of them may not revive, but the ones which are in deep stress could be revived. The government should revive labour-intensive manufacturing industries by providing specific packages to specific industries to boost demand and create jobs,” he said.

The noted economist suggested that the government choose five such sectors -- textiles, garments, leather products, food processing and furniture – to stimulate demand that will eventually lead to creation of jobs.

Access to credit

The Union Government did step in during the Covid lockdown to help the suffering MSMEs by announcing a stimulus package and introducing schemes like the Emergency Credit Line Guarantee Scheme.

However, studies conducted by independent organisations said the financial aid of the governments — both the Centre and states — did not reach the majority of the MSMEs due to ineligibility.

K E Raghunathan, Chairman, Association of Indian Entrepreneurs, says the governments’ financial packages came with riders making only 7% to 8% of MSMEs eligible.

“Others did not have any avenue or choice. They were left high and dry. The problem is the government treated all sectors on an equal footing. They should have gone for a case-to-case, sector-to-sector, or impact-to-impact solution. Those who wanted (credit) never got, and those who did not need but were eligible but never availed or needed more,” Raghunathan says.

A report by the Association of Chartered Certified Accountants found that around 80% of MSMEs lack access to traditional lending channels. The lack of low-cost traditional loans pushes many entrepreneurs to go for informal sources like moneylenders who charged heavy interest.

Another survey titled Indian MSME Responses to COVID 19 Pandemic Crisis conducted by Dr S K Prasad, Professor of Management, Reva University, Bengaluru from July-December 2021 in select states in south India found only a little over 38 per cent entrepreneurs who were surveyed said they were found ineligible for ECLGS while only 12 per cent said availed funds using the scheme.

A total of 63.13 per cent respondents said that they were not aware of Equity Infusion through the Fund of Funds Scheme announced in June 2020, it found.

“The ground reality is that most of the high-sounding and well-articulated schemes never reached the needy. Neither they were able to match the immediate requirements of MSMEs in general and they were miles away from the reach in the case of micro enterprises,” Dr Prasad, the study lead, told DH.

Another Survey conducted by ILO said 61 percent of MSMEs surveyed neither applied for any financial support nor received during the Covid-19 crisis.

The professor said it was high time that policymakers, support systems of MSMEs, banks, and financial institutions to have a fresh look at the existing ecosystem and take short-term and long-term measures to strengthen the MSMEs that “have tremendous potential for contributing to accelerated growth of the Indian economy.”

He also pushed the need for a policy to ensure that MSMEs are registered and that entrepreneurs realize the need for registration.

Mariappan says banks should adopt the strategy of rehabilitation, restructuring and revival before going for recovery. “Wherever there is sufficient collateral available, banks go for immediate recovery which is unfair. If MSMEs have to survive, banks should provide short-term and timely loans to entrepreneurs,” he says.

Pradeep Shuroor, a micro-scale businessman from Karnataka, has this to say. “Even in banks, there is an exorbitant rate of interest if there is a delay in payment. They can reduce this extra interest rate. This would certainly help small businesses."

However, a report published by NeoGrowth said despite being the first ones to be impacted by the pandemic, MSMEs have shown grit and the credit demand from them is back to a “healthy level” which indicates that the sector is on a successful resurgence trajectory.

“They (MSMEs) were struggling in 2020-21 due to the burden of loan repayments because of the cessation of demand. The MSME ecosystem in India is on a survival to revival saga. The lessons learned during the pandemic have transformed the way businesses operate and fast-tracked their move to digital,” Arun Nayyar, Chief Executive Officer, NeoGrowth, said.

MSME Minister Narayan Rane said the Union Government has been making a series of interventions to address the problems faced by the MSMEs. “Given the complexity of the problem, a lasting solution will need all stakeholders – the buyers, solution providers and MSMEs – to come together to address it,” he added.

He also called for coordinated efforts from all stakeholders to resolve the issue of delayed payments, saying delayed payments from buyers weaken the MSME suppliers and impede their growth.

Shutting shop

All these difficulties mean that MSMEs have been dying quick deaths. In 2021 alone, according to the Union government's conservative estimates, 5,577 MSMEs shut shop.

Babu of CODISSIA, says around 30% of the micro-units in the city have gone out of business in the past few years.

The situation isn’t rosy in Gujarat, a heavily industrialised state, either. Gujarat Chemical Association claims that nearly one-third of the 11,000 units in the state, 98% of which are MSMEs, are suffering because of a 50% reduction in production.

"Roughly 30% to 40% units have been forced out of business in Ahmedabad and elsewhere in the state in the past two years," Jayendra Tanna, President, Gujarat Traders' Federation, says.

Uttar Pradesh has 90 lakh registered MSMEs, making the sector the biggest job provider in the state. Even here, conservative estimates say, around 35% of micro and small units have closed in the past few years.

“These units were suffering, like their counterparts in other states, from non-availability of skilled labour, high cost of power, lack of proper roads and non-availability of piped water,” an entrepreneur from UP says.

In Kanpur, the number of closed mills is much higher than the ones that are open. The leather industry is also suffering due to government restrictions – they now operate just 15 days a month.

How concentrating on exports will helpHow concentrating on exports will help

While Raghunathan says there is a “total disconnect” between reality and policymakers, Mehrotra adds the government should stop “frowning at domain experts” and involve MSMEs while formulating policies.

“It was like performing a surgery without administering anaesthesia. The pain was more killing than the wound,” Raghunathan said on government policies being implemented “suddenly without time to prepare or been part of the decision.”

Mehrotra also spoke about merchandise exports, which were growing at a rate of 15 to 18 per cent every year, suddenly contracting in value terms from 2014-2015 and the lowest they went is $265 billion in 2015-2016 from $315 billion in 2013-2014.

“The exports have risen to $400 billion in 2022 and this is a recent phenomenon. The government should remember that exports which were growing fell suddenly for five years. This was because it allowed the rupee to appreciate as a result of which merchandise exports collapsed. One has to remember that over 40 per cent of exports are accounted for by MSMEs. Much more needs to be done in this sector,” Mehrotra said.

He concluded saying the capacity utilisation of industries slowly rising to 72 per cent hands out hope as this might lead to private investment and is an indicator that aggregate demand may go up. Right now, the demand is low, and joblessness is high, even as private jobs have not been growing for the past few years.

(With inputs from Varsha Gowda in Bengaluru, Satish Jha in Ahmedabad, Mrityunjay Bose in Mumbai, and Sanjay Pandey in Lucknow)