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Small Scale Industry in India: A study of its growth and role of commercial banks

Abstract

Small Scale Industry (SSI) sector has been playing a significant role in the economic
development of the country. Its contribution to GDP, employment generation and export has
been growing steadily over the years. As less capital- intensive producers of consumer goods
and providers of employment it addresses the problems of poverty and unemployment.
According to the Third All India Census 2002-03, there are about 113.95 lakh SSI units
(registered and unregistered) in the country accounting for more than 40 percent of gross
value of output in the manufacturing sector and about 34 percent of the total export of the
country. It provides employment to about 271.36 lakh persons, which is second only to
agriculture. The small scale industry sector contributes almost 40% of the gross industrial
value added in the Indian economy. SSI Sector plays a major role in India's present export
performance. 45%-50% of the Indian Exports is contributed by SSI Sector. However, the
sector has its own share of problems. Stakeholders often express concern over inadequate
flow of institutional credits to small scale sector and hold the same responsible for increasing
incidence of sickness. In this backdrop, this paper examines the flow of bank credit and its
impact on SSI sector vis-à-vis incidence of sickness and Non Performing Assets (NPA). It
has been found that growth in bank credit has trailed behind the consistent growth in
production as well as in export from the SSI sector despite steady decline in NPA.
Key words: Small Scale Industry, Commercial banks, Non performing assets, Bank credit
Dr. Mukul Mitra, Principal and Professor, NSHM College of Management and
Technology, Kolkata
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Introduction

P.C. Mahalanobis, one of the architect of five year planning in India, once observed – “in
view of meagerness of capital resources there is no possibility in short run for creating much
employment through the factory industries – now consider the household or cottage industry.
They require very little capital. With any given investment employment possibilities would
be 10 -15 or even 20 times greater in comparison with corresponding factory industries”.
(Reddy,2008). Presently MSE sector which was earlier known by the generic term - Small
Scale Industries, is pivotal to country’s overall economic growth as less capital- intensive
producers of goods and services and providers of employment. Since 55% of total MSEs is
located in rural areas, this sector makes significant contribution in demand creation,
employment generation and poverty alleviation in the rural areas. Growth of this segment is
also important for removing regional imbalances and rural urban disparities. However,
paucity of funds is stated to be a major hurdle for MSEs. In 1997, S.L.Kapur committee
appointed by the Reserve Bank of India (RBI) to look into the whole gamut of financing in
this sector observed that less than 15% of MSEs were covered by institutional credit.
Shortage of funds is also one of the main reasons for growing sickness in this sector (GOI,
2008).

Overvie w of Indian Small Scale Industry sector

Micro, Small & Medium Enterprises Development (MSMED) Act, 2006, classified the Small
Scale Industry sector in (a) Manufacturing Enterprises and b) Service Enterprises: The
manufacturing enterprises are defined in terms of investment in plant & machinery and the
enterprises engaged in rendering of services are defined in terms of investment in equipment.
Enterprise Investment in Plant & Machinery / Equipment

Manufacturing sector Service sector

Micro Does not exceed Rs 25 lakhs Does not exceed Rs 10 lakhs

enterprises

Small More than Rs.25 lakhs but does not More than Rs.10 lakhs but does not
enterprises exceed Rs. 5 crores exceed Rs. 2 crores

[Source: MSME ]
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Table 1: No of SSI units

(in lakhs)

Year No of units Productivity per employee

2000-01 100.11 0.77

2001-02 100.52 1.12

2002-03 100.95 1.16

2003-04 114.00 1.22

2004-05 118.60 1.30

2005-06 123.40 1.40

2006-07 128.40 1.51

[Source: MSME]

The data in Table 1 shows that SSI units are registering a steady growth and from 101.1 lakhs
units in 2000-01, the same as increased to 128.44 lakhs units in 2006-07 and the productivity
has increased from Rs 0.77 lakhs to Rs.1.51 lakhs per employee during the same period.

However, the registered and unregistered units constitute 19% and 81% of the total units
respectively. Non registration of units is a major weakness for the sector. It is not only that
banks’ risk perception is substantially high for the non registered units, non registration
prevents these units from receiving several benefits extended by the central and the state
governments. Further, this sector contributes almost 40% of the gross industrial value added
in the Indian economy. It has been estimated that a million rupees of investment in fixed
assets in the sector produces 4.62 million worth of goods or services with an approximate
value addition of ten percentage points. This sector plays a major role in India's present
export performance with a share in the range of 45%-50%. SSI contributes to 35% of total
exports directly and 15% indirectly which takes place through merchant exporters and
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trading houses. This sector in India creates significant employment opportunities for the
Indian populace,

next only to Agriculture. An investment of 100,000 rupees in fixed assets in the micro
and small enterprises generates employment for four persons. Data in Table 2 shows that in
between 1999 and 2007, there has been a steady growth in the number of employment in
these units from 229.10 lakhs to 312.53 lakhs and the target set in five year plans have been
surpassed in all these years.
Table 3: Employment generation in SSI sector
(In lakhs)
Year Target Actual
2000-01 180.00 240.94
2001-02 249.33 252.29
2002-03 258.13 263.68
2003-04 266.93 275.30
2004-05 275.73 287.85
2005-06 284.53 299.85
2006-07 293.33 312.52

[Source: MSME ]

Sickness
However, sickness is a major constraint for the SSI sector. In terms of the latest definition of
sickness given by the Working Group on Rehabilitation of Sick Units set up by the RBI
(Kohli Committee) a small scale industrial unit will be considered as sick :-
(a) if any of the borrowal accounts (i.e. the loan account with bank) of the unit remains
substandard for more than six months, i.e., principal or interest, in respect of any of its
borrowal accounts has remained overdue for a period exceeding one year or
(b) There is erosion in the net worth due to accumulated losses to the extent of 50 per cent of
its net worth during the previous accounting year, and the unit has been in commercial
production for at least two years.” (RBI, 2002)
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The Third All India Census of Small Scale Industries (2002-03) found that out of 23,05,725
registered units surveyed, it was estimated that 8,68,021 units were closed. Lack of demand
was found to be the main reason for sickness in this sector followed
by paucity of bank finance as are indicted in Table 4.
Table 4 :- Reasons for sickness in SSI sector

Sl no Reason for sickness % of sick units *

Registered SSI sector Unregistered SSI sector
1 Lack of demand 71.60 84.10
2 Shortage of working capital 48.00 47.10
3 Non availability of raw material 15.10 15.20
4 Power shortage 21.40 14.80
5 Labour problems 7.40 5.10
6 Marketing problems 44.50 41.20
7 Equipment problems 10.60 12.90
8 Management problems 5.50 5.10

* The total will exceed 100% as some units reported more than one reason
[Source: All India Survey of Small Scale Industries 2002-03]

Credit flow to SSI sector

In view of the significant role of bank credit in growth as well as sustainability of SSI units,
the Government has come out with several policy initiatives to improve credit flow to this
sector.
Reserve Bank of India (RBI) postulates that the domestic commercial banks (excluding
Regional Rural Banks) are to enlarge credit to priority sector and ensure that priority sector
advances (which includes the SSI sector) constitute 40 per cent of net bank credit. Though,
unlike sub-target of 18% advance for agriculture sector, there is no fixed target for the banks
for this sector, RBI stipulates that ( i ) 40 per cent of total advances to SSI should go to micro
(manufacturing) enterprises having investment in plant and machinery up to Rs 5 lakh and
micro (service) enterprises having investment in equipment up to Rs. 2 lakh; (ii) 20 per cent
of total advances to SSI should go to micro (manufacturing) enterprises with investment in
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plant and machinery above Rs 5 lakh and up to Rs. 25 lakh, and micro (service) enterprises
with investment in equipment above Rs. 2 lakh and up to Rs. 10 lakh. Thus, 60 per cent of

total SSI advances should go to the micro enterprises). All advances granted to units in the
KVI sector, irrespective of their size of operations, location and amount of original
investment in plant and machinery will be eligible for consideration under the sub-target (60
per cent) of the SSI segment within the priority sector Moreover as per the policy package
announced by the Government for stepping up credit to this sector, banks are to fix self set
target for growth in advances to achieve a minimum 20% year on year growth in credit with
the objective to double the flow of credit to the this sector within a period of 5 years i.e. from
2005-06 to 2009-10.

Foreign banks are expected to enlarge credit to priority sector and ensure that priority sector
advances (which include the SSI sector) constitute 32 per cent of net bank credit. Within the
overall target of 32 per cent to be achieved by foreign banks, the advances to SSI sector
should not be less than 10 per cent of the net bank credit. The sub targets for the micro
enterprises are same as that for domestic banks.

RBI closely monitors the performance of the banks in this regard and in case of non
fulfillment of the targets, for shortfall amount domestic banks and foreign banks are to
contribute to Rural Infrastructure Development Fund (RIDF) of National Bank for
Agriculture and Rural Development (NABARD) and Small Enterprise development Fund
(SEDF) of the Small Industries Development Bank of India (SIDBI).

Disposal of loan applications and collate ral security

It is often highlighted that banks make undue delay in processing loa n applications which
adversely affect working capital cycles of small enterprises. To redress the grievance RBI
stipulates that all loan applications for SSI up to a credit limit of Rs. 25,000/- should be
disposed of within 2 weeks and those up to Rs.5 lak h within 4 weeks provided the loan
applications are complete in all respects and accompanied by a 'check list'. From high risk
perception for loans to this segment, banks usually insist on adequate collateral security,
which, however, is a deterrent for small borrower from approaching banks and they look for
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finance from informal sources at a higher cost. To this effect, RBI has directed banks not to
insist on collateral security for loans upto Rs. 5 lakhs which may further be extended upto Rs.
25 lakhs subject to good track record and financial position of the applicants.

Specialized Branches

In order to augment quick and sufficient credit flow RBI has advised Public sector banks to
open at least one specialized branch in each district for lending to small and micro enterprises.
(RBI, 2008)
In addition to all these policy interventions, to look into the entire gamut of credit flow to
this sector, the Government has time to time set up several high level committees such as the
Nayak Committee (1991-92), the Kapur Committee (1997-98) and the Ganguly committee
(2003-2004). Nayak committee recommended that bank should give preference to village
industries, tiny industries and other small scale units in that order, while meeting the credit
requirements of the small scale sector and in granting working capital credit limits to SSI
units to be computed on the basis of minimum 20% of their estimated annual turnover whose
credit limit in individual cases is upto Rs.2 crore [ since raised to Rs.5 crore ]. Kapur
committee made 126 recommendations covering wide range of areas pertaining to financing
of this sector. Out of these RBI accepted as many as 88 recommendations for implementation
which include i) Delegation of more powers to branch managers to grant ad-hoc limits; ii)
Simplification of application forms; iii) Freedom to banks to decide their own norms for asses
SSI of credit requirements; iv) Opening of more specialized SSI branches; v) Enhancement in
the limit for composite loans to Rs.5 lakh.(since enhanced to Rs.1 crore); etc. The Ganguly
committee has urged banks to exploring new instruments for promoting rural industry and to
improve the flow of credit to rural artisans, rural industries and rural entrepreneurs.

Credit Guarantee Fund Scheme (CGFS)

The Government of India launched the Credit Guarantee Fund Scheme for MSEs in
2000, with an objective of making available credit to MSEs, particularly micro enterprises,
for loans extended by banks without collateral/third party guarantees. The scheme covers
collateral- free credit facility (term loan and/or working capital including non fund based
working capital) extended by eligible lending institutions to new and existing MSE up to Rs.
50 lakh per borrowing unit. However, the cover is up to 75 per cent of the credit sanctioned
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subject to maximum guarantee limit of Rs. 37.50 lakh. In case of loans up to Rs. 5 lakh
extended to micro enterprises and MSE operated and/or owned by women, the cover is up to
80 per cent. Under the scheme, 73431 proposals amounting to Rs. 1971.33 crore have been
approved for guarantee cover up to 30th June, 2007.

Present state of bank finance to SSI

The Government’s intervention through RBI, have increased bank finance to this sector as is
observed from the data in Table 5. It is to be ascertained whether the same is adequate
enough to meet requirement of our SSI. Usually, bank finance has inverse relationship with
non performing assets (NPA). Banks prefer to increase exposure in sector where NPA is on
decline.
Table: 5 Bank credit and other data relating to SSI sector
(Rs. in crores)

Year Production Bank Export from SSI Sickness in SSI NPA in SSI
credit sector sector sector
2000-01 261297 60141 69797 4506 11340.14
2001-02 282270 67107 71244 4819 12069.21
2002-03 314850 64707 86013 5706 11423.39
2003-04 364547 71209 97644 5285 10100.33
2004-05 429796 83498 124417 5380 8799.27
2005-06 497842 101285 150242 4981 7724.84
2006-07 585112 127323 160000 5267 6487.87
CAGR
(%) 14.38 13.31 14.82 2.63 -8.88%
[Source: Database of CMIE and BSR of RBI]

Chart 1: Movement of bank credit vis-à-vis growth in SSI sector

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The data in Table 5 and the graph in Chart 1 reveal that growth in bank credit has trailed
behind the consistent growth in production as well as in export from the SSI sector despite
steady decline in NPA. The production and the export recorded Compounded Annual Growth
Rate (CAGR) of 14.38% and 14.82% respectively against 13.31% CAGR in bank credit.
While sickness has increased marginally during the period, Non Performing Assets (NPA)
has declined steadily with CAGR of (-) 8.88%. Decrease in NPA is expected to give boost in
bank credits However, it is observed that against a production level of Rs 5,85,112 crores and
export of Rs.1,60,000, bank credit is only Rs.1,27,323 crores which indicates that SSIs
depend on other sources of finance for their operation and sustainability and banks are to
increase their involvement in this sector significantly to bridge the existing gap.

Conclusion

It may be concluded that despite several measures taken by the Government and the Reserve
Bank of India, flow of bank credit is still not adequate for this vital sector of economy. High
risk perception about SSI is the main deterring factor for the banks in

this regard. That is why despite introduction of Credit Guarantee Fund Scheme (CGFS) way
back in the year 2000, only a small portion of stakeholders could harness the benefit as yet.
Stringent capital adequacy norms under BASEL II are likely to make banks more cautious.
Small and Medium Enterprise Credit Rating Agency (MSERA) has a significant role to play
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in mitigating risk perception of banks. One of the major weaknesses of SSI sector is that
despite simplification of registration process 80% of total units are non registered but their
existing is a ground reality. The Indian Institute of Foreign Trade has recently conducted an
important study with the unregistered firms at a few specific clusters such as Surgical cluster
at Baruipur, West Bengal, Chemical cluster at Ankleswar, Gujarat, Knitwear and Handloom
cluster at Tripur, Tamil Nadu and Food processing cluster at Muzaffarpur, Bihar. On credit
linkage, the study found that the banks are reluctant to recognize credit worthyness of the
units under study and thereby causing the producers sourcing money from informal agencies
at a high cost of capial. (IIFT, 09) Therefore, there is a need to develop means through policy
intervention so that banks do not shy away from extending credit to the unregistered units. As
the microfinance movement has become quite matured over the years, the time is ripe enough
to extend the knowledge in development of SSI sector with more credit flow through
microfinance and Self Help Group Bank Linkage Programme. After all micro enterprises
constitute more than 90% of total SSI in the country.

Reference:
1.IIFT (2009): Workshop on enhancing competitiveness of unregistered firms in India,
Kolkata dt 18.1.09

2.MSME (2004): Third All India Census of Small Scale Industries 2002-03

3. MSME (2008): Circular no. SO 1642 (E) dt 29.9.08

4. RBI (2002): Recommendations of the Working Group for Rehabilitation of sick SSI units,
circulated on 16th January 2002

5.RBI (2008): Circular no. RBI/2008-09/ 41 RPCD.MSE&NFS. BC. No. 2 / 06.02.31/ 2008-
09 July 1 , 2008

6 .RBI (2008): RBI Circular no. RBI/2008-09/69 RPCD. CO. Plan. BC. 9 /04.09.01/ 2008-09
July 1, 2008

7. RBI (2007): BSR report

8. RBI (2009): Annual Policy Statement, 2009-10, p-38

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9.Reddy, Koti T (2008): Problem and prospect of small scale industry in India “Man and
Development”, Centre for Research in Rural & Industrial Development(CRRID) Sept 2008,
p-23

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