Mumbai - Imagine if companies hiring two-thirds of the US workforce were left out of official assessments. That was the case in India, until now.
Starting January, state-run Small Industries Development Bank of India and Crisil - the local arm of S&P Global - will publish a quarterly sentiment indicator to track capacity utilisation, order books and margins at micro, small and medium-sized enterprises.
Alternately referred to as the "backbone" of the Indian economy and the country’s "missing middle," MSMEs were easy to overlook given they average about two employees each and are mostly run out of private homes, from where they feed into vast supply chains for big companies.
However, sweeping policy change under Prime Minister Narendra Modi looks set to kill the weak and burnish the strong, offering a promising destination for global investors if they can identify sectors with value.
"There’s hunger for genuine price discovery in the MSME space," said Tirthankar Patnaik, Mumbai-based chief strategist at Mizuho Bank.
"Put together they form a significant part of India’s output, and are even more significant when it comes to employment."
Fries to Fashion
Conservative estimates peg MSME contribution at over 10% of India’s output, 40 of exports and 111 million workers. About a fifth are owned by women.
The BSE SME IPO Index, which tracks the performance of small and medium-sized companies that have listed on BSE's SME platform, has risen 74% over the past year compared with 54 percent for the S&P BSE Small Cap Index.
Convoluted laws force these firms to stay tiny but you can see them everywhere you go, repairing cars or frying up crisps; manufacturing components for powerful machines on the factory floors of big corporations or engaged in intricate embroidery for French fashion houses.
The new index will cover more than 1,000 MSMEs, drawn through sources including Sidbi and Crisil’s client base. Sectors with strong MSME presence, such as engineering and textiles, will have bigger representation in the sample and so will states that are home to a larger number of these firms.
"There is a dearth of real time data at the micro level, which is making it difficult to assess the true impact of major economic policy initiatives," said R. Vasudevan, business head at Crisil SME Ratings.
"We expect the index to provide a trend which will allow policy makers to take timely, even proactive, steps, including based on early warnings."
The need to track India’s small companies is greater than ever after Modi last year invalidated 86 percent of currency in circulation and this July rolled out a new consumption tax.
The moves disproportionately affect MSMEs because they transact mainly in cash and can’t afford high compliance costs.
Aftershocks of India’s new tax are creating a two-speed economy
Sanjeev Prasad, managing director at brokerage Kotak Institutional Equities, said he will watch for disruptions to business models of listed companies due to the changes, as well as any shifts in patterns within the informal sector as they’re forced into more formal means of business.
Analysts at Morgan Stanley, including Subramanian Iyer and Derrick Kam, say MSMEs will be one of the key beneficiaries from the changes.
While their access to credit was inconvenient, expensive or unavailable, Modi’s policies have forced them to embrace formal channels of finance, they said.
To understand how behavior may change in an increasingly digital India, the analysts surveyed 1,522 businesses with turnover of less than 50 million rupees ($770,000) across 28 large and small cities.
"Survey conclusions overall increase our conviction in our thesis," they wrote in a November 9 report.
Crisil estimates bank credit to MSMEs will grow 11% annually over the next two financial years compared with about 7% to bigger companies.
MSMEs are also important because they’re often the only employers for millions of Indians fleeing a weakening farm sector.
Failure to offer jobs to the swelling workforce risks triggering social strife in the world’s second-most populous nation, observers including Raghuram Rajan, a professor at the University of Chicago and India’s former central bank governor, have warned.
So, while informality itself isn’t a bad thing, the sector needs to be tracked to ensure workers are ultimately provided stable wages and other benefits offered by big companies, said Sudha Narayanan, associate professor at the Indira Gandhi Institute of Development Research in Mumbai.* Sign up to Fin24's top news in your inbox: SUBSCRIBE TO FIN24 NEWSLETTER