The missing link: A Made in India policy needed to create global SMEs

In 2023, 162 small and medium sized enterprises (SMEs) listed on the Indian stock exchanges, which indicated, in some ways, that the sector was now poised to grow in its own right. But are existing conditions truly adequate to allow globally focused SMEs to thrive in India? Perhaps not quite as yet. Though on February 1 there will be an interim budget, there are expectations in some quarters that policies to address credit challenges and drive innovation among Indian SMEs will be announced. Targeting towards manufacturing will be the key.

The government wants SMEs to contribute to 50 percent of GDP and $2 trillion of exports by 2030, and much needs to be done on the manufacturing front to achieve this target. The Indian service sectors, especially in IT and allied segments, are global in their outlook and can provide quality products. But the country’s manufacturing is not especially when compared with China, Japan, South Korea or even a Germany. Indian SMEs are still not critical cogs in global value chains (GVCs), far from the extent that SMEs in China, Japan, or Germany. Precise and conclusive data for manufacturing SMEs especially in sectors where they could be a part of GVCs is unavailable.

The heft

Manufacturing contributed to just 17.7 percent of India’s economy in FY23. The Indian micro, small and medium enterprises (MSME) sector contributed to around 33 percent to the economic output. Data from the Laghu Bharati Udyog indicates that the manufacturing MSME sector contributes to just around 6 percent to India’s GDP.

Last year, Bhanu Pratap Singh Verma, the Minister of State for MSMEs had noted in a Rajya Sabha reply that the share of them in India’s overall exports in FY23 stood at 43.6 percent, declining from 45.03 percent in FY22 and 49.35 percent in FY21. The share might still be lower. India’s tariff code system or the Indian Trade Clarification based on Harmonized System (ITC-HS) does not distinguish whether some goods are manufactured by large enterprises or MSMEs.

Manufacturing SMEs are critical to growth. But most Indian government policies are more a broad brush without industry-specific targeting for manufacturing SMEs. India now needs policy that looked at this particular segment in the MSME space as distinct from micro-enterprises and indeed MSMEs as a general classification.

As Hidekazu Nomura of Kyoto University wrote in a research paper: “High growth of post-war Japanese capitalism has not been achieved only by giant companies. On the contrary, without small businesses, especially their roles as subcontractors, it would have been impossible to achieve such high growth, which has drawn attention internationally.” Figures from Japan’s METI indicate that today SMEs add around 53 percent to the country’s gross value added. The figures from China only put this into sharper perspective. China’s SMEs contribute to over 60 percent of the country’s GDP, 50 percent of the taxable income and 70 percent of its technological innovation.

Fostering SME role

Some beginnings have been made with the Production Linked Incentive (PLI) Scheme where across many sectors an anchor-led model that drives OEMs to adopt an import substation approach is envisaged. The PLI schemes also envisage that global OEMs should source products from the local manufacturing supply chain ecosystem. The government has also built basic electronic platforms necessary to link SMEs to GVCs. Yet strong links between global OEMs and SMEs, fostering concrete mutually dependent partnerships have not yet emerged.

Policies for Transfer of Technology (ToT) agreements that drive the diffusion of knowledge, managerial know-how, and supply chain best practices are somewhat in place, but are targeted more towards a large-scale industry level. Specific policy designs that target, propel, and incentivise manufacturing SMEs towards global competitiveness are yet to come. There are some recent investments that might indicate some shoots on the ground, though.

Some of these, especially in the aviation sector, like the manufacture of Airbus’ C295 military aircraft facility at Vadodara in collaboration with Tata Advanced Systems and the recent announcement that the France-based aircraft manufacturer will also set up a facility for the final assembly of its H125 helicopters in India, are interesting. Earlier this month, the Prime Minister Narendra Modi inaugurated the Boeing India Engineering and Technology Centre (BIETC) campus in Bengaluru meant to partner with India for products in the global aerospace and defence industry.

But this is only a start, where India does enter some spaces in GVCs successfully. Policy does not quite incentivise the SME-GVC link even across high-technology sectors, and it certainly does not specifically incentivise product-level manufacturing at the SME scale. A facility for assembly, would not foster the kind of ecosystem that is required to set up a globally oriented, manufacturing supply chain-based ecosystem where manufacturing SMEs can thrive.

Neither will the Boeing facility, if it emerges in the future as a mere Global Capability Centre (GCC), rather than a centre that drives through partnerships specific technology-based product manufacturing and outsourcing from Indian shores. GCCs, though vital and extremely valuable in the larger scheme of the economy and the country’s research and innovation, are much less likely to spawn and grow the kind of export-oriented manufacturing targets that India needs desperately to set for itself.

The question that then arises is whether current policies are enough to drive GVC-oriented investment, partnerships and technology into the Indian SME manufacturing space. Credit growth and credit schemes the Indian government has tried to incentivise are not enough. Credit is vital but what is equally, if not more, vital is the vision of a manufacturing ecosystem that incentivises say a German or Japanese SME or OEM to partner with Indian SMEs.

Policy goals

What is also needed is for private equity to invest in globally substantial OEM partners, currently at the SME scale, who are incentivised with subsidy and facility driven support that drives growth. Free Trade Agreements (FTAs) are being signed at pace, but the FTAs are not enough and agreements with major manufacturing countries are still to come into place. More importantly, domestic policy structures must be put in place alongside FTAs.

Policy needs to look at how product technology is changing, alongside the global definitions of quality in specific. Industry-defined global contexts and incentives need to be micro-managed to push towards such elements. Manufacturing in India, whether at the large scale or small-scale level is largely geographically fragmented and policies that incentivise the building of local or regional clusters, across either specific technologies, products, or classes of OEMS are unavailable.

Managing cost structures and driving innovation then becomes a challenge within the SME space and the competitive element and agility that would help turn the companies into global tigers does not quite develop. Scale and the ability to learn and grow through adjacencies is also disincentivised in the current policy environment. The use, and development of globally competitive technology, at quality would happen if OEMs recognise that sourcing opportunities within the country are thriving, which is a bit of a paradox. Policy though must be incentivised to create the base for these conditions.

Exports would develop if sourcing joint ventures are enabled through both export and manufacturing subsidies precisely targeted towards identified manufacturing. Incentivising domestic production alone with localised products does not cut it. Domestic SMEs that orient themselves towards serving local niches or narrow domestically oriented specializations will necessarily face problems like a lack of growth-driven technology expertise, an inability to innovate at a global or even regional scale and poor employee quality. Limited growth oriented financial resources are then likely to become a corollary. Policy design for Indian manufacturing SMEs must change urgently.

Vivek Y. Kelkar is co-founder of The Cosmopolitan Globalist, an online magazine that analyzes geopolitics and geo-economics.

Views are personal and do not represent the stand of this publication.