VZCZCXRO7043
RR RUEHAST RUEHCI RUEHLH RUEHNEH RUEHPW
DE RUEHBI #0056/01 0410913
ZNR UUUUU ZZH
R 100913Z FEB 09
FM AMCONSUL MUMBAI
TO RUEHC/SECSTATE WASHDC 6936
INFO RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHBI/AMCONSUL MUMBAI 2109
RUEHBJ/AMEMBASSY BEIJING 0131
RUEHNE/AMEMBASSY NEW DELHI 8177
RUEHHK/AMCONSUL HONG KONG 0016
RUEHGH/AMCONSUL SHANGHAI 0025
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEAIIA/CIA WASHDC
RHEHAAA/NSC WASHINGTON DC

UNCLAS SECTION 01 OF 04 MUMBAI 000056 
 
SENSITIVE 
SIPDIS 
 
PASS TO EX-IM BANK:JESSICA FARMER AND RAY ELLIS 
PASS TO USTR: ADINA ADLER 
 
E.O. 12958: N/A 
TAGS: EFIN ECIN ECON IN
SUBJECT: INDIA'S LABOR INTENSIVE SMALL BUSINESS SECTOR STRUGGLING IN 
WAKE OF GLOBAL SLOWDOWN 
 
MUMBAI 00000056  001.2 OF 004 
 
 
¶1.  (U)  Summary:  During a discussion with Consul General, 
stakeholders from the Micro, Small and Medium Enterprises 
(MSMEs) noted that shrinking global demand, and not lack of bank 
credit, is hurting the sustainability of MSME business 
operations.  They pointed out that most MSMEs could not get bank 
credit even before the economic meltdown, and they had little 
faith that the government's recent financial stimulus package 
would ease their financing woes.  MSMEs, constrained by lack of 
personnel or lack of adequate data, cannot manage what they view 
as excessive and duplicative loan documentation needed to 
qualify for bank loans.  Our interlocutors also maintained that 
their other challenges are similar to those faced by large 
corporations like restrictive labor laws, multiple and 
duplicative taxes, excessive regulation and compliance 
mechanisms.  They also admitted that changing the mind-set of 
these mostly family-owned businesses to empower them to "think 
big" was the main inhibitor to the growth and sustainability of 
the MSME sector.  The panelists recommended U.S.-India MSME 
collaboration as a key enabler for the development of the Indian 
MSME sector.  End Summary. 
 
India's MSME Sector 
----------------------- 
 
¶2. (U)  Like most other countries across the world, the micro, 
small and medium enterprise (MSME) sector is a vital component 
of the industrial sector in India.  As per the Ministry of 
Micro, Small and Medium Enterprise's estimates, micro and small 
enterprises account for about 39 percent of the manufacturing 
output and around 33 percent of the total exports, in terms of 
value.  According to the ministry, the sector employs about 31 
million people spread over 12.8 million businesses.  The Indian 
MSME Ministry classifies micro, small, medium enterprises in 
manufacturing as companies with investments in productive plant 
and machinery of up to Rs. 2.5 million ($52,000), between Rs. 
2.5-50 million ($52,000-1 million) and between Rs.50-100 million 
($1-2 million), respectively.  Similarly, service-oriented 
micro, small and medium enterprises are companies with 
investment in productive equipment of up to Rs. one million ($ 
20,000), between Rs. one-20 million ($20,000-400,000) and 
between Rs.20-50 million ($400,000-1 million), respectively. 
However, MSME stakeholders pointed out that trade associations 
use different variables to classify MSMEs, and that MSMEs in 
India are relatively much smaller compared to MSMEs in the U.S. 
 
 
¶3.  (U)  The MSME sector receives government concessions -- in 
the form of financial and tax incentives, and the provision of 
infrastructural facilities -- as part of the government's 
strategy to achieve inclusive growth.  MSME financing is part of 
the Priority Sector Lending policy of banks. (Note: Along with 
MSMEs, banks are required to lend proportionally to the 
agriculture, education, housing, export credit, and other 
sectors.  End note).  For public and private sector banks, 40 
percent of the net bank credit (NBC) is earmarked for priority 
lending.  However, no specific percentage is assigned solely for 
the MSME sector for public sector and Indian private banks, and 
they are free to use their discretion to decide loan allocation 
to MSMEs.  In contrast, foreign banks are required to allocate 
10 percent of the NBC specifically for MSME loans. 
 
Government Steps in to Ease MSME Financing Woes 
---------------------------- 
 
¶4. (U)  In December 2008, following negative export growth in 
India as a result of the global economic slowdown , the 
Government of India (GoI) and Reserve Bank of India (RBI) 
announced several measures to support the MSME industry.  The 
RBI announced a refinance facility of Rs. 70 billion ($1.5 
billion) for the Small Industries Development Bank of India 
(SIDBI), to be disbursed directly to MSMEs or indirectly via 
banks, non-banking finance companies (NBFCs) and State Finance 
Corporations.  The government also doubled the guarantee cover 
under the Credit Guarantee Scheme on loans to micro enterprises 
from Rs. 5 million ($100,000) to Rs. 10 million ($200,000) with 
an 85 percent guarantee cover for credit facility up to Rs. 0.5 
million ($10,000).  (Note: In 2000, with the aim of lowering the 
"risk-perception" of MSME financing, the GoI in collaboration 
with SIDBI, had set up the Credit Guarantee Fund Trust to 
 
MUMBAI 00000056  002.2 OF 004 
 
 
provide a counter guarantee for loans extended to the MSME 
sector.  End Note).  The lock-in period for such collateral-free 
loans was also reduced from 24 to 18 months. 
 
But MSMEs Complain that Access to Credit Still Problematic 
--------------------------------------- 
 
¶5.  (U)  Despite these remedial measures to facilitate easy 
credit for MSMEs, our interlocutors complained that banks are 
still reluctant to lend to them.  Deepak Doshi, the President of 
the Indian Small Scale Paint Association and the Director of a 
medium-sized paint company, said that banks required lengthy, 
cumbersome and duplicative loan applications, making it 
difficult for MSMEs -- with limited personnel and less robust 
record keeping -- to access loans at the prime lending rate. 
Banks cite most often a lack of transparency and insufficient 
information in denying a loan, he added. 
 
¶6.  (U) Yogesh Dixit, the Head of SME Ratings for CRISIL, agreed 
with Doshi, and noted that "information asymmetry" between the 
MSMEs and the banking sector was one of the major challenges for 
the industry.  MSMEs need timely and adequate funds, but banks 
require complete information and documentation which the smaller 
industry players may not be in a position to provide, he 
admitted.  He recommended that an information sharing platform 
be created to enable transparency and compliance to ensure that 
banks can provide timely and adequate credit to MSMEs.  Doshi 
suggested that MSMEs get "smart cards" with embedded financial 
information about their business, which they can use to access 
loans up to a pre-sanctioned limit.  Another alternative, Dixit 
suggested, is for MSME trade associations to collect funds from 
their members which could be used as bank collateral to avail 
credit for the member MSME. 
 
¶7.  (U)  Doshi believes that only those MSMEs who were already 
getting credit from banks would benefit from the government's 
stimulus package.  He dismissed the perception that MSMEs that 
are rated by a third-party would qualify for easy bank credit. 
The bank would itself rate the MSME and take a loan decision 
based on its internal rating, he opined; banks view MSMEs as 
unreliable and lacking creditworthiness, he claimed, and no 
outside rating system can overcome this bias. 
 
Delayed Order Payments More Worrisome than Lack of Bank Credit 
------------------------------------- 
 
¶8.  (U)  Despite problems accessing credit, all interlocutors 
agreed that the MSME industry was hit more by shrinking global 
and domestic demand following the economic meltdown.  Rajendra 
Gandhi, the Managing Director of Gujarat Rubber Reclaim and a 
Managing Committee member of the All India Rubber Industries 
Association, explained that globalization caused several 
inefficient and non-competitive MSMEs, who previously depended 
on government support for their survival, to shut operations. 
Driven by the demand of larger companies that they serviced, the 
remaining MSMEs became more competitive, efficient, and 
technology savvy.  They made significant investments to become 
the "preferred supplier" of large companies.  Currently, Gandhi 
said, these "efficient" MSMEs are "at the mercy" of their larger 
customers who -- hit by the economic slowdown and global 
financial crisis -- have reduced demand from the MSME vendors. 
Doshi claimed that the large companies are demanding longer 
credit periods and delaying payments to their MSME suppliers. 
In a way, the MSME sector is "refinancing" larger companies, he 
argued. 
 
¶9.  (U)  K. R. Sharma, Director of the MSME Development 
Institute which is under  the Ministry of MSME, explained that 
the MSME industry can broadly be classified into family-owned 
MSMEs which cater directly to the domestic market, the ancillary 
units or vendor MSMEs who sell to larger companies, and 
export-oriented MSMEs.  The economic meltdown has impacted the 
ancillary vendors and exporters the most, he admitted.  These 
units have made large capital investments and accumulated 
inventories which they now cannot sell due to shrinking global 
demand, he continued.  Doshi noted that the MSME industry could 
not even gain from the crash in commodity and raw material 
prices.  He explained that when prices rose, the MSEMs were not 
able to pass on these price increases to the customers, and now 
 
MUMBAI 00000056  003.2 OF 004 
 
 
when prices have fallen, their clients expect them to reduce 
prices proportionately.  Gandhi claimed that China, which 
experienced a slowdown in the last quarter, is dumping a lot of 
low-cost goods in India which is hurting the competitiveness and 
sustainability of MSMEs. 
 
"Usual" Challenges to Doing Business in India Cited as Industry 
Challenges 
--------------------------- 
 
¶10.  (SBU)  Raj Nair, the Chairman of the MSME wing of the 
Indian Merchant's Chamber, emphasized that India's restrictive 
labor laws constrain the growth of the MSME sector.  It is 
difficult for any company, including an MSME, to hire contract 
labor for an extended period of time.  The inflexible labor laws 
do not allow MSMEs to adjust their labor demand to market 
requirements.  Moreover, MSMEs would like the ability to hire 
during an economic boom and fire during a downturn.  This would 
allow MSMEs to finetune their ability to service orders at a 
particular point in time.  The existing employment in the MSME 
sector could double if Indian labor laws are relaxed, he argued. 
 
 
¶11.  (SBU)  Doshi emphasized the need for less regulation; he 
believes that MSMEs have to comply with multiple authorities and 
government agencies.  (Comment:  This is a common complaint of 
Indian businesses and is not unique to the MSME industry.  End 
Comment).  Nair said that the government should tackle the issue 
of multiple and duplicative taxes as a priority.  The MSME 
Ministry's Sharma accepted this argument and said that the 
government was planning a scheme of collecting taxes at one 
source and then distributing it to different agencies.  Gandhi 
noted that multiple taxes and excessive regulation harbors 
corruption. 
 
MSMEs Struggling to Upgrade 
--------------------- 
 
¶12.  (U)  Nair said that some MSMEs are diversifying into new 
product lines and new markets to cope with the current economic 
crisis.  Nevertheless, he admitted that the majority of MSMEs 
are "waiting and watching" to see how the market situation plays 
out.  Most MSMEs are long-term suppliers to larger companies and 
believe that their fate is tied to the fate of the larger 
players.  According to Nair, they believe that the government 
will not let large companies fail and will either bail out 
distressed companies or empower them with liquidity.  Therefore, 
they believe that the recovery of the MSME sector is tied to the 
recovery of larger companies, he said. 
 
¶13.  (U)  Gandhi pointed out that many MSMEs "choose" to remain 
small to qualify for fiscal concessions.  Nair concurred, and 
admitted that the biggest challenge is to change the mind-set of 
these players and teach them to "think big."  (Note: In order to 
promote small scale industries (SSI), the Government of India 
reserved the production of some industrial and tradition items - 
ranging from socks and industrial goods to handwoven items - for 
production by small enterprises.    In recent years, many of 
these restrictions have been removed.  Companies protected by 
SSI rules now find themselves facing greater competition, or 
opportunities to expand.   End Note.)  Some MSMEs try to 
manufacture a wide product range rather than specialize, which 
hurts their export competitiveness, he added.  Gandhi argued 
that MSMEs need a "professionalization" of family-owned 
businesses to separate the owners from the management to ensure 
sustainability. 
 
¶14.  (U)  Doshi pointed out that U.S. and Indian MSMEs are 
"natural partners."  He emphasized the need for more U.S.-India 
joint ventures where the U.S. partner can bring in technology 
and the Indian partner can provide the cheap labor and the huge 
market base.  Dixit suggested that building institutional 
linkages between U.S. and India will provide a good information 
sharing platform for MSMEs of both countries to exchange their 
experiences and share lessons learned.  Nair believes that a 
trade association would be a better mechanism to link U.S. and 
Indian MSMEs.  Gandhi suggested that U.S. MSMEs adopt industrial 
clusters.  (Note:  In a separate discussion with SIDBI, we heard 
that the government is promoting industrial clusters to provide 
 
MUMBAI 00000056  004.2 OF 004 
 
 
backward and forward linkages to MSMEs and to create common 
infrastructural facilities.  End Note). 
 
¶15.  Comment:  (U) Recognizing that the MSME sector is a 
contributor to the India growth story and to the vision of 
"inclusive growth", the Government of India has undertaken 
numerous reforms for the development of the sector.  The need of 
the hour is to streamline these efforts and ensure that it 
reaches the most deserving MSME.  However, sustainability of the 
MSME industry also depends on the ability of the MSME to scale 
up efficiency using technology, research and development.  All 
the participants unanimously agreed that the MSME sector had 
tremendous opportunities to grow, but admitted that changing the 
mind-set of these mostly family-owned businesses to empower them 
to "think big" was the main inhibitor to their growth and 
sustainability.  End Comment. 
FOLMSBEE