Regulatory Barriers To Micro, Small and Medium Enterprises: Amit Chandra & Vrinda Pareek Centre For Civil Society

Regulatory Barriers to Micro,
Small and Medium Enterprises

Amit Chandra & Vrinda Pareek
Centre for Civil Society
Contact: ccs@ccs.in 10 July 2014

Table of Contents
_Toc407117669Section I: Background to the Study ................................................................. 3

1.1 Aims and Objectives ............................................................................................................... 4
1.2 Research Question and Hypothesis ...................................................................................... 4
1.3 Methodology .......................................................................................................................... 4
Section II: Introduction ................................................................................................................ 5
2.1 Definition of MSMEs .............................................................................................................. 5
2.2 Challenges Faced by the MSME Sector ................................................................................ 6
2.3 Trends: Implications for the Economy ................................................................................. 8
Section III: Large Enterprises and MSMEs: A Comparative Overview Post 1991 ................... 9
Section IV: Documentation and Analysis of Regulatory Norms............................................ 14
3.1 Entry: Documentation .......................................................................................................... 14
3.2 Entry: Analysis of Regulatory Norms ................................................................................. 18
3.3 Continuance: Documentation of Regulatory Norms ........................................................ 21
3.4 Continuance: Analysis of Regulatory Norms ................................................................ 35
3.5 Exit: Documentation of Regulatory Norms ....................................................................... 36
3.6 Exit: Analysis of Regulatory Norms .................................................................................... 45
Section V: International Comparison ....................................................................................... 46
5.1 How Does the Ease of Doing Business (EoDB) Index Work? ........................................... 46
5.2 Where Does India Stand?..................................................................................................... 48
5.3 India: Why does it Stand Where it Stands on the Index? ................................................. 49
5.4 Doing Business Parameters: The Indian Perspective ........................................................ 52
Section VI: Policy Recommendations ....................................................................................... 65
References ................................................................................................................................... 69
Regulatory Barriers to MSME | Centre for Civil Society | www.ccs.in Page 2

List of Tables
Table 1: Definition Of MSMEs ..................................................................................................... 5
Table 2: GDP Growth Rates: Before and After Liberalisation ................................................ 10
Table 3: Employment and Performance Of MSMEs (*Estimated Values) ............................. 10
Table 4: The Decline of MSMEs................................................................................................. 12
Table 5(a): Growth of Manufacturing Sector in India ............................................................ 12
Table 6: Credit Flow to MSMEs ................................................................................................. 22
Table 7: Sickness in MSMEs: Causes ......................................................................................... 38
Table 8: Stages in the Nursing Process of Sick MSMEs .......................................................... 39
Table 9: MSMEs - Nature of Organisation ............................................................................... 41
Table 10: Doing Business Parameters: India 2014 v. India 2015. .......................................... 50
List of Figures
Figure 1: Employment Pattern and Distribution in MSME Sector ........................................ 30

Figure 2: India's Ranks on Doing Business & Distance to Frontier Scores ........................... 49
Figure 3: How Indian and Comparator Economies Rank on Ease of Starting Business ...... 53
Figure 4: How India and Comparator Economies Rank on Ease of Dealing with
Construction Permits ................................................................................................................. 55
Figure 5: How India and comparator economies rank on the ease of registering property
...................................................................................................................................................... 56
Figure 6: how india and comparator economies rank on ease of paing taxes .................... 59
Figure 7: how india and comparator economies rank on ease of trading across borders . 61
Figure 8: distance to frontier scores (DOING BUSINESS 2015) ............................................. 63

Section I: Background to the Study
1.1 Aims and Objectives
Against the post-New Industrial Policy (1991) growth witnessed in large-scale industries, a
corresponding boom in the small and mid-sized domestic industry has been conspicuously
absent. The paper seeks to document the causes for the same. Further, a comparative
evaluation of Indian MSMEs with those operating in other BRICS nations will be conducted, in
an attempt to understand the overall effect of the business, policy and legal/regulatory
environment on the growth of MSMEs.
1.2 Research Question and Hypothesis
Research Question:
What have been the causes behind the inability of MSMEs to realise their growth potential?
Hypothesis:
It has been observed that given the business environment in India, large-scale companies have
thrived while MSMEs have not been able to realise their full growth potential. The study
hypothesises—and seeks to verify whether and the extent to which—this handicap of MSMEs is
attributable to the regulatory norms applicable to them. Further, it is suggested that the
business environment in India, as contrasted against that of other BRICS nations, is not
sufficiently conducive to MSME growth.
1.3 Methodology
The paper employs secondary data analysis as the major tool of research. Primary methods
were used to supplement this analysis, by means of telephonic, semi-structured interviews with
officials from the concerned government ministries and departments.

Section II: Introduction
2.1 Definition of MSMEs
Generally, Micro, Small and Medium Enterprises (MSMEs) are defined in terms of investment
made towards plant, machinery and/or equipment, as also in terms of number of people
employed and the annual turnover. In India, however, Section 7 of the MSME Development Act,
2006, classifies them along the investment ceiling. For manufacturing enterprises, the
investment ceiling lies below INR 25 lakhs (Micro), between INR 25 lakhs and 5 crore (Medium)
and between INR 5 crore and 10 crore. The criterion for service enterprises lies as follows:
below INR 10 lakh (Micro), between INR 10 lakh and 2 crore (Small) and finally, between INR 2
crore and 5 crore (Medium) (MSMED Act, 2006).
Table 1: Definition Of MSMEs

Industry Enterprises engaged in the Enterprises engaged in
manufacture or production of providing or rendering of
goods: investment in plant services: investment in
and machinery equipment
Micro Not exceeding INR 25 lakh Not exceeding INR 10 lakh
Small Between INR 25 lakh and INR Between INR 10 lakh and INR
5 crore 2 crore
Medium Between INR 5 crore and INR Between INR 2 crore and INR
10 crore 5 crore
This comprehensive definition of MSMEs came in post the enactment of The Micro, Small and
Medium Enterprises Development Act (MSMED), 2006. Formerly, MSMEs were collectively
termed as Small Scale Industries (SSIs) under the Industrial Development and Regulation (IDR)
Act, 1951 and the criteria for their classification was marked by ambiguity; acquiring clarity of
definition and objectives has been a definite achievement of the MSMED, 2006. The need for an
enactment specific to MSMEs has been clarified in the Statement of Objects and Reasons of the
MSMED Act:
Small scale industry is at present defined by notification under section 11B of the
Industries (Development and Regulation) Act, 1951. Section 29B of the Act provides for
notifying reservation of items for exclusive manufacture in the small scale industry sector.
Except for these two provisions, there exists no legal framework for this dynamic and
vibrant sector of the country’s economy…Central enactment to provide an appropriate

legal framework for the sector to facilitate its growth and development…a growing need is
being felt to extend policy support for the small enterprises so that they are enabled to
grow into medium ones, adopt better and higher levels of technology and achieve higher
productivity to remain competitive in a fast globalization area”
(MSMED Act, 2006).
This shift in policy perspective towards MSMEs has been a positive development. A policy
specifically aimed at MSMEs, is bound to integrate them into economic development strategies
and plans.
2.2 Challenges Faced by the MSME Sector
From this section on, the focus of the paper lies on identifying and briefly documenting
problems that hinder and threaten to severely limit, the growth prospects of MSMEs. It
becomes imperative to do so in order to later be in a position to analyse the impact of policy
measures and regulatory norms on these challenges: whether these are mitigated or
aggravated by the said norms.
“Poor infrastructure and inadequate market linkages are among key factors that have
constrained the growth of the sector. However, lack of adequate and timely access to finance
continued to be the biggest challenge” (International Finance Corporation, Year Unknown). The
sector’s total financial demand was estimated to be INR 32.5 trillion in 2009-10, with 80 percent
of the demand originating from the informal sector. Inability to market their products well is a
challenge associated with this financial crunch. Further, even the tax system in place in India has
been criticised along several aspects deemed undesirable for the business environment:
number of payments required, procedures for filing payments and non-uniformity across states
associated with taxation (Ease of Doing Business Index, International Finance Corporation,
World Bank, 2014).
The Ease of Doing Business Index 2014 places India at the 142 nd position (as opposed to 134th
in 2013), amongst a total of 189 countries; the index is composed of 10 indicators, a majority of
them being associated with regulatory norms, automatically drawing attention to the
potentially adverse effect of these norms on the general business environment and
subsequently, on the performance of MSMEs. These regulatory norms may pertain to the entry,
continuance or exit of MSMEs, as has been discussed in detail later in this paper.
Documentation and declaration procedures under several regulatory statutes are seen to be
rather cumbersome, extensive and protracted.

Lack of information and awareness on part of entrepreneurs as to governmental benefits and
schemes designed to facilitate their induction into and continuance in the MSME sector could
be a cause of their sub-optimal performance. In the event of imperfect information, the efficacy
and actual operationalisation of schemes is rendered to the status of a secondary concern;
individuals must be aware of potential benefits in order to be in a position to avail them.
Given these problems faced by MSMEs, coupled with globalisation and international
competitive pressures, there is a recognised and “urgent need of a dynamic and self-sustaining
culture of innovation” (FICCI Summit, 2012). As per the FICCI report, share of innovating firms in
India rested at a mere 19 percent. India is ranked 62nd on the Global Innovation Index and 8th in
its income group, following China, Moldova, Jordan, Thailand, Vietnam, Ukraine and Guyana.
The necessity of an R & D wing is underestimated by most MSME owners, presumably driven
by the financial crunch they are constantly faced with.
Despite the fact that MSMEs account for 40 percent of overall employment, non-availability of
skilled labour is a problem reported by several MSME owners. The educated and sufficiently
skilled prefer the higher wages and job security offered by larger enterprises. Labour retention
is, in itself, an added challenge. MSMEs often rely on informal contracts in their operation,
rendering their obligatory value negligible.
Further, the smaller the firm, the likelier it is to be affected by corruption. More SMEs than
larger firms believe that corruption is “part of the way things work in the country”. They pay
much higher percentages of annual revenues in bribes to public officials and make additional
payments to get things done much more frequently than larger companies (UNIDO, 2007).
These challenges faced by MSMEs cannot be treated in isolation from one another. They must
be studied holistically for they interact with one another only to compound themselves.
A challenge faced by the sector from a policy perspective, and which cannot be readily
quantified, lies in the fact that Micro, Small and Medium enterprises are often lumped
together—in making budgetary allocations, devising policy measures and in the subsequent
application and implementation of policies so drafted. The distinction between them is not
merely academic; it comes with variations in their requirements and, therefore, holds practical
value. Micro, Small and Medium enterprises, for instance, have different finance needs. Micro
enterprises primarily rely on debt for both early and growth-stage financing; micro and small
services enterprises primarily transact in cash and tend to keep minimal records. Finally,
manufacturing enterprises and those with order-driven services tend to need more finance
because of longer working capital cycle and higher capital expenditure (International Finance

Corporation, Year Unknown). These different requirements can naturally not be catered to and
addressed when they are not even recognised in making policy decisions.
2.3 Trends: Implications for the Economy
A study of macroeconomic trends indicates that the contribution of the manufacturing sector
to the GDP, output and exports of the country has been declining. Considering the fact that the
MSME segment registers 6 percent of the GDP, 45 percent of the manufacturing output, 40
percent of the total exports from India and is the second largest employer (following
agriculture), an overall decline can safely be presumed to be indicative of a decline in the
MSME sector. This decline can be attributed, in part, to a variety of reasons ranging from lack of
access to global markets to problems of storage, designing, packaging and product display,
low technology levels and lack of access to modern technology (Sarkar, 2011).
Given this undesirable trend, it becomes imperative to undertake a systematic study aimed at
identifying the causes behind the same, from a policy perspective; and to deliberate upon
possible policy measures that could be employed to remedy the same.

Section III: Large Enterprises and MSMEs: A Comparative
Overview Post 1991
A need for a reform in the economic structure of the country was recognised when India had
acquired a reputation as one of the most protected and heavily regulated economies in the
world. The broader view with which the government liberalised the economic policies of the
country (with the New Economic Policy, 1991) was that it would result in growth in productivity.
The broad reforms in India’s industrial policy were outlined as follows:
“Industrial policy was restructured to a great extent and most of the central government
industrial controls were dismantled. Massive deregulation of the industrial sector was
done in order to bring in the element of competition and increase efficiency. Industrial
licensing by the central government was almost abolished except for a few hazardous and
environmentally sensitive industries. The list of industries reserved solely for the public
sector -- which used to cover 18 industries, including iron and steel, heavy plant and
machinery, telecommunications and telecom equipment, minerals, oil, mining, air
transport services and electricity generation and distribution was drastically reduced to
three: defense aircrafts and warships, atomic energy generation, and railway transport.
Further, restrictions that existed on the import of foreign technology were withdrawn.”
(Ministry of External Affairs, Government of India, Year Unknown)
However, growth in productivity of the economy as intended by these reforms occurred

through a process; that is, import liberalisation provides domestic firms with access to capital
embodied with technology. Freedom to invest and enter the market increases the extent of
competition and puts pressure on the incumbents to upgrade their technologies. With the
entry of new firms in a more competitive market, the process of creative destruction goes to
work. Efficient firms drive the inefficient firms, resources gets reallocated to more productive
use and the overall productivity of the factors in the economy increases. Due to technology
transfer, productivity in the industry and service sectors grows rapidly.
(Kotwal, Ramaswami and Wadhwa, 2011)
Relying on the standard criteria of growth rates in national income and per capital income, the
Indian economy has done well post liberalisation. The data of selected time periods before as
well as after economic liberalisation is as follows:

Table 2: GDP Growth Rates: Before and After Liberalisation
Year GDP Secondary Sector

1951-52 to 1980-81 3.63 5.29
1981-82 to 1985-86 4.92 5.08
1986-87 to 1990-91 5.88 6.86
1992-93 5.40 3.60
1994-95 6.40 9.30
1996-97 8.00 7.30
1998-99 6.70 4.30
2000-01 4.40 6.80
2002-03 3.80 6.90
2004-05 7.50 10.50
2006-07 9.60 12.70
2008-09 (P) 6.80 4.70
1992-93 to 2009-10 6.86 7.34
(P) – provisional estimate.

Source: (Saikia, 2012)
Facilitating the growth of Small Scale Industries post 1991 has been a major concern for the
Government because of its direct impact on the economy due to its potential for employment
opportunities, output and exports. According to the Annual Report 2012-2013 on MSMEs
published by the Ministry of MSME, there has been a significant increase in the employment
and performance of MSMEs over the last decade.
Table 3: Employment and Performance Of MSMEs (*Estimated Values)
S. No. Year Total Employment Gross

Working (In Lakh) Output
Enterprise (In Crore)
(In Lakh)
1 2001-02 105.21 249.33 282270.00
2 2002-03 109.49 260.21 314850.00
3 2003-04 113.95 271.42 364547.00
4 2004-05 118.59 282.57 429796.00
5 2005-06 123.42 294.91 497842.00
6 2006-07 361.76 805.23 1351383.45

7 2007-08* 377.37 842.23 1435179.26
8 2008-09* 393.70 881.14 1524234.83
9 2009-10* 410.82 922.19 1619355.53
10 2010-11* 428.77 965.69 1721553.42
11 2011-12* 447.73 1012.59 1834332.05
Source: (Ministry of Micro, Small and Medium Enterprises, Government of India, 2012-13)
With the initiation of market liberalisation, there have been many significant concomitant
changes in the institutional arrangements that governed various operations of SMEs. The
changes, inter alia, included de-reservation1 of the products for the small-scale sector and de-
licensing, leading to increased competition with the large-scale sector from within the country.
Further, dismantling of tariff barriers led to the replacement of the earlier policy of infant
industry protection with a regime of open competition with foreign firms. Along with the
integration of India’s innovation system with the world market, certain sectors within SMEs
could manage to get access to global market inter alia on account of their increasing
participation in the global production network (GPN). But, given the weakness of the innovation
system with the absence of institutional arrangements for interactive learning and competence
building, and the varied constraints in the spheres of credit market, factor market (including
labor and skill), product market, and technology, the large number of units in the SME sector
could hardly withstand the heightened competition resulting from liberalisation.
This sudden induction into a competitive environment while they were still in their nascent
stages of development gave MSMEs a shock that they were unable to absorb effectively. The
outcome has been an unprecedented increase in the number of sick units and decline in the
rate of growth in exports by the SME sector.
Year Items Reserved for Items on Open Remaining items

MSMEs General License (OGL) under Reserved List
1998-1999 821 478 343
1999-2000 812 576 236
2000-2001 812 643 169
2001-2002 799 799 NIL
(http://www.dcmsme.gov.in/policies/preseve.htm)

Table 4: The Decline of MSMEs
Year Number of Year Rate of Growth in

Sick Units Exports
1990 0.2 million 1986-91 31%
2000 0.3 million 2000-2010 18%
Large industries, meanwhile, had the definite advantage of having been established and found
their footing in the economy, thus being able to sustain themselves against the wave of
newfound competition, both domestic and international.
India has experienced rapid industrial growth since the enactment of the economic
liberalisation policies in 1991. Economic liberalisation has accounted for a substantial impact on
the manufacturing industry through an increase in the presence of manufacturing units, from
98,379 in the pre-liberalisation period of 1987 to 140,355 industrial units in 2007 reflecting a
42.67 percent growth during this 20 year period, and a rise in the production capacity and
output within individual manufacturing facilities.
Table 5(A): Growth of Manufacturing Sector in India

Sector 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11
Manufacturing 10.1 14.3 10.3 4.2 8.8 8.8
Construction 12.8 10.3 10.7 5.4 7 8
Mining & 1.3 7.5 3.7 1.3 6.9 6.2
Quarrying
GDP at Factor 9.5 9.6 9.3 6.8 8 8.6
Cost

The table below represents the growth rate of factories, employees and gross output.
Table 5(B): Growth of Manufacturing Sector in India

Years Factories (%) Employees (%) Gross Output (%)
SSI Large SSI Large SSI Large
1980-81 to 1984- -0.6 11.9 -2.1 2.1 0.6 8.7
85
1985-86 to 1990- 0.7 15.0 1.5 0.5 7.9 9.6
91
1980-81 to 1990- 0.2 13.7 0.1 1.1 5.0 9.3
91
The larger industries have been performing better, since MSMEs are generally equipped with
obsolete, inefficient and polluting technologies and processes due to lack of funding. 70
percent of the total industrial pollution load of India is attributed to MSMEs. Regulatory
mechanisms to ensure compliance are ill-suited towards MSMEs, as they are tailored more
towards larger industries, creating a scenario where MSMEs are unable to comply with
regulations. (Such regulatory barriers will be discussed in detail in the next section.) A vast
majority of them are actually self-employed people who survive by producing something or by
providing a service. Estimates are that more than 90 percent of them do not have access to any
approved developed industrial or business space for work, nor any form of institutional finance
nor any government support schemes. Another reason is because of their inability to access
affordable planned industrial space because of which they are compelled to work in ‘industrial
slums’ (Planning Commission of India, 2012).
Having accounted for the gap in terms of opportunity and growth differential between SSIs and
large enterprises, that remained even after the liberalisation reforms, the question automatically
arises: what were the factors that impeded, and in fact continue to stop, MSMEs from realising
their growth potential. While socio-cultural factors cannot be ignored in their entirety, it is a
safe presumption that the business environment and regulatory framework prevalent in India
are the primary cause of this differential. The study therefore seeks to document and analyse
Indian regulatory norms in an attempt to identify whether, and the extent to which, they
contribute to a retardation of MSME growth.

Section IV: Documentation and Analysis of Regulatory Norms
This section seeks to document regulatory norms associated with MSMEs; for convenient and
systematic study. These norms will then be discussed, classified along those pertaining to entry,
continuance (broadly including labour, taxation and finance) and exit. Further, procedural
formalities and documentation associated with these three stages will also be listed and
evaluated, as to their justification and requirement.
3.1 Entry: Documentation
The process of entry, in terms of regulatory barriers, can largely be studied along registration
and licensing obligations.
3.1.1 Registration
3.1.1.1 Process
As per section 8(1) of the MSMED Act, registration of micro or small enterprise (both,
manufacturing and service-oriented units) or a medium enterprise engaged in providing or
rendering of services is optional. However, a medium enterprise engaged in manufacture or
production of goods2 is required to mandatorily file the memorandum of registration with the
General Manager, District Industries Centre or any District level officer of equivalent rank in the
Directorate or the Department dealing with MSMEs of the state government or union territory.3
With the rider that these goods must pertain to an industry specified in the First Schedule to the
2
Industrial Development Regulation Act, 1951.

The MSMED Act, 2006 provides any enterprise established before this Act came to force i.e.
3
nd
enterprise pre-existing before 2 October 2006:
(i) In case of a registered small scale industry filing of memorandum is optional;
(ii) In case of an industry engaged in manufacture or production of goods pertaining
to industry specified in the First Schedule to IDR Act, 1951having investment in
plant and machinery more than INR 1 crore but not exceeding INR 10 crocre, shall
st
within 180 days i.e. by 31 of March 2007 file an Industrial Entrepreneurs’
Memorandum.

3.1.1.2 Justification Behind the Registration Process
Registering under the MSMED Act, 2006 ensure certain advantages.4
o The Act provides that if the buyer has purchased goods or availed services from micro or
small enterprise, which has filed a memorandum with the authority, then the buyer shall
make payment on or before the date agreed upon between him and the supplier in writing.
o If no agreement in writing is available, then payment will be made within a period of 15
days from the day the goods are delivered or services are rendered.
o The Act further stipulates that even if the period between the buyer and supplier is agreed
to in writing, such period shall not exceed 45 days from the day of delivery of goods or
rendering of services. In short, any credit term from a micro or small enterprise stipulating
payment terms beyond 45 days, shall be in violation of the MSMED Act, 2006. Failing this,
the buyer is liable to pay compounded interest with monthly rests from the date falling
after due date, at three times of the bank rate notified by the RBI (Kantilal Patel & Co., Year
Unknown).
Under Section 27, this Act also prescribes a penalty for, “whoever intentionally contravenes or
attempts to contravene or abets the contravention of any of the provisions contained in sub-
section (1) of section 8 (as mentioned above) or sub-section (2) of section 265 shall be
punishable:
(a) in the case of the first conviction, with fine which may extend to rupees one thousand;
and
(b) in case of any second or subsequent conviction, with fine which shall not be less than
rupees one thousand but may extend to rupees ten thousand.
Further, where a buyer contravenes the provisions of Section 226, he shall be punishable with
fine which shall not be less than rupees ten thousand; Section 22 seeks to ensure that the buyer
With the enactment of the MSMED Act, 2006, the Interest on Delayed Payments to Small Scale
4
and Ancillary Industrial Undertakings Act, 1993 was repealed.

Section 26 states that:
5
(1) The Central Government or the State Government may appoint such officers with such
designations and such other employees as it thinks fit for the purposes of this Act and may
entrust to them such of the powers and functions under this Act as it may deem fit.
(2) The Officers appointed under sub-section (1) may, for the purpose of this Act, by order
require any person to furnish such information, in such form, as may be prescribed.
Section 22 requires that:
6

provides complete information about the amount due on his end to the seller, so as to keep
tabs on and thereby protect the basic financial interest of the seller, that is, recovery of
remunerative price.
3.1.2 Licensing
Licensing in the industries sector is governed by the Licensing Exemption Notification issued by
Government of India on July 25, 1991 under the Industries (Development and Regulation) Act,
1951. In the case of SSIs, there are virtually no licensing restrictions. No industrial license is
required except in case of six product groups included in compulsory licensing. These products
groups include distillation and brewing of alcoholic drinks, cigars and cigarettes of tobacco and
manufactured tobacco substitutes, electronic aerospace and defence equipment of all types,
industrial explosives (including detonating fuses, safety fuses, gun powder, nitrocellulose and
matches), hazardous chemicals extending to hydrocyanic acid and its derivatives, phosgene and
its derivatives, isocyanates and di-isocyanates of hydrocarbon, not elsewhere specified. These
are mainly cover products that can only be made in large sector. But if a small-scale unit
employs less than 50 to 100 workers with/without power then it would not require a license
from the Government of India even for the six product groups covered in licensing (under
Schedule II of the notification). Subject to this minor limitation, an entrepreneur can set up a
SSI unit anywhere in the country without any restriction. The units are, of course, subject to the
locational/land use and zoning restrictions in force under the local laws (Development
Commissioner, Ministry on MSMEs, Government of India).
Where any buyer is required to get his annual accounts audited under any law for the time being
in force, such buyer shall furnish the following additional information in his annual statement of
accounts, namely:-
(i) The principal amount and the interest due thereon (to be shown separately) remaining
unpaid to any supplier as at the end of each accounting year;
(ii) The amount of interest paid by the buyer in terms of Section 16, along with the
amount of the payment made to the supplier beyond the appointed day during each
accounting year;
(iii) The amount of interest due and payable for the period of delay in making payment
(which has been paid but beyond the appointed day during the year) but without
adding the interest specified under this Act;
(iv) The amount of interest accrued and remaining unpaid at the end of each accounting
year; and
(v) The amount of further interest remaining due and payable even in the succeeding
years, until such date when the interest dues as above are actually paid to the small
enterprise, for the purpose of disallowance as a deductible expenditure under section
23.

Further, item groups reserved for exclusive manufacture by micro and small enterprises, as per
the Gazette notification include: food and allied industries, wood and wood products, paper
products, injection moulding thermo-plastic products, chemicals and chemical products, glass
and ceramics and mechanical engineering products excluding transport equipment (Anand G,
2009).
3.1.3 Procedural Norms: Starting a Business, Acquiring Construction Permits, Registering

Property
More than statutory stipulations, it is the procedural aspects of registration and licensing that
have the potential to serve as hindrances to MSME owners, owing to their tedious and
protracted nature. Starting a business, acquiring a construction permit (for the purpose of
setting up a manufacturing unit/warehouse for storage purposes) and registering or
transferring property are fundamental, and often essential, processes associated with the
establishment and entry of an enterprise into the MSME sector. Identified here, in detail, are the
processes that have to be fulfilled before these basic necessities of setting up an enterprise can
be fulfilled.
Starting a Business
The steps involved in starting a business in Delhi have been listed below; the detailed
procedure entailed by each step has also been tabulated.
1. Obtaining a Director Identification Number (DIN) online from the Ministry of Corporate
Affairs (MCA) portal
2. Obtaining a digital signature certificate from a private agency authorised by MCA
3. Reserving the company name with the Registrar of Companies (ROC) online
4. Paying stamp duties online, filing all incorporation forms and documents online and
obtaining the certificate of incorporation
5. Requesting and obtaining Certificate to Commence Operation
6. Making a seal
7. Obtaining a Permanent Account Number (PAN) from an authorised franchise or agent
appointed by National Securities Depository Services Limited (NSDL) or Unit Trust of
India (UTI) Investors Services Ltd., as outsources by the Income Tax (I-T) Depatment
8. Registering with Employees’ Provident Fund Organisation
9. Register for medical insurance at the regional office of Employees’ State Insurance
Corporation (ESIC)
10. Register for VAT online

11. Obtaining a tax account number (TAN) for income taxes deducted at source from an
authorised franchise or agent appointed by the National Securities Depository Ltd.
(NSDL), as outsourced by the I-T Department
In Mumbai, the process is marked by two additional steps:
12. Registration with Office of Inspector, Mumbai Shops and Establishment Act
13. Registration for profession tax
The detailed procedure can be seen in Table 2.2 of the Doing Business Report 2015.
Acquiring a Construction Permit
The procedure involves the following steps:
1. Submit application and design plans and pay scrutiny fee

2. Receive site inspection from Building Proposal Office
3. Obtain Intimation of Disapproval and pay fees
4. Submit structural plans approved by a structural engineer
5. Apply for No-Objection Certificate (NOC) from Tree Authority
6. Receive inspection from Tree Authority
7. Obtain NOC from Tree Authority
8. Request and obtain NOC from Storm Water and Drain Department
9. Request and obtain NOC from Sewerage Department
10. Request and obtain NOC from Electric Department
11. Request and obtain NOC from Traffic & Coordination Department
12. Request and obtain NOC from Chief Fire Office
13. Obtain commencement certificate and pay development charges
14. Request and receive inspection of plinth
15. Submit letter stating completion of building works to obtain an occupancy
certificate and certificate of completion
16. Request and obtain completion NOC from Tree Authority
17. Request and obtain completion NOC from Storm Water and Drain Department
18. Request and obtain completion NOC from Sewerage Department
19. Request and obtain completion NOC from Electric Department
20. Request and obtain completion NOC from Traffic and Coordination Department
21. Request and obtain completion NOC from Chief Fire Office
22. Apply for permanent water and sewer connection

23. Receive on-site inspection for connection to water and sewer
24. Request and receive completion inspection from Building Proposal Office
25. Obtain completion certificate
26. Obtain occupancy certificate
27. Obtain permanent water and sewer connection
More information on the time, cost and procedures for dealing with construction permits in
Mumbai can be seen in Table 3.2 of the Doing Business Report 2015.
Registering Property
The following procedure has to be complied with, uniformly throughout India, in order for
property to get registered, transferred or in any manner dealt with.
1. Obtain non-encumbrance certificate

2. Ensure that property is clear of all local tax dues
3. Conduct charges search at the Registrar of Companies
4. Preparation of the final sale deed by the purchaser’s lawyer
5. Payment of Stamp Duty on the final Sale Deed through franking at the designated
bank
6. Execute final sale deed and submit documents to the local office of the Sub-
Registrar of Assurances;
7. Apply to the Land & Survey Office for mutation of the title of the property
More information on time, cost and procedures for registering property in India can be found
in Table 5.2 of the Doing Business Report 2015.
3.2 Entry: Analysis of Regulatory Norms
Simplification of the Registration Process
The MSMED Act, 2006, replaces the erstwhile system of two-stage registration (provisional and
permanent) for SSIs, with ‘filing of memorandum’ under Section 8 of the Act. Meanwhile, there
is no provision that necessitates the surrendering of the SSI Registration Certificate before filing
for the Entrepreneurs’ Memorandum (EM).
The attempt, rather evidently, has been to simplify the registration process and in doing so, to
allow MSME owners to avail the several benefits that accompany registration. However, it

becomes crucial to also note that Standing Order 941 (E), dated 7 June 2007, provides for
separate filing of Ems. That is to say, an enterprise engaged in both, manufacturing and service
activity, has to file two separate EMs with the same ownership/management/office/work
address etcetera.
Statutory Protection of Financial Interest of MSME Owner
The MSMED Act is punitive in a manner that serves to protect the financial interest of the
supplier (or the MSME unit in question) by ensuring that apprehension of non-payment is not a
deterrent for an enterprise otherwise willing to indulge in productive/service-providing activity.
This fact is evident from the discussion on Sections 22, 26 and 27, as conducted in the
foregoing section dealing with documentation of regulatory norms.
Minimal Licensing Obligations
We observe that licensing requirements are rather liberal so far as MSMEs are concerned and
contrary to general understanding, are not a major hindrance or deterrent to their entry and
subsequent growth. The very notification that provides for licensing is termed the ‘Exemption
from Licensing Notification, 1991’, pointing rather significantly at the shift in policy attitude
towards small-scale entrepreneurial ventures.
Procedural Barriers
A major drawback of the procedures associated with entry, as studied above, is the time and
cost involved. As per the analysis conducted by the World Bank Group in coming up with the
Ease of Doing Business Index, compliance with formalities to build a warehouse requires 25.4
procedures, takes 185.9 days and costs 28.2 percent of the warehouse value. Such costs cannot
be borne by most MSMEs, given that financial crunches are one of the major problems faced by
them. Further, the protracted nature of the procedure encourages and incentivises non-
compliance; greater instance of unregistered property transfer being a befitting illustration.
While transferring a large part of procedure (obtaining a DIN for instance, or applying for a
PAN card) to electronic form has facilitated entrepreneurs, it becomes difficult for those relying
on conventional methods and physical filing of applications to adapt to these new forms. Thus
both modes of complying with procedure—physical and electronic—must be kept open.

Further, it is witnessed that while carrying out the procedure for several entry-associated
activities (obtaining construction permits, in particular) necessitates the obtainment of NOCs
from multiple authorities. This process is tedious and time-consuming for the entrepreneurs
and can have a dampening effect on the business environment.
3.3 Continuance: Documentation of Regulatory Norms
Regulatory norms associated with continuance of a firm in the MSME sector can be studied
along three broad dimensions: Financing, Taxation and Labour.
3.3.1 Financing
As discussed in a former section of the paper dealing with challenges faced by MSMEs,
insufficiency of finances, funding sources and the resultant debt gap are a cause of major
concern for the MSME sector. A sub-group established by the Planning Commission estimates
the outstanding credit gap for the MSME sector at 62 percent of credit demand at the
beginning of the 12th Five Year Plan. Total credit demand, just for microenterprises, comes to
around INR 7.9 trillion for 2012.
According to the Ministry of MSMEs, the need for financing can be categorised as:
1. Long and medium term loans

2. Short term or working capital requirements
3. Risk Capital
4. Seed Capital/Marginal Money
5. Bridge loans
The important potential sources of funding for MSMEs are:
1. Commercial/Regional Rural/Co-operative Banks.

2. SIDBI: Small Industries Development Bank of India (refinance and direct lending)
3. SFCs/SIDCs: State Financial Corporations (Delhi Financial Corporation, for
instance)/State Industrial Development Corporations.
This list, however, is not exhaustive. Financing of MSMEs need not be restricted to these
sources. It also includes venture capital funds and non-government finance companies.

3.3.1.1 Availability of Credit
The table below gives the status of credit flow to the micro and small enterprises (MSE) sector
from the public sector banks since 2000:
Table 6: Credit Flow to MSMEs
As at the end of March

2000 2001 2002 2003 2004 2005 2006 2007
Net Bank
3,16,427 3,41,291 3,96,954 4,77,899 5,58,849 7,18,722 10,17,614 13,17,705
Credit (NBC)
Credit to
46,045 48,400 49,743 52,988 58,278 67,634 82,492 1,04,703
MSEs
% to NBC 14.6 14.2 12.5 11.1 10.4 9.4 8.1 8.0
(Source: http://www.dcmsme.gov.in/thrustareas/credit.htm)
The Reserve Bank of India had issued a Master Circular in 2010 comprising guidelines for
lending to Micro and Small Enterprises (MSE) sector on part of Domestic Commercial Banks
and Foreign Banks operating in India, as under Section 3 of the circular. In terms of the
recommendations of the Prime Minister’s Task Force on MSMEs, banks are advised to achieve a
20 percent year-on-year growth in credit to micro and small enterprises and a 10 percent
annual growth in the number of Micro enterprise accounts (Reserve Bank of India, 2010).
The data shows that banks have succeeded in doing so. As per the provisional data of March
2011, there has been an increase by 34.13 percent in credit to MSMEs since March 2010
thereby achieving the 20 per cent year-on-year growth in credit to micro and small enterprises.
However, the number of accounts just manages to cross the set limit of 10 percent.
(Table 2A, http://planningcommission.gov.in/aboutus/committee/wg_sub_pvtsec_MSME.pdf)
Further, public sector banks have been advised by the RBI to open at least one specialised
branch in each district. Banks have also been permitted to categorise their MSME general
banking branches having 60 percent or more of their advances to MSME sector in order to
encourage them to open more specialised MSME branches for providing better service to this
sector as a whole (Reserve Bank of India, 2010).

3.3.1.2 High Credit Cost
Another issue that has come to light persistently, besides low availability of credit, is the high
cost of credits. The Planning Commission has held that high cost of credit is a major
impediment in upbringing of MSMEs (Planning Commission of India, 2010). An overwhelming
80 percent of the 100 participants said high cost of credit was the biggest impediment in the
growth and development of the MSME sector. About 55 percent said that procurement of raw
material at competitive rates and delayed payment along with lack of availability of credit are
also crucial factors that inhibit growth and development of MSMEs (The Economic Times, 2010).
The Confederation of Indian Industries (CII) in its report (2010) ‘Financing for MSMEs’ has
elucidated some reasons as to why institutions like banks are not readily willing to finance
MSMEs. MSMEs depend predominantly on internal sources of finance (personal savings, loan
from relatives, and loan from local money lenders) than that of institutional financing by banks
and other financing institutions. An indication of this is that even in recent times, MSME credit
as a percentage of net bank credit of commercial banks has been below 15 percent.
Banks perceive MSMEs as a risky field of investment due to the following:
• Low growth rate of small firms

• Firms following informal business practices
• Inability of MSME owners to maintain collateral securities
• Lack of credit worthiness and goodwill
• Relatively high processing costs (in background checks, etc)
• Lack of transparency due to poor reporting of firm data
(Confederation of Indian Industries, 2010)
3.3.1.3 Deceleration of Credit Growth in the MSME Sector: Solutions
In view of the concerns emerging from the deceleration in credit growth to the MSME sector,
an Indian Banks’ Association (IBA)-led sub-committee was set up to suggest a structured
mechanism to be put in place by banks to monitor the entire gamut of credit related issues
pertaining to the sector. Based on the recommendations of the committee, banks have been
advised to:
(a) Strengthen their existing systems of monitoring credit growth to the sector and put in
place a system-driven comprehensive performance management information system
(MIS) at every supervisory level (branch, region, zone, head office) which should be
critically evaluated on a regular basis
(b) Put in place a system of e-tracking of MSME loan applications and monitor the loan
application disposal process in banks, giving branch-wise, region-wise, zone-wise and
State-wise positions. The position in this regard is to be displayed by banks on their
websites; and
(c) Monitor timely rehabilitation of sick MSE units. The progress in rehabilitation of sick
MSE units is to be made available on the website of banks.
(Reserve Bank of India, Year Unknown)
That being said, there has been a high extent of financial exclusion7 (92 percent) in the MSME
sector. Keeping in mind the aforesaid condition, RBI has set forth guidelines for commercial
banks to effectively address the issue by setting up Financial Literary Centres (FLCs) (Reserve
Bank of India, 2012).
3.3.1.4 Significance of Credit Rating for MSMEs
One of the most important procedures undertaken by financial institutions that offer credit to
MSMEs is the scrutiny of their credit rating status in order to determine the creditworthiness of
the enterprise in question.
Credit rating is done on the basis of credit scores that are numerical values assigned to the
MSMEs based on a statistical analysis. This score and rating serves to notify their credit
worthiness or the ability to maintain non-default on credit borrowed. These scores are often
evaluated on the basis of the credit reputation of a company, commonly known as a credit
report, available from the Credit Bureau of India.
In this direction, the Government of India operates a specialised rating agency known as the
SME Rating Agency of India Limited (SMERA), which is a third-party rating agency exclusively
set up for micro, small and medium enterprises in India for ratings on creditworthiness. It
provides ratings which enable only MSME units to raise bank loans at competitive rates of
interest. (Pricewaterhouse Coopers, 2013)
3.3.1.5 Identification of Policy-Level Finance-Oriented Problems
A high level committee on MSME set up by the Prime Minister—Prime Minister’s Task Force on
MSME (January 2010), has reported some major finance-related problems faced by MSMEs that
persist despite the aforesaid measures put in place in an attempt to remedy them.
Financial exclusion can be defined as the non-availability of banking services to people with low
7
or no income.

Access to adequate and timely credit at a reasonable cost is the most critical problems faced by
the sector. The major reason for this has been the high risk perception among banks about this
sector and the high transaction costs for loan appraisal for the aforementioned reasons. While
the quantum of advances from the public sector banks (PSBs) to the MSEs has increased over
the years in absolute terms, from INR 46, 045 crore in March 2000 to INR 185,208 crore in
March 2009, the share of the credit to the MSE sector in the Net Bank Credit (NBC) has declined
from 12.5 percent to 10.9 percent during the same period (2000-09). Similarly, there has been a
decline in the share of the micro sector as a percentage of NBC from 7.8 percent in March 2000
to 4.9 percent in March 2009.
Some recommendations of the Task Force were:
o While loans up to INR 50, 000 are covered under microfinance, banks are generally not
inclined to provide loans below INR 500,000 due to a high risk perception and transaction
costs. Banks may, given this context, lend to a pool of micro entrepreneurs who have been
financed by Micro Finance Institutions and are now ready for borrowing at higher levels in
the missing middle segment of INR 50,000 to INR 500,000 by covering them under the
Credit Guarantee Scheme.
o The Task Force noted that a Working Group under the chairmanship of Executive Director,
RBI is looking into the issues regarding: (a) enhancement of the collateral-free loan limit for
MSEs from INR 500,000 to INR 1,000,000; and (ii) absorption of the one-time guarantee fee
and annual service charges by the banks under the Credit Guarantee Scheme to facilitate
higher flow of credit to MSEs without collateral/third party guarantee. The Working Group
was required to submit its report within three months.
o The ability of MSMEs (especially those involving innovations and new technologies) to
access alternative sources of capital like angel funds/risk capital needs to be enhanced
considerably. For this purpose, removing fiscal/regulatory impediments to use such funds
by the MSMEs should be considered on priority (Prime Minister’s Task Force on MSMEs,
Report 2010).
3.3.1.6 FDI into an SSI Undertaking/MSME
Foreign Direct Investment (FDI) can be a potentially viable source of finance for MSMEs. It
therefore becomes important to understand the legal norms that govern FDI in MSMEs.
Prior to 2006, an SSI undertaking was defined in terms of: (a) investment in fixed assets in plant
and machinery and (b) equity participation (both, foreign and domestic) in the SSI by other
industrial undertakings. Vide Press Note 18 (1997), it was further notified that in cases involving

foreign collaboration, proposals for induction of foreign equity in excess of 24 percent would
be subject to certain conditions, since the maximum equity participation allowed for in SSIs was
limited to 24 percent. These conditions were that the company would get itself de-registered as
an SSI and also, obtain an industrial license or file for an Industrial Entrepreneur Memorandum,
as per prescribed procedure.
With the promulgation of the MSMED Act, the ceiling for equity participation (both domestic
and foreign) in MSMEs by other enterprises/undertakings was removed and MSMEs, unlike
their predecessor SSIs, were defined solely in terms of the investment in plant and machinery
(for micro and small enterprise engaged in manufacturing) and equipment (for micro and small
enterprise engaged in the rendering of service).
Accordingly, as under Notification Number S.O. 563 (E), dated 27 February 2009, issued by the
Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce and Industry and
as clarified in Press Note 6 (2009):
“The present policy in FDI in MSE (as defined under the MSMED Act, 2006) permits FDI subject
only to the sectoral equity caps, entry routes and other relevant sectoral regulations.”
In Press Note 14 (1997), it was also clarified that Industrial Undertakings manufacturing items
reserved for the small scale sector were not eligible for automatic approval for induction of
foreign investment. Accordingly, the FDI policy notified vide Press Note 2 (2000) prescribed
prior approval of the government where foreign investment exceeded 24 percent in the equity
capital of units manufacturing items reserved for SSIs.
The DIPP has also clarified through Press Note 6 (2009) that any industrial undertaking (with or
without FDI) which is not an MSE manufacturing items reserved for the MSME sector (presently,
21 in number and clubbed into seven categories, as discussed previously in the paper) would
require an Industrial License under the Industries (Development and Regulation) Act, 1951, for
such manufacture. The issue of the Industrial License will be subject to a few general conditions
and the specific condition that the undertaking shall ”export a minimum of 50 percent of the
new or additional annual production of the MSE reserved items to be achieved within a
maximum period of three years. The export obligation would be applicable from the date of
commencement of commercial production.“ Such an industrial undertaking would also require
prior approval of the Foreign Investment Promotion Board (FIPB) where foreign investment is
more than 24 percent in the equity capital. (Anand G., 2009)

So far as the ease of getting credit in India is concerned, the Ease of Doing Business Index ranks
it at 36 of the 189 countries. Questions pertinent to the strength of legal rights and the depth
of credit can be seen in the Doing Business Report 2015 (Page 76).
3.3.2 Labour
3.3.2.1 Problems Associated with Labour in MSMEs
The most effective manner of identifying problems pertaining to the labour associated with the
MSME sector would presumably be to bring together the representatives of the labour class
itself, as opposed to sticking with a top-down model of study. The Sub Group on Labour under
the Prime Minister Task Force, created in 2010 adopted this approach to identify problems
relating to labour in the MSME sector. The views and concerns of various stakeholders, as put
forth in a meet organised by the Task Force have been documented as follows:
o The representatives of Industry Associations felt that considering limited additional

absorption capacity of labour force in agriculture, the mantle of promoting employment
falls on the manufacturing sector, especially on SMEs. Hence, a facilitating environment
needs to be created by enacting a separate comprehensive labour law for SME Sector,
which has been recommended by Second National Commission on Labour (SNCL). This
would serve to make regulation more comprehensive and compliance more effective.
Presently, most labor laws are not even applicable to the Micro and Small Enterprises, given
that they do not satisfy the statistical requirements necessary to ensure the applicability of
said laws; this aspect has been dealt with in further detail in the next section of the paper,
whereby these laws have been enumerated and their provisions discussed.
The representatives recognised that while the intention of the existing labour laws is good,
the unintended consequences are the complications in implementation, automatically
resulting in corruption and lack of accountability. Hence, a re-vamping is required even by
prescribing higher limits for applicability of such laws and provision of social security for
MSE employers through cross subsidy.
o The representatives of Trade Unions, on the other hand, stated that workers’ interests
should not be compromised, the existing laws and their provisions should not be diluted,
wage standards should be maintained and protection should be available in terms of job
and social security. While the MSEs need to be helped through marketing, technology and
financial assistance, there should not be any relaxation on applicability of labour laws,
otherwise it may lead to serious problems on labour front. While implementation of labour
laws cannot be ensured without inspectors, the system of inspection can be improved by
encouraging self-certification, prescribing reduced number of registers and returns etcetera.
Difficulties in registration and recognition of unions, non-payment of minimum wages and

not having national minimum wage, and prevalence of huge number of contract labourers
were stated to be problem areas.
The Ministry of MSMEs and the Confederation of Indian Industries (CII) made the following
input on the subject of labour-related concerns:
o Ministry of MSMEs
(i) Presently, the Labour Laws (Exemption from Furnishing Returns and Maintaining
Registers by Certain Establishments) Act, 1988 covers nine Acts. The Ministry of
MSME proposed that the Act be amended so as to expand its coverage to 16
principal Acts; such expansion should incorporate, amongst others, the
Employees’ State Insurance Act, 1948 and the Employees’ Provident Fund and
Miscellaneous Provisions Act, 1952.
This would lessen the burden of procedural compliance (maintaining registers,
for instance) on MSMEs.
(ii) Further, the Ministry also suggested that the traditional inspection regime where
Government inspectors are the only ones empowered to undertake inspection
jobs is in need for review. It suggested that a mechanism may be evolved where
the burden of inspection could be shared by the Government inspectors and
other parties in a balanced manner, for this has been one of the best practices
prevailing internationally.
o CII
The CII, having recognised that archaic labour laws fetter the growth and
competitiveness of most manufacturing MSMEs in the country, recommended the
simplification of several labour laws governing the sector. These regulations are
purported to protect the interests of worker; however, they are in fact redundant
and detrimental to the interests of all stakeholders in the sector.
3.3.2.2 Law and Regulation Relating to Labour
The subject of ‘labour’ figures in the Concurrent List of the Constitution. Thus, both the Centre
and the States can legislate in this area. There are about 44 labour related statutes enacted by
the Central Government. They have been classified along eight broad categories by the Ministry
of Labour and Employment, each comprising a certain number of statutes within itself:
o Industrial Relations (4 statutes)

o Industrial Safety and Health (3 statutes)
o Child and Women Labour (3 statutes)

o Social Security (8 statutes)
o Labour Welfare (15 statutes)
o Employment and Training (2 statutes)
o Wages (7 statutes)
o Other (12 statutes)
(Ministry of Labour and Employment, http://labour.gov.in/content/)
All the statutes find specific enumeration in Annexure A. The applicability of some of these
statutes is as follows:
 Factories Act, 1948 is applicable to the establishments employing ten or more

workers with power, or 20 or more workers, without making use of power.
 The Payment of Wages Act, 1936 is applicable to the employees drawing wages
upto INR 10,000 per month and the Minimum Wages Act, 1948 is universally
applicable.
 So far as important Social Security Acts are concerned, the Employees’ State
Insurance Act, 1948 provides for healthcare and cash benefit payments in the
case of sickness, maternity and employment injury. The Act is applicable to non-
seasonal factories using power and employing ten or more employees and non-
power using factories and certain other establishments employing 20 or more
employees.
 Further, the Employees’ Provident Fund and Miscellaneous Provisions Act, 1952
is applicable to factories and other classes of establishments engaged in specific
industries and classes of establishments employing 20 or more persons.
Most Micro and Small Enterprises get automatically exempted unless they cross the number
filter. Many MSMEs, as can be seen below statistically, do not cross the minimum number of
workers required for the aforementioned Acts to be applicable. (Prime Minister’s Task Force on
Micro, Small and Medium Enterprises Report, 2010).
According to the MSME survey of 2006-07 their workforce was very large. While the registered
MSME units employed 92 lakh workers, the unregistered units employed 502.6 lakh workers,
pushing up total employment in the MSME sector to 594.6 lakh workers. However, despite the
large numbers, the MSME units were of very small size. While the average number of workers
per unit was 5.9 in the registered units, the numbers was only 2 in the unregistered units, which
pushed down the average number of workers in each MSME unit to just 2.3. Despite some
reports claiming that the total number of employees in the MSME sector for the period of

2006-07 to be 805.23 lakh, the numbers are still not enough to meet the requisite criteria for
the above mentioned Acts to be applicable. (Council of State Industrial Development and
Investment Corporations of India, 2011).
Employment in MSMEs: Break-Up
Registered
MSME Units
Unregistered
MSME Units
Unregistered MSMEs
Average Number of Registered MSMEs

Workers/ Unit Overall/ Total
0 2 4 6 8
Figure 1: Employment Pattern and Distribution in MSME Sector
The Second National Commission on Labour (SNCL) had recommended enactment of the Small
Enterprises (Employment Relations) Act for establishments having less than 19 workers with a
view to reduce pressure on them. One of the demands of the MSE Associations relates to
formulation of a separate legislation for MSE Sector. This would ensure the relevance of the
regulatory framework so far as labour associated with the MSME sector is conducted, as
opposed to a majority of the existing legislation, which as discussed above, is largely redundant
and inapplicable to Micro and Small Enterprises.

So far as labour is concerned, regulatory norms do not present the sole hindrance to the
growth of MSMEs. Lack of skills among labourers is another issue that adversely affects MSMEs.
There are many schemes that the Government has launched in order to train the workers. These
schemes have been discussed in the later sections.
3.3.3 Taxation
Here, the study seeks to document the tax obligations that MSMEs have to comply with and
the tax concessions that are made available to them. It will go further to determine whether,
and the extent to which, taxation procedures serve as a barrier to MSME owners in their
operation and successful continuance.
Taxation remains an issue of relevance in the context of Indian industries, a result of it being
considered flawed with regards to the number of payments required, procedures for filing
these payments, and the non-uniformity across states associated with them, as was indicated
by the World Bank in their Ease of Doing Business Index (International Finance Corporation,
World Bank, 2014).
On an average, firms in India make 33 tax payments annually; spend 243 hours a year filing,
preparing and paying taxes; and the total tax payment amounts to 61.7 percent of profit.
Globally, India stands at 156th position along the ‘Paying Taxes’ parameter, from amongst 189
countries.
Reports and research suggested a combination of three factors affect the psyche of the
entrepreneur with respect to the tax system she is bound to (Bernadette Kamleitner, 2012):
A. Perception about Non-Compliance Opportunity
B. Decision-Frame Rendering Taxes as Painful Losses
C. Knowledge about Tax-System
3.3.3.1 Structure for Tax Payments in India: Regulatory Framework
Direct Taxes
The authority to levy taxes in India is divided between the central and state governments; the
Central government levies direct taxes comprising income tax and wealth tax. Administration,

supervision and control in the area of direct taxes lie with the Central Board of Direct Taxes
(CBDT). The CBDT works under the Ministry of Finance (MoF) and exercises significant influence
over the working of the country’s direct tax laws.
The Indian tax year extends from 1 April of a year to 31 March of the subsequent year. The tax
year for a corporation also follows the same calendar. All corporations (except those who are
required to submit a transfer pricing certificate in Form 3CEB, with respect to international
transactions or specified domestic transactions) are required to file a Return on Investment
(ROI) by 30 September, even in the event of loss. However, corporations who are required to
submit a transfer pricing certificate in Form 3CEB are required to file a ROI by 30 November.
Non-resident corporations are also required to file a ROI in India if they earn income in India or
have a physical presence or economic nexus with India. Corporate tax liability needs to be
estimated and discharged by way of advance tax in four installments on 15 June, 15 September,
15 December and 15 March of every year.
Late filing of a ROI and delays in payment or shortfalls in taxes are liable to attract penal
interest at prescribed rates. Interest is generally imposed on the balance of the unpaid tax and
on underpayment of the advance tax (Ernst and Young, Doing Business in India, 2014).
Indirect Taxes
The Central Government levies indirect taxes comprising customs duty, excise duty, central
sales tax and service tax. The states are empowered to levy profession tax and state sales tax
apart from various other local taxes, including entry tax and octroi or local body tax.
The procedure for filing taxes, along with the rates of taxation, can be seen in Table 8.2 in the
Doing Business Report 2015.
3.3.3.2 Tax Benefits, Schemes and Incentives for the MSME Sector
The most important promotional policy of the Government for the SSIs is fiscal incentives in the
form of tax concessions and exemptions from direct or indirect taxes which are levied on
production or profits.
o Deduction in Respect of Profit and Gains
With effect from financial year 2005-06, SSIs can claim deductions in respect of profits and
gains (under section 80IB of Income tax Act) at the following rates:

 If SSI unit is owned by a company, the deduction available is 30 percent for first
10 years. If SSI unit is owned by a co-operative society, the deduction available is
25 percent for first 10 years.
 If any other person owns SSI unit, the deduction to be claimed is 25 percent for
first 10 years.
SSI unit can avail this tax exemption after fulfilling following conditions:
(i) They should not be subsidiary of, or owned or controlled by other industrial
undertakings.
(ii) They should not be formed as a result of splitting up or reconstruction of any
industrial undertaking/business.
(iii) SSI units can manufacture any nature or type of goods, which they are permitted to.
(iv) They should have commenced business between 1 April 1991 and 31 March 2002.
(v) They should employ at least 10 workers in a manufacturing process carried out with
aid of power or at least 20 workers without aid of power.
This tax exemption from total income is allowed from the assessment year in which the unit
begins to manufacture goods.
According to the Income Tax Act, 1961 the amount of interest payable or paid by any buyer, for
delayed payments to Micro and Small Enterprises shall not be allowed as deduction for the
purpose of computation of income under the Income Tax Act, 1961.
o Ambiguity as to the Definition of SSIs for Purposes of Tax Deduction
No special tax benefits have been made available to MSMEs under the MSMED Act, 2006. Even
the tax incentives available under Section 80-IB(3) of the I-T Act, 1961, as discussed above,
display ambiguity as to their validity.
For the purposes of section 80-IB(3), ‘Small Scale Industrial Undertaking’ (SSI) means an
undertaking which on the last day of the previous financial year was regarded as such under
Section 11B of the Industries (Development and Regulation) Act, 1951. However, the
notification providing for this definition [SO 857 (E), dated 10 December 1997], was itself
rescinded vide notification number SO 563 (E), dated 27 February 1997. Therefore, as the
position stands with effect from 27 February 2009, no industrial undertaking is considered an
SSI under the said section 11B.

This ambiguity, therefore, requires clarification from the Central Board of Direct Taxes so as to
make the scheme actually operational and allow the benefits to reach the intended
beneficiaries, which are MSME owners. (Anand G., 2009)
o Excise Exemption
Small Scale Industries are subjected to excise duties under the Central Excise Tariff Act,1985
(five of 1986). The eligibility for excise concessions for SSIs has been based on annual turnover
rather than SSI registration. Only SSI units having turnover of less than INR 4 crores are eligible
for concessions. Government of India has provided various concessions to SSIs by granting full
exemption from payment of central excise duty on a specified output and thereafter slab-wise
concessions.
 SSI units producing goods upto INR 100 lakhs are exempted from payment of
excise duties.
 SSI units having turnover less than INR 60 lakhs per annum need not have a
separate storeroom for storing finished products.
 SSI units are not required to maintain any statutory records such as daily stock
accounts, etc. Their own records are adequate.
 SSI exemption is available for goods for home consumption as well as goods
exported to Nepal and Bhutan.
(Author Unknown, Year Unknown)
o Presumptive Taxation Scheme, Union Budget (2009-10)
A presumptive tax scheme was introduced in the Union Budget 2009-10, particularly for small
businesses, and declared by the Finance Minister in his budget speech:
“…I propose to expand the scope of presumptive taxation to all small businesses with a
turnover up to INR 40 lakhs. All such taxpayers will have the option to declare their
income from business at the rate of 8% of their turnover and simultaneously enjoy
exemption from the compliance burden of maintaining books of account. As a procedural
simplification, I also propose to allow them to pay their entire tax liability from business at
the time of filing their return by exempting them from paying advance tax. This new
scheme will come into effect from the Financial Year 2010-11…”
Accordingly, the Finance (No. 2) Act, 2009 amended the Income-Tax Act, 1961 (Section 44AD).
Having understood the tax structure and regulatory framework applicable to MSMEs, it also
becomes significant to note that the tendency amongst micro enterprises to consider taxation

laws applicable to them as being a hindrance (beyond certain difficulties in filing) was largely
absent. The laws in place, available for registration as an MSME, currently grant concessions to
MSMEs, such as Excise Exemption Scheme and Exemption under Direct Tax Laws. The low rate
of registration does imply that these tax benefits do not reach a large number of micro
enterprises. Regardless of this tax was not reported to be a regulatory barrier per se (Centre for
Civil Society, 2014).
3.4 Continuance: Analysis of Regulatory Norms
Increasing Availability of Credit: Positive Role of RBI
The RBI, through its Master Circulars and periodic guidelines, has consistently been seen to
channelise credit from banks in the public sector to MSMEs. As has been documented above,
credit to the MSME sector has displayed a steady rise from 2000 to 2007, as also beyond this
period.
Betterment in FDI Policy Towards MSMEs
Removal of the 24 percent equity cap on FDI in the MSME sector and the retention of
reasonable sectoral caps has managed to achieve a balance between sufficient credit flow to
the sector and protecting MSMEs from foreign control, as was the apprehension expressed by
several owners.
Labour Intererests vis-à-vis Restrictive Labour Regulatory Framework
As gathered from the various points of view brought together by the PM’s Task Force on
MSMEs, labour interests (such as reasonable working hours, payment of timely and adequate
wages and the like) that are sought to be secured by existing labour laws, need to be weighed
against and balanced out with the maintenance of a business environment only reasonably
checked by a labour regulatory framework.
The present legal framework, it has been observed, is one of ‘over-legislation’, so to speak. The
excessive number of laws, and the extent of their stringency, is unnecessary and in fact,
detrimental to a healthy business environment.

Redundancy of Labour Laws
With respect to MSMEs, the existing labour laws are largely redundant. They are not even
applicable to most micro and small enterprises, owing to the fact that their small employment
figures do not qualify to fall within the ambit of the Acts. Simplification of Labour Laws
becomes an automatic and necessary requirement. Further, the codification of a single,
comprehensive labour legislation particularly for MSMEs, is desirable.
Protracted Procedure for Tax
It acts as an incentive for non-payment and may presumably serve as a deterrent to MSME
owners for continuance of their enterprises.
Ambiguity as to Definition of SSIs for Tax Purposes
The regulatory framework is in need of clarity on what constitutes ‘Small Scale Industrial
Undertakings’ for the purposes of availing tax benefits vide the I-T Act, 1961, as formerly
discussed.
3.5 Exit: Documentation of Regulatory Norms
The scheme for closure of business of micro, small and medium enterprises, as under Section
25 of the MSMED Act, 2006, states that:
“Notwithstanding anything contained in any law for the time being in force, the Central
Government may, with a view to facilitating closure of business by a micro, small or
medium enterprise, not being a company registered under the Companies Act, 1956 (1 of
1956), notify a scheme within one year from the date of commencement of this Act.”
Till now, however, there is no legal framework for the reorganisation/winding up/exit of small
units leading to a huge wastage of human resources (promoters and employees), capital (banks
and financial institutions) and physical resources (industrial land and buildings, plant,
machinery).
(The Times of India, 2014)
This policy gap and failure remains, despite the Prime Minister’s Task Force on MSMEs (2010)
having recognised a comprehensive and settled exit policy as necessary:
“The MSME sector remains in a state of dynamic flux- with a large number of startups
counterbalanced by a substantial number of exits. This is typical of entrepreneurial search

for not only business viability but of activities that provide the most suitable outlet to
talent. Therefore efficient exit is as important to this sector as easy entry.”
Exit and sickness are associated, often correlated, phenomenon. Sickness in a firm may be
followed by attempts at revival, by placing the firm under a nursing and rehabilitation regimen.
Failure in terms of revival, however, leads to exit. The sickness and exit process in any industry is
associated with immense financial and social stress. However, MSMEs are generally considered
more vulnerable because of non-availability or disinterest of many sources of aid.
3.5.1 Definition of Sickness
An older definition given by the Working Group on Rehabilitation of Sick Units set up by RBI
(Kohli Committee) states:
“A small scale industrial unit is considered as sick when if any of the borrowal accounts of the unit
remains substandard for more than six months; that is, principal or interest, in respect of any of its
borrowal accounts has remained overdue for a period exceeding one year;
OR
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.”
This implies that if the net worth of a unit diminishes under circumstances whereby loss
incurred amounts to 50 percent of its net worth in the preceding year, the unit is deemed to be
sick, given that its operation at such point had been continuing for a minimum period of 2
years.
The changed definition as notified by RBI stands as follows:
“An MSE is considered ‘sick’ when:

a) any of the borrowal account of the enterprise remains NPA (Non-Performing Asset) for three
months or more
OR
b) There is erosion in the net worth due to accumulated losses to the extent of 50% of its net
worth.”

The stipulation that the unit should have been in commercial production for at least two years
has been removed.
3.5.2 Sickness: Trends, Causes and Criteria
Of two lakh enterprises that availed loans, 1.17 lakh enterprises have outstanding loans for the
period of 2006-07. Of the units having loan outstanding with institutional sources like banks
and financial institutions, sickness was about 29.40 percent in registered MSMEs.
(Ministry of Micro, Small and Medium Enterprises, 2006-07)
For the enterprises falling under the category sick/incipient sick and not working satisfactorily,
reasons or causes are:
Table 7: Sickness in MSMEs: Causes

Reason for sickness/incipient sickness Proportion of sick/incipient sick units (%)
Lack of demand 41.94
Shortage of working capital 20.49
Non-availability of raw materials 5.11
Power shortage 5.71
Labour problems 5.64
Marketing problems 11.48
Equipment problems 3.17
Management problems 6.46
3.5.2.1 Criteria for and Measure of Sickness
Information on sickness and incipient sickness was collected during Fourth Census of MSMEs
(2006-07). In order to measure incipient sickness, continuous decline in gross output for three
consecutive years was identified as a suitable indicator, whereas for measuring sickness, the
latest definition given by Kohli Committee was used. Thus, the following criteria were adapted
to identify sick/incipient sick units in the Fourth Census:
(i) Continuous decline in gross output compared to the previous two financial years
(ii) Delay in repayment of loan, taken from institutional sources, for more than 12 months
(iii) Erosion in net worth to the extent of 50 per cent of the net worth during the previous
accounting year
The number of enterprises deemed viable compared to the number of sick enterprises, as
indicated, is very low. Further, only a small number of these are put under nursing. This

indicated a tendency of banks to prefer vying for the closure of MSEs as opposed to providing
financial aid for them and preventing them from becoming insolvent.
3.5.3 Revival of sick MSMEs: Role of Banks
The evaluation of banks, while considering sick enterprises for revival, is very often influenced
by a conflict of interest, as stakeholders. The number of units deemed potentially viable as a
percent of the total number of sick enterprises is extremely low. The figure is 12.1 percent for
March 2012 of which 7.8 percent were put under nursing, which came down to 5.1 percent sick
units in March 2013, and further only 1.8 percent were put under nursing. This might be a result
of banks preferring not to extend aid towards the uncertain area of sick micro enterprises. This
is in sharp contrast to the corporates whose loan portfolios are routinely rescheduled.
The nursing process, largely similar for most banks, can be documented as follows:
TABLE 8: Stages in the Nursing Process of Sick MSMEs

NATURE OF MEDIUM MICRO AND SMALL
CONCESSION ENTERPRISES ENTERPRISES
Prevailing BPLR or 1% 1.5 % below the
Interest on fresh and prevailing BPLR or
below the applicable
existing (renewed) 1.5% below the
1. rate which ever is
working capital applicable rate which
lower.
ever is lower.
Reduction by a
Reduction by a
maximum of 2 % (3%
Interest on existing maximum of 2 %
for Micro
2. Term Loan from the applicable
Enterprises) from the
rate
applicable rate.
1.5 % below the

Interest on fresh prevailing BPLR or
Rehabilitation Term Prevailing BPLR or 1% 1.5% below the
Loan (RTL). (For Small
below the applicable applicable rate or as
manufacturing units for
3. rate which ever is prescribed by
start up expenses and
lower. SIDBI/NABARD
margin for working
capital). where refinance is
obtained, which ever
is the least.

Interest on Contingency
At the concessional
Loan Assistance to meet
rate allowed for
escalations in capital Not applicable.
4. working capital
expenditure under the
assistance.
rehabilitation scheme.
1 % below the 1.5 % to 3 %

below the
Interest on Working prevailing BPLR or 1%
prevailing BPLR or
Capital Term Loan below the applicable
5. 1% to 2% below
(WCTL). rate which ever is
the applicable rate
lower.
whichever is lower.
2 % below the
prevailing BPLR NIL for a period of
Interest on Funded
or 1% below the three years at the
Interest Term Loan
6. applicable rate discretion of the
(FITL).
whichever is bank.
lower.
Normally 3 to 5 years
(Can be prolonged to
6 to 7 years in To be repaid within 3
exceptional cases). As years from the date
Repayment period for
far as possible should of commencement of
Funded Interest Term
7. get precedence over, implementation of
Loan.
or is spread over a rehabilitation
shorter duration than Programme.
the repayment of
institutional loans.
The repayment period Should not normally

for restructured exceed 7 years from
debts may extend up the date of
to a maximum period restructuring and 15
8. of 10 years, but the years from the date
Funded Term Loan
interest concession
(FTL). of first disbursement
will be available only
for a period of 7 years of original loan. For
being the outer limit Micro Enterprises, the
for rehabilitation. said period may be 5

and 7 years
respectively.
Staggered or
ballooning
repayment may also
be permitted so that
the instalments are
aligned to the cash
flows.

- do -
9. Working Capital Term - do -
Loan (WCTL).
Waiver of Penal Waiver of Penal
Interest from the Interest from the date
beginning of the of account becoming
10. Waiver of Penal Interest accounting year in NPA or started
which the unit started
incurring cash losses
incurring cash losses
whichever is earlier.
continuously.
Regardless, since a low percentage of micro enterprises obtain loans through formal sources
such as banks, the facilities extended towards the revival of such sick units very often do not
impact the most vulnerable section of the segment.
3.5.4 Contribution of Laws and Regulatory Norms to Exit
Around 94 percent of MSMEs are unincorporated bodies i.e. proprietorships or partnerships, as

opposed to a significantly lesser number for small and medium enterprises (Fourth All India
Census of Micro, Small and Medium Enterprises, 2006-07).
Table 9: MSMEs - Nature of Organisation

Sector Proprietary Partnership Private Public Ltd. Cooperative Others
Company Company
Micro 91.77 3.47 1.78 0.37 0.28 2.33
Small 59.12 14.24 21.02 3.37 0.57 1.68
Medium 38.11 9.75 34.46 13.06 1.86 2.75
All 90.08 4.01 2.77 0.54 0.30 2.30

They are governed by the Presidency Towns Insolvency Act, 1909, and the Provisional
Insolvency Act, 1920. These acts disregard the concept of limited liability, which implies the
non-separation of the personal assets of the entrepreneur with those of the enterprise. This
results in an intertwining of the insolvency of an enterprise and the bankruptcy of the
entrepreneur. This acts as a disincentive to undertake an MSME in the first place for as long as
an entrepreneur possesses within his personal assets the finances to pay off the enterprise’s
dues, he is culpable and will not be considered an insolvent; this involves a huge financial risk
that may deter many potential entrepreneurs.
These laws have largely remained static in terms of determining entrepreneurial liability since
their inception, and are carried out by district courts, which culminates in a long drawn out,
court driven process of seizing debtor assets, and appointing receiver, and initiating punitive
action against the debtor. These may very well result in his subsequent imprisonment. The
focus of any proceedings undertaken is recovery of statutory dues (such as third-party
obligations of the enterprise), rather than an attempt at revival of the enterprise. (Prime
Minister’s Task Force on Micro, Small and Medium Enterprises Report, 2010).
During this period, the entrepreneur, alongside struggling to revive his business, further had to
face the possibility of being sued or penalised under various regulations. In addition, the stigma
attached with owning a failed enterprise has a social impact on the entrepreneur, and severely
affects his ability to obtain financing for a future entrepreneurial undertaking.
Measures have been taken to mitigate this, such as establishing the Limited Liability
Partnerships Act, 2008, and allowing the registration of one-person companies (OPCs) under
the Companies Act.
3.5.4.1 Limited Liability Partnership Act, 2008
The Minister of SSIs and Agro and Rural Industries had announced a Promotional Package for
Micro and Small Enterprises on 27 February 2007 in the Lok Sabha, wherein he had committed
to “enact a law on limited liability partnerships covering, among others, micro, small and
medium enterprises with a view, inter alia, to facilitating infusion of equity and venture capital
funding in these enterprises”. Thus, the LLP model presents an alternative corporate business
form that gives the benefits of limited liability of a company and the flexibility of a partnership.
An LLP is a separate legal entity and is liable to the full extent of its assets; however, the liability
of the partners is limited to their agreed contribution in the LLP. Further, no partner is liable on
account of the independent or unauthorised actions of other partners; thus, individual partners
are shielded from joint liability created by another partner’s wrongful business decisions or
misconduct (Anand G., 2009).

The ease of compliance, taxation laws, and registration process make these viable options for
micro entrepreneurs to limit their personal liability. Freed from the deterrence imparted by
uncertain financial liabilities and potential bankruptcy, individuals are bound to be more
enterprising towards undertaking ventures in the MSME sector, allowing the sector to realise its
optimum growth potential. However, steps must be taken to ensure the availability of
information channels to micro enterprises, the most vulnerable of the MSMEs.
3.5.4.2 Procedure for Resolving Insolvency
The procedure for resolving insolvency in India is marked by inefficiency and inordinate delays.
According to data collected by Doing Business, resolving insolvency takes 4.3 years on average
and costs 9.0 percent of the debtor’s estate, with the most likely outcome being that the
company will be sold as piecemeal sale. Globally, India stands at 137 in the ranking of 189
economies on the ease of resolving insolvency.
3.5.5 Rehabilitation of Sick Enterprises
Procedure for rehabilitation of sick enterprises:
1. Timely and adequate assistance to MSEs and rehabilitation effort should begin on a
proactive basis when early signs of sickness are detected. This stage would be termed as
‘handholding stage’ as defined below. This will ensure intervention by banks immediately
after detecting early symptoms of sickness so that sickness can be arrested at an early
stage. An account is deemed to have reached the ‘handholding stage’; if any of the
following events are triggered:
a. There is delay in commencement of commercial production by more than six months

for reasons beyond the control of the promoters
b. The company incurs losses for two years or cash loss for one year, beyond the
accepted timeframe
c. The capacity utilisation is less than 50 percent of the projected level in terms of
quantity or the sales are less than 50 percent of the projected level in terms of value
during a year
2. The bank branches should take timely remedial action which includes an enquiry into the
operations of the unit and proper scrutiny of accounts, providing guidance/counselling
services, timely financial assistance as per established need and also helping the unit to
sort out difficulties which are non-financial in nature, or require assistance from other

agencies. In order to ensure timeliness for banks for taking remedial action/measures in
‘handholding stage’, the handholding support to such units should be undertaken within
a maximum period of two months of identification of such units.
3. The decision on viability of the unit should be taken at the earliest but not later than 3
months of becoming sick under any circumstances.
The following procedure should be adopted by the banks before declaring any unit as unviable:
a. A unit should be declared unviable only if the viability status is evidenced by a

viability study. However, it may not be feasible to conduct viability study in very
small units and will only increase paperwork. As such for micro (manufacturing)
enterprises, having investment in plant and machinery up to INR 5 lakh and micro
(service) enterprises having investment in equipment up to INR 2 lakh, the Branch
Manager may take a decision on viability and record the same, along with the
justification.
b. The declaration of the unit as unviable, as evidenced by the viability study, should
have the approval of the next higher authority/ present sanctioning authority for
both micro and small units. In case such a unit is declared unviable, an opportunity
should be given to the unit to present the case before the next higher authority.
The modalities for presenting the case to the next higher authority may be worked
out by the banks in terms of their Board approved policies in this regard.
c. The next higher authority should take such decision only after giving an
opportunity to the promoters of the unit to present their case.
d. For sick units declared unviable, with credit facilities of INR 1 crore and above, a
Committee approach may be adopted. A Committee comprising of senior official of
the bank may examine such proposals. A Committee approach will improve the
quality of decision as collective wisdom of the members shall be utilised, especially
while taking decision on rehabilitation proposals.
e. Decision of the above higher authority should be informed to the promoters in
writing. The above process should be completed in a time bound manner not later
than three months.
4. The banks may, however, take decision in cases of malfeasance or fraud without following
the above procedure.
5. Banks may decide on the relief and concessions for rehabilitation of viable/potentially
viable units based on their own Board approved policies.
6. The banks are to put in place a Non-discretionary One Time Settlement scheme for
recovery of non-performing loans for the MSE sector, duly approved by the Board of
Directors.
(Reserve Bank of India, 2013)

As discussed above, there is no prescribed procedure for exit of MSMEs. “There is a need to
facilitate start-ups and evolve a time-bound exit mechanism; that being said, the Ministry of
MSME has assured of amending the MSMED Act, 2006 to facilitate the inclusion of a viable
method for exit of MSMEs.
(Ministry of Micro Small and Medium Enterprise, Year unknown)
3.6 Exit: Analysis of Regulatory Norms
Rehabilitation and Resolving Insolvency Measures to be Aimed at Revival
It has been observed that most rehabilitation efforts or resolution of insolvency are largely
aimed at satisfying the statutory obligations (such as fulfillment of liabilities towards third
parties) of the enterprise. The focus does not lie on revival of the firm itself. The number of
units deemed potentially viable as a percent of the total number of sick enterprises is extremely
low. The figure is 12.1 percent for March 2012 of which 7.8 percent were put under nursing,
which came down to 5.1 percent sick units in March, 2013, and further only 1.8 percent were
put under nursing. Even the Ease of Doing Business Index recognises that the most likely
outcome of insolvency resolution in India is that the “company will be sold as a piecemeal sale”.
Thus, policy attitude is in need of modification so as to lead resolution efforts towards revival,
not exit.
Legal Framework for Exit
Contrary to the yearlong time frame allowed under section 25 of the MSMED Act, 2006, there
has been no definite legal procedure. This allows for arbitrariness on part of banks when
resolving insolvency and finalising exit proceeding. A statutory framework, focused on
facilitating revival (or at least easy exit) of MSMEs is imperative.
The regulatory framework in India, along all aspects that constitute an MSME’s life cycle—entry,
continuance and exit—having been evaluated, it is imperative to now understand what the
effects of such regulations are on the general business environment, and on the ease with
which MSMEs can establish and maintain themselves. Further, the study cannot preclude a
critical view of the Indian regulatory scenario by placing it in a global context. Hereafter, the
study therefore proceeds to an international view of where the Indian business environment
stands, with respect to micro, small and medium enterprises in particular.

Section V: International Comparison
In this section, an analysis of India’s performance along several parameters that contribute to
the larger business environment will be conducted. Further, in an attempt to identify best
practices in terms of providing policy and institutional support to the MSME sector, it becomes
relevant to place India in a global perspective. This international comparison has been
conducted along two dimensions:
o An analysis of the Ease of Doing Business Index 2014 has been conducted so as to enable a
critical and reformatory view of the existing business environment in India, and its
subsequent impact on the performance of MSMEs
o Given the developing nature of all the nations in the group and their comparability with
India along socio-cultural-economic lines, the performance of India, along the Index, has
been juxtaposed against that of China, the Russian Federation and Bangladesh.
5.1 How Does the Ease of Doing Business (EoDB) Index Work?
The Doing Business 2015 Report (DB15) presents results for two aggregate measures: the
distance to frontier score and the ease of doing business ranking (which is based, for the first
time in the DB 15, on the former).
The ease of doing business ranking (henceforth, “Ranking”) compares economies with one
another in terms of the stringency of regulatory norms. It is a measure of the extent to which
regulatory norms lend themselves to a business environment—conducive or otherwise. The
distance to frontier score (henceforth, “Score), meanwhile, benchmarks the economies with
respect to the regulatory best practice, showing the absolute distance to the best performance
on each Doing Business Indicator. To illustrate, Canada and New Zealand have the smallest
number of procedures required to set up a business (1) and hence, it is they who establish the
frontier at 1. Significantly, when compared across years, the Score shows how much the
regulatory environment for local entrepreneurs in an economy has changed over time in
absolute terms, while the Ranking can only show how much the regulatory environment has
changed relative to that in other economies. (World Bank, Doing Business Rankings, 2014)
A composite of the two results in the Ease of Doing Business Index (henceforth referred to as
“Index”); a high ranking on the Ease of Doing Business Index means the regulatory environment
is more conducive to the starting and operation of a local firm. The rankings are determined by

sorting the aggregate distance to frontier scores on ten parameters, each consisting of several
indicators, giving equal weight to each; the parameters being:
1. Starting a business
2. Dealing with construction permits
3. Getting electricity
4. Registering properly
5. Getting credit
6. Protecting minority investors
7. Paying taxes
8. Trading across borders
9. Enforcing contracts
10. Resolving insolvency
(World Bank Doing Business Rankings, 2014)
In the context of MSMEs, it becomes very important to take note of the fact that Doing
Business, as a holistic, comprehensive measure sheds light on how easy or difficult it is for a
local entrepreneur to open and run a small to medium-size business when complying with
relevant regulations. It measures and tracks changes in regulations affecting the
aforementioned 11 areas in the life cycle of a business. The data not only highlights the extent
of obstacles to doing business, it also helps identify the source of those obstacles, supporting
policy makers in designing regulatory reform.8
(World Bank, Doing Business India Profile;, 2014)
The Doing Business methodology has limitations which must be duly recognised and
8
acknowledged. Other areas important to business—such as an economy’s proximity to large

markets, the quality of its infrastructure services (other than those related to trading across
borders and getting electricity), the security of property from theft and looting, the transparency
of government procurement, macroeconomic conditions or the underlying strength of
institutions—are not directly studied by Doing Business. The indicators refer to a specific type of
business, generally a local limited liability company operating in the largest business city. Because
standard assumptions are used in the data collection, comparisons and benchmarks are valid
across economies.
While this ranking tells much about the business environment in an economy, it does not tell the
whole story. The ranking on the ease of doing business, and the underlying indicators, do not
measure all aspects of the business environment that matter to firms and investors or that affect
the competitiveness of the economy. Still, a high ranking does mean that the government has
created a regulatory environment conducive to operating a business.

5.2 Where Does India Stand?
India’s DB 2014 rank stood at 140 while DB 2015 lies at 142, the change in rank being two rank
points to India’s detriment. Meanwhile, the distance to frontier (DTF, in terms of percentage
points) saw a shift from 52.78 (DB 2014) to 53.97 (DB 2015), showing a marginally positive
development of 1.19 percentage points.
To get a quantified overview of the business environment in India, it is interesting to note that
on a scale of 0 (worst performance) to 100 (depicting the frontier), India stands at a score of
53.97, which is marginally below the South Asian Regional Average (54.56). As against
comparator economies9, India lies far below China and Russia, each with Rank 90 and 62, their
scores along ‘business environment’ parameter being 62.58 and 66.66, respectively. As against
Bangladesh, India fares positively, with the former having the rank and score of 173 and 46.84,
respectively.
Owing to their comparability along socio-cultural, developmental and income-grouping lines.

9

Figure 2: India's Ranks on Doing Business & Distance to Frontier Scores
(Doing Business, 2015)
Having placed India in a regional and global context in terms of the overall business
environment, it becomes imperative to study how it fares along the several parameters that
constitute the Index.
5.3 India: Why does it Stand Where it Stands on the Index?
Hereunder, the DB Index Rank for India has been broken down into its constituent components,
in an attempt to understand which factors play a contributory role—and to what extent—in
determining the present-day regulatory environment of India, which has been witnessed to not
be very amenable to doing business despite the developments documented under Section IV
of the paper.

The calculation of scores for India, for all intents and purposes associated with the DB Index, is
done on the basis of collated data from the cities of Delhi and Mumbai, population-based
weights assigned to the two being 53 and 47, respectively.
Table 10: Doing Business Parameters: India 2014 v. India 2015.

DB TOPIC/ PARAMETER DB RANK 2015/2014 ALONG DISTANCE TO FRONTIER
THE TOPIC SCORES 2015/2014
Starting a Business 158/ 156 (-2) 68.4/ 65.54 (+2.88)
Dealing with Construction 184/183 (-1) 30.89/ 29.70 (+1.19)
Permits
Getting Electricity 137/ 134 (-3) 63.06/ 62.55 (+0.51)
Registering Properly 121/115 (-6) 60.40/ 60.40 (-)
Getting Credit 36/ 30 (-6) 65.00/ 65.00 (-)

Protecting Minority Investors 7/ 21 (+14) 72.50/ 65.83 (+6.67)
Paying Taxes 156/ 154 (-2) 55.53/ 55.64 (-0.11)
Trading Across Borders 126/ 122 (-4) 65.47/ 64.89 (+0.58)

Enforcing Contracts 186/ 18 (-) 25.81/ 25.81 (-)
Resolving Insolvency 137/ 135 (-2) 32.60/ 32.43 (+0.17)
(Source: Doing Business, 2015)
We see that in terms relative to other nations, as indicated by the differential in the DB 2014
and DB 2015 Ranks, India has fared poorly. ‘Protecting Minority Investors’ is the only parameter
along which it has gained a substantial 14 rank points. However, the Rank differential simply
indicates performance relative to other economies. A yardstick more suited to gauging India’s
performance along the regulatory norms guiding business environment, in absolute terms, is
the DTF score. Here, India presents a more promising picture. Starting a business, dealing with
construction permits, getting electricity, trading across borders and resolving insolvency have
all become easier to negotiate. Being associated with all stages of the growth of an MSME—
entry, continuance as well as exit—these developments have contributed to a more amenable
business environment, and can be traced and documented as follows Doing Business, World
Bank, 2014):
DB 2008
o Getting Credit: India’s private credit bureau started to provide credit information on firms.
India also strengthened its secured transactions system by launching a unified and

geographically centralised collateral registry that covers security interests granted by
companies, can be searched by debtor name and encompasses the entire country.
o Trading Across Borders: It was made easier by introducing ICEGATE—an electronic data
interchange system making it possible to lodge customs declarations through the Internet
and facilitating the operation of a risk management system, an electronic payment system
and an electronic manifest system that allows shipping lines to submit their cargo manifest
in advance.
DB 2009
o Trading Across Borders: India reduced the time for exporting by implementing an electronic
data interchange system.
DB 2010
o Resolving Insolvency: India made resolving insolvency easier by increasing the effectiveness
of processes and thereby reducing the time required.
DB 2011
o Starting a Business: India eased business start-up by establishing an online VAT registration
system and replacing the physical stamp previously required with an online version.
o Paying Taxes: The administrative burden of paying taxes was reduced by abolishing the
fringe benefit tax and improving electronic payment.
DB 2012
o Paying Taxes: India eased the administrative burden of paying taxes for firms by introducing
mandatory electronic filing and payment for value added tax.
DB 2013
o Dealing with Construction Permits: India reduced the time required to obtain a building
permit by establishing strict time limits for preconstruction approvals.

DB 2015
o Starting a Business: India made starting a business easier by considerably reducing the
registration fees, but also made it more difficult by introducing a requirement to file a
declaration before the commencement of business operations. These changes apply to
both Delhi and Mumbai.
o Protecting Minority Investors: India strengthened minority investor protections by requiring
greater disclosure of conflicts of interest by board members, increasing the remedies
available in case of prejudicial related-party transactions and introducing additional
safeguards for shareholders of privately held companies. This reform also applies to both
Delhi and Mumbai.
o Getting Electricity: In India the utility in Mumbai made getting electricity less costly by
reducing the security deposit for a new connection.
To delve deeper into the status of regulatory and legal norms affecting the climate of business
in India, these DB topics can further be broken down into processes and practicalities
associated with the establishment and maintenance of an MSME. Further, performance along
these sub-parameters can be viewed relative to that of comparable economies as well as best-
performing nations, globally.
5.4 Doing Business Parameters: The Indian Perspective
Hereunder, the major parameters/ topics that constitute the ease of doing business index have
been listed and an analysis of how the Indian policy and regulation framework fares along the
criterion has been conducted.
Parameter 1: Starting a Business
The ease of starting a business is measured by the DB Index by taking account of:
o The number of procedures required to legally start and operate a company. This in turn
includes: pre-registration (name verification or reservation and notarisation, for instance),
registration in the economy’s largest business city10 and post-registration (for example,
company seal or a social security number in case of certain countries).
In case of countries with population exceeding a 100 million, a weighted average of the two
10
largest cities is taken. In case of India, these are Mumbai and Delhi, as previously mentioned in the
paper.

o The time required to complete each procedure, expressed in calendar days. Calculations
hereunder do not factor in the time spent gathering information and procedures that can
be fully completed online are recorded as only half a day. Procedure is deemed to be
complete once the final document is received by the applicant (MSME owner) and no prior
contact or association with the concerned officials is assumed.
o Another sub-parameter lies in the cost required to complete each procedure and it is
expressed as a percentage of income per capita. This cost is inclusive of only official costs
and not bribes; professional fees also stands excluded, unless the services they correspond
to are mandated by law.
o The final factor is the paid-in minimum capital, also expressed as a percentage of income
per capita—it refers simply to the capital deposited in a bank or with a notary either prior
to, or within three months of, registration.
India stands at 158th rank (with a DTF score of 68.42) on the ease of starting a business
parameter. All comparable economies, as also the South Asian Regional Average, stands above
India. The Russian Federation stands at rank 34 (with DTF being 92.17), China at 128 (77.43),
Bangladesh at 115 (81.36) and the South Asia rank is 95 (83.29).
Figure 3: How Indian and Comparator Economies Rank on Ease of Starting Business

In India, starting a business requires 11.9 procedures, takes 28.4 days, costs 12.2 percent of
income per capita and requires paid-in minimum capital of 111.2 percent of per capita income.
(Doing Business 2015 India Report, 2014).
Parameter 2: Dealing with Construction Permits
The Doing Business Report has appropriately identified that “regulation of construction is
critical to protect the public. But it needs to be efficient, to avoid excessive constraints on a
sector that plays an important part in every economy. Where complying with building
regulations is excessively costly in time and money, many builders opt out. They may pay bribes
to pass inspections or simply build illegally, leading to hazardous construction that puts public
safety at risk. Where compliance is simple, straightforward and inexpensive, everyone is better
off.”
This parameter measures the following:
o The number of procedures to legally build a warehouse. The processes involved extend to:
submitting all relevant documents and obtaining all necessary clearances, licenses, permits
and certificates; submitting al required notifications and receiving all necessary inspections;
obtaining utility connections for water and sewerage; registering the warehouse after its
completion (if required for use as collateral or for transfer of the warehouse).
o Time required, in calendar days, to complete each procedure. This does not include the
time spent gathering information and procedure is deemed to be complete only when the
final document is received; no prior association with authorities is presumed.
o Finally, the cost required to complete each procedure is factored in as a percentage of
warehouse value; hereunder, only official costs are added, to the exclusion of bribes.
To comply with the formalities to build a warehouse in India, an MSME owner must go through
25.4 procedures, 185.9 days and costs as high as 28.2 percent of the warehouse value.
India stands at a dismal 184 (of 189 economies), with a DTF score of 30.89. Russia stands at 156
(56.7), China at 179 (43.75), Bangladesh at 144 (61.9) and the South Asian Regional Average at
118 (60.66); India, thereby, being the worst performer amongst these comparators.

Figure 4: How India and Comparator Economies Rank on Ease of Dealing with Construction Permits
The estimated cost of constructing a warehouse, factoring in the procedure applicable in
Mumbai and Delhi, stands at a staggering INR 4,496,273; presumably, this facility of building
their own warehouse cannot be availed by many MSME owners, given the extent to which it is
financially demanding.
Parameter 3: Registering Property
Ensuring formal property rights has been identified as fundamental by Doing Business; effective
administration of land being part of that. If formal property transfer is too costly or
complicated, formal titles might go informal again. The most important aspect of registration of
property for MSMEs lies in the fact that where property is informal or poorly administered, it
has little chance of being accepted as collateral for loans—limiting access to finance, a
challenge that already weighs heavy on MSME owners, as formerly discussed.
The parameter involves the following components:
o The number of procedures required to legally transfer title on immovable property. These
include: pre-registration (for instance, checking for liens, notarising sales agreement, paying

property transfer taxes), registration in the economy’s largest business city and post-
registration (for example, filing title with the municipality).
o Time required to complete each procedure, in calendar days, whereby time spent gathering
information is not included. Again, procedure is considered completed once the final
document is received by the applicant and no prior contact with officials is presumed.
o The cost required to complete each procedure is expressed as a percentage of property
value. Only official costs are factored in and no bribes, value added or capital gains taxes
included.
Completing a property transfer in India involves seven procedures, takes 47 days and costs 7
percent of the property value. Globally, India stands at 121 in the ranking of 189 economies on
the ease of registering property, its DTF score being 60.4. This is as against China’s rank 37
(80.67), the Russian Federation’s standing at 12 (91.27), Bangladesh’s 184th position (31.34) and
the South Asian Regional average which lies at 127 (55.09).
FIGURE 5: HOW INDIA AND COMPARATOR ECONOMIES RANK ON THE EASE OF REGISTERING PROPERTY
(DOING BUSINESS 2015 )

Parameter 4: Getting Credit
Two types of frameworks can facilitate access to credit and improve its allocation: credit
information systems and borrowers and lenders in collateral and bankruptcy laws. Credit
information systems enable lenders’ rights to view a potential borrower’s financial history
(positive or negative)—valuable information to consider when assessing risk. And they permit
borrowers to establish a good credit history that will allow easier access to credit. Sound
collateral laws enable businesses to use their assets, especially movable property, as security to
generate capital—while strong creditors’ rights have been associated with higher ratios of
private sector credit to GDP (Doing Business India Profile, 2014).
The ‘getting credit’ indicators measure the following:
o Strength of legal rights index (0-12)11; hereunder, the rights of borrowers and lenders
through collateral laws are taken into account. Also, the protection of secured creditors’
rights through bankruptcy laws is measured.
o Depth of credit information index (0-8)12; the scope and accessibility of credit information
distributed by credit bureaus and credit registries is measured.
o Credit bureau coverage, expressed as a percentage of adults, measures the number of
individuals and firms listed in the largest credit bureau.
o Credit registry coverage calculates the number of individuals and firms listed in the credit
registry as a percentage of adult population.
The pertinent question here is as to how well do the credit information system and collateral
and bankruptcy laws in India facilitate access to credit? The economy has a score of seven on
the depth of credit information index and a score of six on the strength of legal rights index.
Higher scores indicate more credit information and stronger legal rights for borrowers and
lenders.
Globally, India stands at 36 (DTF score: 65) in the ranking of 189 economies on the ease of
getting credit; the highest amongst all comparable economies, indicating how well regulations
and institutions in India support lending and borrowing. China stands at rank 71 (50), the
Russian Federation at 61 (55), Bangladesh at 131 (30) and the South Asian Regional Average
performance is 97 (41.88).
Data collected to assess the overall legal framework for secured transactions and the
11
functioning of the collateral registry.

Data collected on accessing borrowers’ credit information online and availability of credit
12
scores.

How strong legal rights are for borrowers and lenders are determined by the economy scores
along the legal rights index: India (6), China (4), Russia (4), Bangladesh (6). Higher scores
indicate that collateral and bankruptcy laws are better designed to facilitate access to credit.
The depth of credit information index, meanwhile, indicates how much credit information is
share and how widely: India (7), China (6), Russia (7), Bangladesh (0). Higher scores indicate the
availability of more credit information, from either a credit registry or a credit bureau, to
facilitate lending decisions. If the credit bureau or registry is not operational or covers less than
5 percent of the adult population, the total score on the depth of credit information index is 0.
Parameter 5: Paying Taxes
While taxes are essential, the level of tax rates needs to be carefully chosen—and needless
complexity in tax rules avoided. Firms in economies that rank better on the ease of paying taxes
in the Doing Business study tend to perceive both tax rates and tax administration as less of an
obstacle to business according to the World Bank Enterprise Survey research (Doing Business
India Profile 2014).
The approach that Doing Business takes towards computing for the purposes of this parameter
is as follows. Using a case scenario, it measures the taxes and mandatory contributions that a
medium-size company must pay in a given year as well as the administrative burden of paying
taxes and contributions. Information is also compiled on the frequency of filing and payments
as well as time taken to comply with tax laws.
The ‘Paying Taxes’ parameter consists of the following indicators:
o Tax payments for a manufacturing company in 2013, in calculating which the number per
year has been adjusted for electronic and joint filing and payment. It includes the total
number of taxes and contributions paid, including consumption taxes (value added tax,
sales tax or goods & services tax). The method and frequency of filing are also factored in.
o Time required to comply with three major taxes, in terms of hours per year, is factored in.
This computation includes: collecting information and computing the tax payable;
completing tax return forms, filing with proper agencies; arranging payment or withholding;
preparing separate tax accounting books, if required.
o Total tax rate, expressed as a percentage of profit before all taxes. The calculation of this
total tax rate accounts for profit/corporate income tax; social contributions and labour taxes

paid by the employer; property and property transfer taxes; dividend, capital gains and
financial transactions taxes; finally, waste collection, vehicle, road and other taxes.
On an average, firms in India make 33 tax payments annually, spend 243 hours a year filing,
preparing and paying taxes, and the total tax payment amounts to 61.7 percent of profit.
Globally, India stands at 156h position along the ‘Paying Taxes’ parameter, with a DTF score of
55.53. It ranks the lowest amongst comparable economies, as can be observed from the
diagrammatic representation given below:
FIGURE 6: HOW INDIA AND COMPARATOR ECONOMIES RANK ON EASE OF PAING TAXES
Parameter 6: Trading Across Borders
In today’s globalised world, making trade between economies easier is increasingly important
for business. Excessive document requirements, burdensome customs procedures, inefficient
port operations and inadequate infrastructure all lead to extra costs and delays for exporters
and importers, stifling trade potential. Research shows that exporters in developing countries

gain more from a 10 percent drop in their trading costs than from a similar reduction in the
tariffs applied to their products in global markets (Doing Business India Profile, 2014).
To understand the standing of any economy along this parameter, it becomes imperative to
measure the time and cost associated with exporting and importing a standard shipment of
goods by sea transport, and the number of documents necessary to complete the transaction.
The ‘Trading Across Borders’ parameter measures the following:
o The number of documents required to import and export, including bank documents,
customs clearance documents, port and terminal handling documents and also, transport
documents.
o Number of days required to export and import. This computation takes account of
obtaining, filling out and submitting all the documents; inland transport and handling;
customs clearance and inspections; port and terminal handling; sea transport time stands
excluded.
o Cost required to export and import, in terms of USD per container, including costs involved
in all documentation, inland transport and handling, customs clearance and inspections and
finally, port and terminal handling; hereunder, only official costs are factored in, bribes
stand excluded.
In India, exporting a standard container of goods requires seven documents, takes 17.1 days
and costs USD 1332. Importing the same container of goods requires 10 documents, takes 21.1
days and costs USD 1462. Globally, India stands at 126 in the ranking of 189 economies on the
ease of trading across borders, its standing with respect to comparable economies being as
follows:

FIGURE 7: HOW INDIA AND COMPARATOR ECONOMIES RANK ON EASE OF TRADING ACROSS BORDERS
Parameter 7: Resolving Insolvency
The significance of this measure lies in the fact that a robust bankruptcy system functions as a
filter, ensuring the survival of economically efficient companies and reallocating the resources
of inefficient ones. Fast and cheap insolvency proceedings result in the speedy return of
businesses to normal operation and increase returns to creditors. By improving the
expectations of creditors and debtors about the outcome of insolvency proceedings, well-
functioning insolvency systems can facilitate access to finance, save more viable businesses and
thereby improve growth and sustainability in the economy overall (Doing Business Report India
Profile, 2014).
The ‘Resolving Insolvency’ indicators measure the following:
o Time required to cover debt, measured in calendar years; appeals and requests for
extension are included.

o Cost required to recover debt, expressed as a percentage of the debtor’s estate. This cost
includes court fees, fees of insolvency administrators, lawyers’ fees, assessors’ and
auctioneers’ fees and other related fees.
o The outcome of the insolvency resolution process is also factored in; that is, whether the
business continues operating as a going concern or business assets are sole piecemeal.
o Recovery rate for creditors measures the cents on the dollar recovered by secured creditors.
o Strength of insolvency framework index (0-16) puts forth the sum of the scores of four
component indices: commencement of proceedings index (0-3), management of debtor’s
assets index (0-6), re-organisation of proceedings index (0-3) and creditor participation
index (0-4).
In India, resolving insolvency takes 4.3 years on average and costs 9.0 percent of the debtor’s
estate, with the most likely outcome being that the company will be sold as piecemeal sale.
India scores 2.0 out of 3 points on the commencement of proceedings index, 3.0 out of 6
points on the management of debtor’s assets index, 0.0 out of 3 points on the reorganisation
proceedings index, and 1.0 out of 4 points on the creditor participation index. India’s total score
on the strength of insolvency framework index is 6.0 out of 16.
Globally, India stands at 137 in the ranking of 189 economies on the ease of resolving
insolvency, with a DTF score of 32.6. The performance of other comparator economies can be
documented as follows:

FIGURE 8: DISTANCE TO FRONTIER SCORES (DOING BUS INESS 2015)
Other Parameters
Parameter 8: Getting Electricity
Obtaining an electricity connection is essential to enable a business to conduct its most basic
operations. In many economies the connection process is complicated by the multiple laws and
regulations involved—covering service quality, general safety, technical standards, procurement
practices and internal wiring installations. (Doing Business India Report, 2014)
India stands at 137th position with a DTF score of 63.03; amongst the comparable economies, it
lies behind only China (Rank: 124, DTF: 66.35). Russia stands at 143 (60.89), Bangladesh at 188
(17.32) and the South Asian Region at 122 (62.47).
Parameter 9: Protecting Minority Investors
Protecting minority investors matters for the ability of companies to raise the capital they need
to grow, innovate, diversify and compete. Effective regulations define related-party transactions
precisely, promote clear and efficient disclosure requirements, require shareholder participation

in major decisions of the company and set detailed standards of accountability for company
insiders (Doing Business India Profile, 2014).
The parameter is composed of several indices: extent of disclosure index, extent of director
liability index, ease of shareholder suits index, extent of shareholder rights index, extent of
corporate transparency index and finally, strength of investor protection index.
How strong minority investor protections are against self-dealing in India, is indicated by the
fact that the economy ranks 7th amongst 189 countries along the parameter (DTF score: 72.5),
with a score of 7.3 on the strength of minority investor protection index; a higher score
indicates stronger protections.
Along this parameter, India is placed higher up than all comparable economies: China being at
132nd rank (45), Russia at 100 (50.83), Bangladesh at 43 (60.83) and the South Asian Regional
position being 78th (52.5).
Parameter 10: Enforcing Contracts
Effective commercial dispute resolution has many benefits. Courts are essential for
entrepreneurs because they interpret the rules of the market and protect economic rights.
Efficient and transparent courts encourage new business relationships because businesses
know they can rely on the courts if a new customer fails to pay. Speedy trials are essential for
small enterprises, which may lack the resources to stay in business while awaiting the outcome
of a long court dispute (Doing Business Report India Profile, 2014). The parameter includes
indicators such as: number of procedures to enforce a contract through courts, time required to
complete procedures and the cost required to complete procedures, expressed as a percentage
of the claim.
In India, commercial dispute resolution or the enforcement of a contract takes 1420 days, costs
39.6 percent of the value of the claim and requires 46 procedures.
In terms of rankings, India stands at 186th position (DTF score: 25.81) in terms of the ease of
enforcing contracts, the only comparator economy lower down being Bangladesh with a rank
of 188 and with its DTF score being 20.82. China occupies the 35 th position (DTF score: 68.21),
Russia stands at 14th position (75.85) and the South Asian Regional average lies at 148th
position (40.95).
The regulatory framework for small-scale business ventures in India and their largely
detrimental impact on the business environment for MSMEs having been understood, the
paper now seeks to suggest measures—at the policy and implementation level. This has been
done in an attempt to mitigate the extent to which MSMEs have been adversely affected, by re-
aligning policy in a manner that facilitates their growth.

Section VI: Policy Recommendations
The study documented and assessed the regulatory framework—both, statutory and
procedural—surrounding the business climate in India, with particular and detailed reference to
MSMEs. Using this assessment, policy recommendations have been made that, if implemented,
will hopefully mitigate the detrimental impact of faulty, or simply redundant, policy measures
on MSMEs—their entry, operation and comfortable, structured exit.
1. Drawing Up a Distinction Between Micro, Small and Medium Enterprises at a

Policy Level
A challenge faced by the sector from a policy perspective, and which cannot be readily
quantified, lies in the fact that Micro, Small and Medium enterprises are often lumped
together—in making budgetary allocations, devising policy measures and in the subsequent
application and implementation of policies so drafted. The distinction between them is not
merely academic; it comes with variations in their requirements and, therefore, holds practical
value. Micro, Small and Medium enterprises, for instance, have different finance needs. Micro
enterprises primarily rely on debt for both early and growth-stage financing; micro and small
services enterprises primarily transact in cash and tend to keep minimal records. Finally,
manufacturing enterprises and those with order-driven services tend to need more finance
because of longer working capital cycle and higher capital expenditure (International Finance
Corporation, Year Unknown). These different requirements can naturally not be catered to and
addressed when they are not even recognised. Legally, the same laws are not applicable to
them for micro and small enterprises do not qualify, statistically, to fall in the ambit of the same
laws as medium enterprises. By lumping them together—at an institutional level, and hence
psychologically—these requirements are often ignored. It is recommended that government
departments (either ministries or sub-functionaries within a ministry) for the three should be
kept separate, with each being specialised to cater to the demands of its assigned segment.
2. Starting a Business: Minimisation of Procedural Compliances Required
In India, starting a business requires 11.9 procedures, takes 28.4 days, costs 12.2 percent of
income per capita and requires paid-in minimum capital of 111.2 percent of per capita income.
India stands at 158th rank (with a DTF score of 68.42) on the ease of starting a business
parameter; this is lower than the South Asian Regional Average and also, all three comparable
economies in question. The procedure can readily be simplified by simply making a few
alterations in the manner of compliance; for instance:

3. Separate Filing of Entrepreneurs’ Memorandum for the Same Enterprise
Involved with Manufacturing and Rendering of Services can be Removed
a. Online or e-filing of documents/ payments (such as the Director Identification Number,

for instance), though more efficient, should always be accompanied by an alternative
option of physical filing for those who may not be comfortable with online compliance
of such obligations.
b. Single Window Clearance for No-Objection Certificates is a viable option. For instance,
in case of acquiring construction permits, NOCs from the sewerage, tree and drainage
departments can easily be acquired through a single-window system.
4. Better Monitoring Mechanism with Respect to Finance for MSMEs
The RBI has taken several measures towards streamlining the flow of finance, from public as
well as private sector banks, to the MSME sector. In response to these directive measures, there
has been a corresponding and steady increase in the flow of such finances. However, when
placed against the debt gap and credit requirements of the sector, this increase proves
insufficient. Better monitoring of the flow of these finances is hereby suggested as a potential
remedy to this problem.
The status of the loan should be available to be tracked online, for higher bank authorities and
applicants alike. This will serve as an incentive for banks to maintain efficiency in the process
and will aid the maintenance of accountability and transparency.
5. Simplification of Labour Regulatory Framework
Currently, 44 legislations (only central; the number does not include state legislations) provide
for labour regulations. Most of these are seen to be inapplicable to micro and small enterprises.
Even for medium enterprises, the regulatory framework is scattered across all these statutes,
making compliance a challenge. In terms of quality, this legislation is marked by unnecessary
complexity and redundancy. In keeping with the view of the Confederation of Indian Industries
(CII), the following statutes are suggested to be amended, and measures to be put in place, so
as to simplify the existing framework:
o The Factories Act, 1948

o The Employees Provident Funds and Miscellaneous Provisions Act, 1952
o The Employees State Insurance Act, 1948
o Definition of wage
o The Industrial Disputes Act, 1947

o The Contract Labour (Regulation and Abolition) Act, 1970
o The Industrial Employment (Stand Order) Act, 1946
The detailed recommendations, adopted from those put forth by the CII, have been discussed
in ‘Annexure B’ to the paper.
6. Inclusive Manner of Checking Compliance with Laws
In an attempt to check the corruption, red-tapism and bureaucratic attitude associated with
inspections undertaken by the government, an alternative compliance-enforcement mechanism
is recommended. Hereby, all stakeholders’ interests will be duly represented while conducting
inspections. For instance, compliance with health and safety norms in restaurant should not be
conducted by a government official alone. The protection of the MSME owner’s interests
should be ensured with the inclusion of an independent expert on such norms.
7. Taxation: Need for Simpler Procedure and Non-Ambiguity in Laws
While taxes are essential, the level of tax rates needs to be carefully chosen, and needless
complexity in tax rules avoided. On an average, firms in India make 33 tax payments annually;
spend 243 hours a year filing, preparing and paying taxes; and the total tax payment amounts
to 61.7 percent of profit. Globally, India stands at 156h position along the ‘Paying Taxes’
parameter, with a DTF score of 55.53. It ranks the lowest amongst comparator economies.
The possibility of introduction of the Goods and Services Tax (GST), for instance, is a step in the
direction of simplifying procedure. GST is a comprehensive tax levy on manufacture, sale and
consumption of goods and services at a national level. Through a tax credit mechanism, this tax
is collected on value-added goods and services at each stage of sale or purchase in the supply
chain. The system allows the set-off of GST paid on the procurement of goods and services
against the GST which is payable on the supply of goods or services. However, the end
consumer bears this tax as he is the last person in the supply chain. Experts say that GST is
likely to improve tax collections and boost India's economic development by breaking tax
barriers between States and integrating India through a uniform tax rate
Needless to say, its introduction will also bring about a reduction in the procedure currently
associated with paying different forms of indirect taxes separately.
Further, the ambiguity in the definition of SSIs for the purposes of the I-T Act, 1961, needs
clarification on part of the CBDT, so that benefits and exemptions granted thereunder can
reach MSMEs.

8. Addressing Lack of Awareness
The government, particularly when it claims to be welfare-oriented, cannot take the plea of
‘Right to Information’ and thereby put the onus on MSME owners to seek information about
various schemes and benefits. It must take on the duty to inform upon itself, for the deficiency
lies not in the existence of schemes, but on their implementation. Incentive to implement can
only be achieved in the ultimate beneficiaries are aware of policies and are in a position to
make a forceful claim for their operationalisation.
9. Legal Framework for an Exit Scheme
In defiance of the yearlong time frame allowed under Section 25 of the MSMED Act, 2006,
there has been no definite legal procedure to provide for a structured winding-up scheme to
facilitate easy exit of MSMEs. This allows for arbitrariness on part of banks when resolving
insolvency and finalising exit proceedings. A statutory framework, focused on facilitating revival
(or at least easy exit) of MSMEs is imperative.

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Regulatory Barriers to Micro,

Small and Medium Enterprises

Contact: ccs@ccs.in 10 July 2014

_Toc407117669Section I: Background to the Study ................................................................. 3

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Figure 1: Employment Pattern and Distribution in MSME Sector ........................................ 30

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1.1 Aims and Objectives

1.2 Research Question and Hypothesis

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2.1 Definition of MSMEs

Table 1: Definition Of MSMEs

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(MSMED Act, 2006).

2.2 Challenges Faced by the MSME Sector

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2.3 Trends: Implications for the Economy

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(Ministry of External Affairs, Government of India, Year Unknown)

However, growth in productivity of the economy as intended by these reforms occurred

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Year GDP Secondary Sector

(P) – provisional estimate.

Table 3: Employment and Performance Of MSMEs (*Estimated Values)

S. No. Year Total Employment Gross

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Year Items Reserved for Items on Open Remaining items

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Year Number of Year Rate of Growth in

1990 0.2 million 1986-91 31%

2000 0.3 million 2000-2010 18%

Table 5(A): Growth of Manufacturing Sector in India

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Table 5(B): Growth of Manufacturing Sector in India

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3.1 Entry: Documentation

Industrial Development Regulation Act, 1951.

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Registering under the MSMED Act, 2006 ensure certain advantages.4

and Ancillary Industrial Undertakings Act, 1993 was repealed.

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3.1.3 Procedural Norms: Starting a Business, Acquiring Construction Permits, Registering

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In Mumbai, the process is marked by two additional steps:

Acquiring a Construction Permit

The procedure involves the following steps:

1. Submit application and design plans and pay scrutiny fee

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1. Obtain non-encumbrance certificate

3.2 Entry: Analysis of Regulatory Norms

Simplification of the Registration Process

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Statutory Protection of Financial Interest of MSME Owner

Minimal Licensing Obligations

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3.3 Continuance: Documentation of Regulatory Norms