Why India’s Quest to make its MSMEs Energy Efficient is a Race against Time

30/11/2024

With sustainability dictating economic discourse worldwide, India’s economy faces the risk of buckling under the pressure.

The bustling hubs of micro, small, and medium enterprises (MSMEs), often referred to as the backbone of the nation, are both substantial energy consumers and significant contributors to the country’s carbon footprint. But mostly, they face an economic choke.

Consuming approximately 25 percent of the industrial sector’s energy, these small businesses are struggling to defend their profit margins. For instance, a textile unit in Tamil Nadu is unable to keep up with export orders because its outdated machinery inflates production costs by 20 percent compared to global competitors.

MSMEs, according to the Observer Research Foundation (ORF), have to spend between 5 and 20 percent of their operational expenses just on electricity—a significantly higher share compared to larger firms across various industrial segments.

“This financial burden creates a competitive disadvantage for MSMEs, as higher operational costs reduce market competitiveness,” says Tushar Bhaskar, Chief Business Officer at Rubix Data Sciences, a risk management company.

After considerable anticipation, however, the central government is ready to provide financial assistance to these struggling MSMEs and, according to reliable sources, is on the cusp of launching a Rs-1000-crore scheme through the Ministry of Power to promote energy efficiency in the sector.

The purpose of this scheme would be to provide financial support through interest subvention. Small businesses will enjoy a 5 percent interest subsidy, while medium enterprises will receive a 3 percent subsidy on loans availed for implementing energy efficient technologies.

Though the scheme may appear to be just a financial incentive for the sector to invest in modern day technologies, the stakes are in fact far higher than that.

Bow to Fate

During the 26th Conference of PartiCOP26) in Glasgow, Scotland, in 2021, countries worldwide were urged to commit to achieving net zero carbon emissions by 2050.

India, which heavily depends on coal for economic growth, announced two significant commitments: first, to meet 50 percent of its energy requirement through renewable sources by 2030 and second, to achieve net zero carbon emissions by 2070.

To meet these ambitious commitments, the MSME sector must embrace modern technologies to swiftly reduce its carbon footprint. According to government data, MSMEs contribute 30 percent to India’s gross domestic product (GDP) and 37 percent to its manufacturing output.

Credit access to the MSMEs has been a major pain point after reforms like demonetization and goods and services tax (GST). That is why the first budget of Prime Minister Narendra Modi’s third term proposed initiatives aimed at reducing barriers to finance faced by small businesses.

“While larger businesses have easy access to knowledge, technology, resources, and capital, the MSME sector lacks the same. Additionally, because of its informal nature, it is challenging for the MSME sector to transition to resource-efficient technologies and sustainable daily operations,” notes Amrita Ganguly, executive director, Risk Advisory, at Deloitte India.

“Lack of awareness of formal financing instruments, resources, and expertise further add to this concern,” she adds.

Informal Sector

India’s MSME sector is largely informal. In fact, a study on MSME finance showed that only around 16 percent of these small businesses are financed through the formal banking system.

The sector’s total debt demand was estimated to be a staggering $888.42 billion. Of this, only $139.74 billion is met by the formal sector, including commercial banks and government institutions. The remaining $748.69 billion is sourced from informal channels such as family, friends, and private businesses.

Credit gap in the MSME sector increased from $58.6 billion in 2010 to $397 billion in 2017

Also, the sector grapples with a significant credit gap—the disparity between the total supply of credit from formal financial institutions and the sector’s addressable demand. In 2010, the credit gap in India’s MSME sector was estimated at $58.6 billion. By 2017, it had ballooned to $397 billion, reflecting a compounded annual growth rate (CAGR) of 37 percent.

In light of this, experts see the government’s subsidy schemes as an intervention to encourage more small businesses to use formal routes of financing. “The scheme subsidises interest cost, and the Rs-1000-crore outlay can be looked at as a pilot investment to identify and demonstrate successful models,” says Rahul Ahluwalia, director and founder of Foundation for Economic Development, a policy advisory think-tank.

India, according to official data, has over 4.8 crore MSMEs, of which over 95 percent are micro-enterprises, the smallest of the small businesses. An outlay of Rs 1000 crore would, therefore, cover only a small fraction of the vast MSME ecosystem, supporting only a few thousand firms initially.

“The more critical requirement is to enable MSMEs to tap global markets in their areas of business. This will enable higher volumes and margins and incentivise firms to organically invest in energy efficient technologies,” adds Ahluwalia.

Adapt or Perish

Revitalising the MSME sector’s energy efficiency involves more than helping them align with net-zero targets. Data by Directorate General of Commercial Intelligence and Statistics (DGCIS) shows that the share of export of MSME specified products in exports fell from 49.4 percent in 2020-21 to 45.7 percent in 2023-24, increasing the pressure on their revenues.

This is happening at a time when India is looking to push its way further into international markets like Europe and North America, where sustainability and low-carbon products are slowly becoming key priorities.

MSME's share in India's exports has been on a declining trend in recent years until 2023-24

Ahluwalia notes that this transition in global markets is at a nascent stage and there is still a window of opportunity for Indian MSMEs to catch up. “But as markets evolve and their preference for low carbon products becomes more pronounced, investment in energy efficient technologies will become critical. At that point, the only way Indian firms will be able to compete is by achieving necessary scale and utilisation levels to invest in such technologies,” he cautions.

“In every free trade agreement (FTA), we have talked about MSMEs, sometimes in paragraphs and sometimes in a full chapter. As a country we will have to start putting more weight behind the work MSMEs can do and how they can be enabled to leverage the FTAs,” Rajesh Agrawal, additional secretary of commerce said at an industry event last year.

Experts highlight that while FTAs bring market opportunities for MSMEs to scale up and integrate into global value chains, they will soon impose tougher standards on sustainability. These standards will involve significantly higher compliance costs, making the situation complex for policy makers, one with do-or-die implications for the MSMEs.

Notably, India is currently looking at more than 50 such potential agreements to boost its economy. India’s growth rate is already displaying signs of fatigue, and history shows that no economy has sustained high growth without robust export performance—an area where India has long struggled.

Modi 3.0 government is in a race against time to get the MSME sector ready before the global markets close their doors on it. For it to succeed, India will have to go beyond offering credit support and push on several policy fronts to enable the sector to transition without losing their viability.

According to outlookbusiness.com