Nudge towards Formalisation

Context: Registering Micro, Small, and Medium Enterprises (MSMEs) under “Udyam” could help them access formal credit channels. But the costs of formalization and compliance are high and onerous.

Steps taken to formalize MSME’s

• Udyog Aadhaar Memorandum (UAM): Notified in 2015 as an online filing system for MSMEs, and was based on the self-declaration and self-certification

• Udyam registration process: under which the enterprise will register itself online based on self-declaration.

• It generates a verified database since Aadhaar is made mandatory for proprietors and companies, and every enterprise can have only one Udyam Registration Number.
• Integration with the Trade Receivables Electronic Discounting System (TReDS) and the Government e-Marketplace (GeM) will benefit MSMEs by offering a free and automatic route to onboard bill discounting mechanisms.

• Updated Priority Sector Lending Guidelines by the Reserve Bank of India: MSMEs will be identified as per the gazette notification laying down the new process of classification and registration. 

• In future, financial institutions can make the Udyam registration a prerequisite for lending purposes.

Problems related to the formalization of MSME in India

• Low number of registrations: 

• Only 1.1% of the total estimated 6.3 crore MSMEs that exist as per the National Sample Survey 73rd Round had registered under Udyam registration process 
• As of January 2020, only 13.5% of the MSMEs was registered under UAM.

• Lack of information: Reliable and updated information regarding small businesses in India are absent since a dedicated census conducted in 2006-2007.

• Basic information regarding MSME units is scattered across various databases such as the UAM, MSME Databank, and Goods and Services Tax Network (GSTN).

• Preference to informal sources of financing: In 2018, the International Finance Corporation estimated that the overall supply of finance from formal sources met only one-third of the credit demand of the MSME sector. 

• Exclusion Issues: While the Udyam initiative is promising in terms of capturing reliable and verified information about MSMEs, those firms which are left out will be excluded from accessing formal finance.

• High costs of formalization and compliance:  Enterprises themselves prefer to stay informal to avoid income tax and GST registration 

Conclusion:  Enabling strategies such as Priority Sector Lending (PSL) could provide a fillip to priority sectors, including MSMEs, which require increased formal financing.