When the national space agency Indian Space Research Organization (ISRO) employees Pawan Kumar Chandana and Naga Bharat Daka founded Skyroot Aerospace in 2018 to build space launch vehicles or rockets, most were apprehensive about the venture ever taking off. Not only was a private company aspiring to build rockets unheard of in India but attracting a huge amount of capital required to run the enterprise appeared almost impossible.

“Raising capital in spacetech was very challenging during the first couple of years as there was no policy or precedence of similar companies in the sector as well as no thesis for any institutional funding for the space sector,” Pawan Kumar Chandana, Co-founder & CEO of Hyderabad-headquartered Skyroot Aerospace told SME one Sunday evening in April.

Seven years later, Skyroot Aerospace has not only successfully launched the country’s first privately built rocket but has also raised $95.5 million in funding, thanks largely to support from the Department of Space (DoS) and its agencies ISRO and Indian National Space Promotion and Authorization Centre (IN-SPACe). The company’s rise abetted by an enabling policy environment can serve as a template for millions of other players wanting to make it big in India’s vibrant Micro, Small and Medium Enterprise (MSME) segment.

India boasts of over 43.1 million registered MSMEs – unofficially, the figure may be as high as 75 million – to rank second after China. These entities located all over the country are engaged in providing a variety of products and services. As the world’s fastest-growing economy seeks to replace Japan and Germany as the world’s third-largest economy by 2027, this base will expand further to play an increasingly important role in becoming the backbone of its industry. After all, it is the presence of a robust SME segment that propelled the rise of Japan, Germany, South Korea, and China as global economic powerhouses in the past.

Experts feel the government’s thrust on infrastructure creation and putting in a significant amount of investment through initiatives such as the Production Linked Incentive (PLI) schemes for the manufacturing sector to build an export-based economy will help boost the demand for MSME products.

“A far stronger MSME ecosystem would be required in the areas of services, component manufacturing, machining, or technology. Fortunately, India has a good amount of entrepreneurship at the small and the medium-scale level, which is ready to take up these challenges to support the large growth programmes the government has set in motion,” declares Deven Choksey, MD of Mumbai-based wealth management firm KRChoksey Holdings.

Simultaneously, the focus on reducing import dependence is also pushing up requirements for goods and services domestically. “Be it railway, defence, electronics manufacturing, engineering R&D, or contract manufacturing, all of these areas are demanding the MSME segment to play a larger role,” says Choksey.

This will be aided by Indian businesses seeking to emerge as important players in the current round of globalisation even as traditional supply chains have been disrupted owing to geopolitical conflicts and global corporations looking to diversify their manufacturing outside China under the China Plus One strategy. “Globalisation isn’t about putting everything in one place, it’s about becoming more diversified. That’s the direction we will continue to see in supply chains. India has a great opportunity there and we are starting to see some significant momentum,” states Steven A Altman, Adjunct Assistant Professor & Director of the DHL Initiative on Globalisation at the NYU Stern School of Business.

For instance, in 2023, India attracted the second-largest amount of announced greenfield FDI after the US. This marked increase in the share of investment going to manufacturing signals India’s growing role in global supply chains. Altman feels that despite the competition from countries like Vietnam, the country has the key ingredients such as scale to become a leader. 

“A fact that was news to me is that India’s exports as a share of GDP of goods and services combined are now higher than China’s! That means India is now an economy that is more oriented towards exporting overall goods and services than China, which is a very notable development.”

Needless to say, those companies will be relying on the MSME segment to supply them with everything from raw materials to hi-technology components as part of their vendor ecosystem. Yet, complications around easy financing needed for creating a vigorous MSME ecosystem persist.

The capital conundrum

The COVID-19-induced lockdowns led the government to announce measures including an upward revision in MSME categorisation and the introduction of the Emergency Credit Line Guarantee Scheme (ECLGS) to assist such firms in meeting their working capital requirements. More measures have been rolled out since. However, only half the battle in the war to reclaim the country’s rightful share of the global GDP has been won till now.

Financing-related challenges depend upon the type and age of the enterprise. “A first-generation entrepreneur setting up a greenfield project has difficulty in arranging equity to raise loans. Secondly, all entrepreneurs find it difficult to arrange assets that could be pledged as collateral security to raise loans from banks,” avers Anil Bhardwaj, Secretary General of the Federation of Indian Micro and Small & Medium Enterprises (FISME), the country’s apex trade body for the segment.

Bhardwaj has a point. Research and analytics advisory CRISIL estimates the share of bank loans to the segment at nearly 80 per cent, though the share of Non-Banking Finance Companies (NBFCs) has also been increasing year-on-year.

“Even if credit guarantee funds are there, bankers’ insistence on collateral security remains, if not for term loans rather than for working capital. Finally, a fast-growing enterprise even after several decades of credit history without blemish struggles to find adequate equity and collateral to fund expansion,” he is quick to add.

Seconding him Sanjay Agarwal, Senior Director at research and analytics advisory CareEdge Ratings adds a lack of sufficient data and documentation to assess business metrics, ignorance regarding awareness of relevant loan schemes and financial products, and absence of credit history or financial records to the list. The last especially can prove to be a significant hurdle.

“Since a considerable number of these businesses do not have access to formal funding channels, there is no documented record of their credit behaviour. Additionally, MSMEs resorting to informal sources for funds lack documentation, leading to their being viewed as new credit customers by banks and NBFCs, making it difficult for them to secure financing.”

Deepak Jasani, Head of Retail Research at the brokerage HDFC Securities attributes this reluctance by banks to MSMEs historically either being simply unable or unwilling to repay loans. “The lack of repayment results in high NPAs (Non-Performing Assets), which is a pressing concern for banks. A lot of MSMEs do not have the necessary collateral needed for borrowing.” Therefore, underwriting such loans in the absence of collateral may require a deeper understanding of the borrowers’ profiles and behaviors.

Jasani also shares an interesting data point concerning women in the segment. “Women entrepreneurs who account for a minor share of the MSME sector face hindrances due to a lack of financing. As per a World Bank report, the funding rejection rate of women entrepreneurs in the country is double that of their male counterparts!”

Buyers often delay payments for goods and services purchased from MSMEs to further muddle the situation. “Such delays in receiving payments from customers lead to cashflow challenges for MSMEs, thereby impeding their ability to not only expand but also to repay existing debts or obtain new loans,” says Agarwal.

To address this issue, a regulation that bars businesses from claiming tax rebates if payment to the MSME is not contractually honoured within 45 days kicked in April this year. Under Section 43B(h) of the Income Tax Act, this can lead to a higher tax liability for errant buyers.

Schemes such as Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) have helped a large number of MSMEs to raise loans without collateral. Established by the Ministry of Micro, Small and Medium Enterprises and refinancing institution Small Industries Development Bank of India (SIDBI), it provides up to 85 per cent credit guarantee. Similarly, the government’s mega schemes such as MUDRA and SVANidhi for disbursing small loans have helped generate self-employment opportunities.

However, raising capital remains an uphill task for companies in the formal sector. So, what more needs to be done? Bhardwaj suggests a holistic approach. “The foremost is inducing competition in commercial lending by privatisation and mergers of public sector banks. We have far too many small banks under government control; the banking sector needs reforms similar to what was done in telecoms.”

He also goes on to recommend the establishment of a National Small Industries Bank. Unlike SIDBI, the proposed entity would be a full-fledged commercial bank offering a bouquet of financial products from branches spread across districts. He also seeks expansion of CGTMSE, credit guarantee for equity support, and insurance surety to replace bank and performance guarantees. 

The digitalisation opportunity

Advancements in fintech have led to the rise of online lending platforms that streamline the application process and offer quicker approvals. “Technologies such as artificial intelligence and machine learning are now aiding fintech companies to give loans to MSMEs more efficiently, allowing businesses to grow,” informs HDFC Securities’ Jasani.

The emergence of specialised digital marketplaces is also helping. The rollout of e-commerce platforms Open Network for Digital Commerce (ONDC) and Government eMarketplace (GeM) has boosted business opportunities for MSMEs. “Both these platforms have been created to enable smaller companies to sell their goods to the larger companies,” says KR Choksey Holdings’ Choksey. The GEM platform doubled its Gross Merchandise Value to more than Rs 4 trillion in FY24.

As the country goes about modernising its military, the Ministry of Defence has emerged as one of the largest buyers of MSME goods on the GeM portal. The Indian Navy, for instance, is working with a clutch of MSMEs, startups, academia, students, and innovators through the three-tier Naval Innovation and Indigenisation Organisation (NIIO) to seamlessly merge the elements of innovation, indigenisation and aatmanirbharta (self-reliance).

“This has resulted in the Navy showcasing 75 prototypes under seven categories, including several global firsts, game changers, and force multipliers last year. We have more than 100 challenges under the iDEX (Innovation for Defence Excellence), with 15 solutions worth about Rs 15 billion being granted Acceptance of Necessity,” Admiral (Retd) Radhakrishnan Hari Kumar, Former Chief of Naval Staff informed a select gathering in New Delhi recently. Additionally, the MoU inked between the Indian Navy and the SIDBI has led to proposals from a large number of MSMEs and startups being approved for loans.

Other thank being a regulatory requirement, MSME lending offers a major growth opportunity for banks. “For NBFCs and fintechs it offers an outlet, which if done prudently can help expand their NIMs (Net Interest Margins) as well as diversify their loan portfolio. Lenders have over time become smarter in mostly avoiding the pitfalls and making the best of the opportunity,” discloses Jasani.

Markets to the Fore

Easy availability of long and short-term financing will enable the Indian MSMEs to leverage the emerging opportunities. “Funds can be utilised for various purposes including procurement of raw materials, machinery, supply chain financing, and working capital loans. Improved technology and digitalisation facilitate faster loan processing during customer onboarding,” affirms CareEdge’s Agarwal. Most importantly, MSME sector’s inclusion in Priority Sector Lending (PSL) also helps reduce the traditional reliance on informal sources of funding such as moneylenders, and the pitfalls associated with such capital.

In her Interim Budget speech in February, Nirmala Sitharaman, Union Minister of Finance specifically observed, “It is an important policy priority for our government to ensure timely and adequate finances, relevant technologies and appropriate training for the MSMEs to grow and also compete globally. Orienting the regulatory environment to facilitate their growth will be an important element of this policy mix.” And if the recent buzz emanating from government quarters is to be believed, the centre is already working on revamping several schemes announced for the segment, including expanding incentives on procurements from MSMEs, streamlining discounts and enhancing export credit guarantees. However, the final details will emerge only after the presentation of the full budget if Prime Minister Narendra Modi-led National Democratic Alliance (NDA) succeeds in winning a third term.

Over time, capital markets have also become an important source of funding. In the previous fiscal, more than 200 MSME firms entered the stock market through IPO listings on the benchmark BSE SME and NSE Emerge exchanges. The total amount collected by Systemic Investment Plan (SIP) mutual funds was nearly Rs 200 billion during the period. “The SIPs are now ready to pump in more money into small and mid-cap companies because the growth there is exponentially higher, while the growth for larger companies would be limited between 15-20 percent,” says Choksey. He foresees small midcap firms raising anywhere between $600-800 billion from capital markets over the next four years. But that’s not all. 

“Unlike in the past where it took around 40 years for some small-cap stocks to become large-cap, we are likely to see a plethora of smaller entities that may not be worth even $1 million today become $1 billion-plus firms over the next ten years!” he asserts.

That may be a bullish forecast. But then, so far, we have only skimmed the surface. 

Pawan Kumar Chandana, Co-founder & CEO, Skyroot Aerospace

Raising capital in spacetech was very challenging during the first couple of years as there was no policy or precedence of similar companies in the sector as well as no thesis for any institutional funding for the space sector.

Deven Choksey, MD, KRChoksey Holdings

Unlike in the past where it took around 40 years for some smallcap stocks to become large cap, we are likely to see a plethora of smaller entities that may not be worth even $1 million today become $1 billion-plus firms over the next ten years!

Steven A Altman, Adjunct Assistant Professor, NYU Stern School of Business

A fact that India’s exports as a share of GDP of goods and services combined are now higher than China’s! That means India is now an economy that is more oriented towards exporting overall goods and services than China.

Anil Bhardwaj, Secretary General, FISME

A first-generation entrepreneur setting up a greenfield project has difficulty in arranging equity to raise loans. Secondly, all entrepreneurs find it difficult to arrange assets that could be pledged as collateral security to raise loans from banks.

Sanjay Agarwal, Sr Director, CareEdge Ratings

MSMEs resorting to informal sources for funds lack documentation, leading to their being viewed as new credit customers by banks and NBFCs, making it difficult for them to secure financing.

Deepak Jasani, Head of Retail Research, HDFC Securities

Women entrepreneurs face hindrances due to a lack of financing. As per a World Bank report, the funding rejection rate of women entrepreneurs in the country is double that of their male counterparts!

Admiral (Retd) Radhakrishnan Hari Kumar, Former Chief of Naval Staff

We have more than 100 challenges under the iDEX (Innovation for Defence Excellence), with 15 solutions worth about Rs 15 billion being granted Acceptance of Necessity.