Navigating Formalisation Challenges In Fragile Economies
The idea of formalisation of the economy has emerged as a significant fulcrum for stability and growth. However, within the delicate fabric of fragile economies, especially those where small businesses operate informally, the formalisation journey poses complex challenges.
Integrating informal businesses into the formal sector substantially bolsters government revenue through enhanced tax inflows. It kicks in a virtuous ‘compliance’ cycle. However, the formalisation goal must extend beyond mere compliance.
*Economy is delicately poised. Formalisation poses complex challenges
India's economic landscape, dependent on the dynamism of small and medium enterprises (MSMEs), confronts a challenging reality. They employ over 80 per cent of the workforce and play a substantial role in ‘lubricating’ the economy. The MMMEs (middle market manufacturing exporters) contribute significantly to the GDP and exports, and yet most struggle to grow beyond a micro-level status. This lack of growth leads to persistent inefficiencies, adds to the broader economic ecosystem's fragility. The prevailing corporate structure often neglects the important 'middle' segment of these enterprises, adversely impacting productivity and competitiveness.
A comprehensive study by Crux across 18 economically progressive states, incorporating the perspectives of 6,000 SMEs and 500 policymakers, reveals the fractured nature of the current economic ecosystem. A disproportionate emphasis on MSME registration, without providing adequate nurturing, leaves these businesses vulnerable to market pressures and systemic barriers that hinder growth. Generic stimulus policies, not sufficiently tailored, blur the distinctions between different industries and regions, often favouring larger companies over smaller ones. The inspection and monitoring mindset saps both the moral and energy and subtracts growth.
*Most MSMEs growth trajectory is flat. Start small, remain small
The study highlights the need for comprehensive reforms, tailored support systems, custom-tailored incentives, and actionable solutions to remove these growth barriers and improve the business environment. It also sheds light on the less explored but critical issue of the productivity gap between smaller and larger firms.
In their current state, MSMEs seem inadequate to act as the backbone for achieving India's ambitious $5 trillion GDP target. Scaling up these enterprises is crucial to increasing their contribution to the economy and enabling them to move up the value chain, capitalising on emerging opportunities. This scale-up is necessary for sustainable growth, as merely creating low-end jobs is insufficient.
The process of formalisation in fragile economies poses complex challenges. Policymakers, often focused on the employment potential of MSMEs, tend to overlook other crucial aspects. This oversight, combined with a romanticised view of MSMEs as major job creators by other economic stakeholders, leads to a neglect of the broader intricacies of formalisation.
*A well-crafted, better executed roadmap can be empowering
The journey towards formalisation has broad implications, affecting both formal and informal employment sectors. A well-crafted roadmap for formalisation can empower MSMEs and bridge the productivity gap between smaller and larger firms. While the short-term effects of formalisation may seem to disadvantage smaller entities, sustained growth ultimately benefits the entire economic spectrum, enhancing the overall economic pie.
The success of this growth is contingent upon the meticulous implementation of formalisation initiatives, emphasising the critical role of institutional capacity and local-level execution.
Formalisation allows businesses access to mainstream financial markets, enabling them to secure loans and resources for expansion and innovation, thus fuelling growth and creating employment opportunities. As formalisation progresses, the benefits of development disseminate, resulting in a more equitable distribution of resources among all stakeholders.
Additionally, formalisation leads to a well-regulated business environment, reducing unethical practices and increasing transparency and accountability. It also creates an attractive environment for foreign investments, signalling stability and predictability, and significantly contributing to national economic development.
Despite these benefits, the journey toward formalisation in fragile economies is not without challenges. In economies with a significant informal sector, rapid and badly executed formalisation risks job losses and economic instability, especially for communities reliant on the informal sector. It exacerbates the existing inequalities, pushing vulnerable communities into deeper poverty.
Small businesses, with limited resources and high operational costs, might struggle under additional regulatory and compliance burdens. The imposition of standards and tax obligations can strain their finances, reducing competitiveness and growth prospects, and posing a threat to their survival and sustainability.
Any formalisation policy must carefully consider the specific challenges faced by small businesses to avoid disproportionately harming the most vulnerable societal segments.
Given these challenges, government intervention is crucial. Policymakers must balance formalisation needs with small enterprises' sustainability. Tailored policies, including tax incentives, financial subsidies, and simplified compliance procedures, are essential to alleviate regulatory burdens on small businesses. Similarly comprehensive support mechanisms, such as access to affordable financial services and targeted capacity-building programmes, are vital for small enterprises' resilience and successful integration into the formal economy.
Insights from the Crux study highlights the need for the government to adopt a holistic approach, with targeted reforms aimed at enhancing the MSME environment. These should focus on dismantling growth barriers and providing tailored support and incentives to create a conducive environment for business growth. Adjusting the GST collection mechanism to occur upon payment receipt rather than at invoicing can inject liquidity into the ecosystem. Ensuring prompt payments to MSMEs would unlock significant liquidity, sending a positive market signal.
*A delicate balance
Policymakers must aim at harnessing the diverse benefits of formalisation while adeptly handling its challenges. A comprehensive and tailored strategy can guide this transformation, ensuring the resilience and prosperity of small businesses and establishing a robust and vibrant economic landscape.
