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India’s small businesses ravaged by radical policies

New Delhi — For 35 years, Mr Jagbir Singh has run a tiny workshop in New Delhi’s Wazirpur industrial estate making compacting machines for the scrap-metal industry. A year ago his enterprise had 12 employees, producing six machines a month. Today, the 62-year-old’s business has collapsed, a casualty of two recent economic shocks.

Demonetisation, which invalidated most circulating cash overnight, and the move to a new value-added tax system have been crushing to informal cash-based businesses in India. Photo: Reuters

Demonetisation, which invalidated most circulating cash overnight, and the move to a new value-added tax system have been crushing to informal cash-based businesses in India. Photo: Reuters

New Delhi — For 35 years, Mr Jagbir Singh has run a tiny workshop in New Delhi’s Wazirpur industrial estate making compacting machines for the scrap-metal industry. A year ago his enterprise had 12 employees, producing six machines a month. Today, the 62-year-old’s business has collapsed, a casualty of two recent economic shocks.

First came demonetisation, which invalidated most circulating cash overnight. Then, in July, India moved to a new value-added tax system, a long-awaited reform intended to create a true single market and curb tax evasion. For an informal, cash-based business dealing with others of similar ilk, these measures have been crushing blows. In the past four months, Mr Singh has sold just one machine.

“My business is over,” he said, hovering over one of his last three welders. “People used to phone two to three times a day, enquiring about machine prices. Now I just sit here and wait. Small people like us will be finished. I will have to look for some other work. But who is going to give a job to this old man?”

For decades, small enterprises have been significant contributors to India’s manufacturing output, a legacy of old socialist-era policies that obstructed the expansion of larger companies and encouraged fragmentation of production among many tiny suppliers. Small enterprises were exempt from the onerous laws and reporting requirements imposed on larger businesses, and could operate below the tax authorities’ radar, providing clear cost advantages.

But India’s new goods and services tax (GST) — and its self-policing mechanism to enforce compliance — is putting heavy pressure on informal businesses, most of which never fully recovered from last year’s demonetisation. In the coming weeks and months, many are expected to shut shop for good in what economists suggest could be India’s most dramatic economic shakeout in decades.

“How many of these SMEs will survive a year ... is still not clear,” said Mr Saurabh Mukherjea, Ambit Capital’s CEO. “My reckoning is that for a substantial number of SMEs, their margin was tax evasion.

“As the government steps up forcing people to comply with GST, a lot of small businesses that managed to stay in the shadows will find themselves sucked into the tax net. Either their profitability will be vastly diminished — or they will go away completely.”

While the GST is expected to boost India’s efficiency and growth prospects in the long run, Mr Jahangir Aziz, chief of emerging markets analysis at JPMorgan, said New Delhi has “underestimated” the impact of transition — both in terms of the hit to growth and how long the damping effect could last.

“Elsewhere, teething problems with GST have lasted for a very long time,” he said. “The small and medium enterprise sector’s productivity is so paper-thin. It’s going to be painful.”

Mainly owned by entrepreneurs with strong technical skills and trading networks but little formal education, small enterprises typically run on cash, handshakes and details written on small chits of paper.

Without computers, they are ill-equipped to file complex online returns or provide the exhaustive documentation now sought by their customers. Most also lack the necessary capital to pay taxes, then wait months for rebates.

“If someone is welding, who will take the bill from a delivery boy who comes to deliver small components,” said Mr Singh. “How do you get a bill from them? They don’t have it. If I go to buy 1kg or 2kg of nut and bolts, the guy doesn’t have any bill.” Any shakeout of small businesses will be widely felt, given how many Indians depend on them for their livelihoods.

According to India’s economic census, about a third of the 30 million people working in manufacturing are in family enterprises with no hired labour, while manufacturers with hired workers employ an average of just seven people. From January to April, India shed an estimated 1.5 million jobs, the Centre for Monitoring Indian Economy recently reported, and economists believe more are inevitable.

While large companies may fill the void, economists say such capacity will be more capital-intensive, employing far fewer people than the operations they replace. “As this trend accelerates of smaller businesses dying out and larger businesses gaining share, the casualty will be employment,” said Mr Mukherjea. The shutdown of small enterprises could also fuel higher imports, especially from China.

From April to June, India’s current account deficit widened to US$14 billion (S$19 billion) or 2.4 per cent of gross domestic product for the quarter, up from just 0.1 per cent of GDP last year, driven mainly by surging imports of consumer goods and components.

Some small businesses are trying to move with the times. In their Wazirpur workshop, entrepreneurs Jassa Ram and Misri Mal make stainless-steel tableware for buyers in southern India. Sales are down nearly 40 per cent since the cash ban and they employ just five workers now, down from 10 before. But the partners are determined to survive the transition to GST, paying a small accountant 6,000 rupees (S$125) a month to handle their filings. Others, they expect, will falter.

While businesses with turnover of less than US$30,000 are technically exempt, buyers prefer supplies that can provide full tax documentation. Even traditional handicraft makers are at risk. “People are not willing to take our products without 100 per cent billing,” said Mr Ram. “All these small players will find it very hard because they do business in cash. They will shut down and only big players will remain.” Mr Mal agrees. “Even those who have never filed taxes before know they cannot survive without it,” he said. “The next one year is crucial. That is when we will get to know what is happening.” FINANCIAL TIMES

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