Explaining the demand for credit by micro, small, and medium enterprises in India

• Published date: 01 May 2022
• Author: Purna C. Parida,Kailash C. Pradhan
• Date: 01 May 2022
• DOI: http://doi.org/10.1002/pa.2437

ACADEMIC PAPER

Explaining the demand for credit by micro, small, and medium

enterprises in India

Purna C. Parida

1

| Kailash C. Pradhan

2

1

National Institute of Labour Economics

Research and Development (NILERD), Narela,

India

2

Department of Economics, Mahatma Gandhi

Central University, Motihari, India

Correspondence

Kailash C. Pradhan, Department of Economics,

Mahatma Gandhi Central University, Motihari,

Bihar, India.

Email: kailasheco@gmail.com

This article examines the key factors, which offer to explain the demand for credit in

the micro, small, and medium enterprises (MSMEs) in India. The study uses survey

data of five industries such as apparel, footwear, textile, sports goods, and furniture

with sample size 320 firms based on purposive sampling techniques. The probit

regression model analyzed the factors of the demand for credit by MSMEs and found

that exports and government scheme have positive impact on demand for credits,

whereas high interest rate, high collateral rate, unfavorable terms, and conditions of

bank loans and lengthy and intricate process in applying for bank loans have negative

impact on the demand for credit.

JEL CLASSIFICATION

H81; L6

1|INTRODUCTION

The micro, small, and medium enterprises (MSMEs) are considered as

the backbone of low-income countries, contribute significantly to eco-

nomic growth and create new jobs to employ the largest number of

people (Ayyagari, Demirguc-Kunt, & Maksimovic, 2011). Not only of

low-income countries but the high-income countries also overly

dependent on MSMEs for their economic development. According to

the Organisation for Economic Co-Operation and Development

(OECD, 2004), the share of the MSMEs in the OECD area is more

than 95%. The share of these enterprises in private sector employ-

ment is almost 60%, and they also contribute largely to innovation,

support regional development, and social cohesion.

In the Indian context, the MSME sector too has made significant

progress and emerged as a highly dynamic sector over the last five

decades. This sector is contributing immensely to the economic

growth and development of the country by promoting entrepreneur-

ship and generating significant employment opportunities at compara-

tively lower capital costs (Ministry of MSME, 2018, Annual Report,

2018–2019, Government of India). MSMEs are producing varieties of

goods and services to meet the demands of domestic and global mar-

kets. More importantly, they are not only directly playing an important

role in economic growth and employment generation, but also as

ancillary units are indirectly supporting the large industries to grow.

The sector contributes to 24.63% of the gross domestic product

(GDP) from service activities and 33.4% of manufacturing output.

MSMEs are also significantly contributing to employment and exports.

This sector provides employment opportunities of around 120 million

people and the share of the country's export is around 45%. The Min-

istry of MSME has set an ambitious target to increase the sector's

contribution to GDP to 50% from 29% now and employment of

150 million by 2025.

1

However, despite the significant contribution of MSMEs to the

Indian economy, it faces several challenges that have been hindering

the growth and development of the sector. One of the critical factors

is credit. MSMEs need credit for modernization, expansion, and diver-

sification of their business and for maintaining day-to-day current

expenditure. But they have been finding it hard to access the long-

term bank loans at a reasonable rate of interest, whereas the large

enterprises can easily get long-term bank credit at a lower interest

rate. The reasons could be due to that while most of the financial

institutions usually go by seeking the transparent information on

financial health of the firm to decide the sanction of loan, on the other

hand, most of MSMEs do not maintain proper financial records of

their business and operate in non-transparent manner, as a result, it

becomes difficult for them to avail formal credit. Considering the

importance of MSME sector to the economy, the National

Manufacturing Policy (NMP), 2011

2

has specifically emphasized on

Received: 15 August 2020 Revised: 22 August 2020 Accepted: 24 August 2020

DOI: 10.1002/pa.2437

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https://doi.org/10.1002/pa.2437