MSME Sector in India: Credit Gap and Scaling Challenges – Economic Survey 2025-26 Analysis
Micro, Small and Medium Enterprises form the backbone of India's economy, contributing significantly to employment generation, industrial output, and exports. The Economic Survey 2025-26 dedicates attention to scaling up MSMEs as critical for India's manufacturing competitiveness and integration into global value chains. This article examines the credit gap facing MSMEs, the challenges in scaling, and policy initiatives addressing these constraints.
The MSME Sector: Size and Significance
India's MSME sector is vast, comprising over 63 million enterprises employing more than 110 million people. This makes MSMEs the largest employer outside agriculture. The sector contributes approximately 30 per cent of India's GDP and about 45 per cent of manufacturing output.
MSMEs span diverse activities from traditional crafts and food processing to precision engineering and IT services. They serve as suppliers to large industries, providing components and services that integrate into final products. Many MSMEs are also direct exporters, particularly in sectors like textiles, leather goods, and handicrafts.
The Economic Survey 2025-26 emphasizes that competitiveness will hinge on innovation, skilling, infrastructure and MSME scaling to embed India as a high-productivity manufacturing hub. This recognition of MSMEs' centrality to industrial strategy underscores their policy importance.
Despite their significance, MSMEs face persistent challenges that constrain their growth and productivity. Access to finance, technology adoption, market access, and regulatory compliance are commonly cited barriers. Addressing these challenges is essential for realizing the sector's potential.
The MSME Credit Gap
Finance is the lifeblood of business, and inadequate access to formal credit is perhaps the most significant constraint facing Indian MSMEs. The MSME credit gap, the difference between finance needed and finance available, is estimated at several trillion rupees.
Multiple factors contribute to this gap. MSMEs often lack the collateral that banks require for secured lending. Their financial documentation may be incomplete or informal, making credit assessment difficult. The cost of assessing small loans is proportionally high for banks, reducing their incentive to serve this segment.
Information asymmetry compounds the problem. Banks cannot easily distinguish good MSME borrowers from risky ones without incurring substantial due diligence costs. This leads to either credit rationing or high interest rates to cover perceived risks.
The Economic Survey 2025-26 discusses measures targeted at MSMEs including expanded credit guarantees, wider use of TReDS, and the rollout of the Unified Lending Interface that have sought to ease credit constraints. These initiatives address different aspects of the credit access problem.
Formal vs Informal Finance
Given constraints in formal credit access, many MSMEs rely on informal sources of finance. This includes borrowing from moneylenders, trade credit from suppliers, and personal savings. While providing liquidity, informal finance typically comes at higher costs and less favorable terms than formal credit.
High informal borrowing rates squeeze MSME margins and competitiveness. An MSME paying 24-36 per cent annual interest to a moneylender cannot compete with rivals accessing bank credit at 12-15 per cent. This creates a productivity drag on the informal segment.
Formalisation of MSMEs is therefore linked to finance access. Enterprises that register, maintain accounts, and file returns become eligible for formal credit and government support. The survey's discussion of GST-driven formalisation is relevant here, as GST registration creates a paper trail that facilitates credit assessment.
The challenge is that formalisation imposes compliance costs that many small enterprises find burdensome. Simplified compliance for smaller units can encourage formalisation without imposing excessive costs.
Credit Guarantee Schemes
Credit guarantee schemes address the collateral problem by providing government guarantee for MSME loans. Banks can lend to MSMEs without demanding personal or property collateral, with the guarantee fund covering losses in case of default.
The Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) provides guarantees for collateral-free loans up to specified limits. The scheme has expanded significantly, enabling MSMEs to access credit they could not otherwise obtain.
Emergency Credit Line Guarantee Scheme (ECLGS), launched during the pandemic, provided additional credit to stressed MSMEs. This helped enterprises survive the demand shock and prevented a wave of closures that would have destroyed productive capacity and jobs.
The Economic Survey 2025-26 mentions expanded credit guarantees as part of measures supporting MSMEs. Guarantee coverage expansion enables more lending while limiting bank risk, encouraging banks to serve the MSME segment.
TReDS: Addressing Delayed Payments
Trade Receivables Discounting System (TReDS) addresses a specific financing challenge: delayed payments from large buyers. MSMEs that supply to corporations often wait 60-90 days or more for payment, straining their working capital.
TReDS enables MSMEs to discount their receivables, receiving immediate payment at a discount while financiers collect from the corporate buyer later. This converts receivables into cash, reducing the working capital cycle.
The Economic Survey 2025-26 mentions wider use of TReDS as part of credit facilitation measures. Expanding TReDS adoption requires both supplier onboarding and buyer participation, the latter sometimes requiring policy encouragement.
Mandatory onboarding of large buyers and government departments onto TReDS platforms can significantly expand the addressable pool of receivables, benefiting MSME suppliers.
The Scaling Challenge
Beyond credit access, MSMEs face challenges in scaling their operations to achieve greater efficiency and market reach. The sector is characterised by a large number of very small enterprises and relatively few that grow to medium or large size.
This distribution reflects both opportunity and constraint. On one hand, low barriers to entry enable entrepreneurship. On the other hand, constraints in growth mean that many enterprises remain subsistence operations rather than scaling to create significant employment and value.
The Economic Survey 2025-26 discusses MSME scaling as critical for manufacturing competitiveness. Deepening competitiveness, expanding market access, and bridging the credit gap are identified as elements of the scaling agenda.
Factors inhibiting scaling include threshold effects in regulations where crossing certain size limits triggers new compliance requirements, limited access to technology and expertise for process improvement, weak market linkages that confine enterprises to local markets, and the credit constraints already discussed.
Industrial Cluster Strategy
The Economic Survey 2025-26 discusses why India must strengthen its industrial cluster strategy to compete globally. Clusters are geographic concentrations of interconnected companies, specialised suppliers, and associated institutions in particular fields.
Successful clusters create ecosystems where knowledge spills over between firms, specialised suppliers emerge, and a trained labour pool develops. Moradabad's brassware cluster, Tirupur's hosiery cluster, and Surat's diamond polishing cluster exemplify this phenomenon.
Supporting cluster development involves infrastructure provision, common facility centers, design support, and marketing assistance. These interventions benefit multiple enterprises collectively rather than individually, creating scale economies in support.
The One District One Product programme channels cluster-based thinking into policy, identifying signature products for each district and providing focused support. This creates concentration that enables ecosystem development.
Technology Adoption
Technology adoption can significantly enhance MSME productivity and competitiveness. Modern manufacturing technologies, digital tools for marketing and operations, and quality testing capabilities distinguish competitive enterprises from laggards.
However, many MSMEs lack the resources and expertise to adopt new technologies. The upfront investment is unaffordable, while benefits are uncertain. Technical knowledge to select and implement appropriate technologies may be absent.
Common facility centers in industrial clusters provide shared access to expensive equipment that individual MSMEs could not afford. Testing laboratories enable quality certification essential for certain markets. Design centers support product development.
Digital technology adoption has accelerated, particularly after the pandemic forced many enterprises online. E-commerce platforms enable market access beyond traditional geographic boundaries. Digital payment acceptance has expanded, reducing transaction friction.
Market Access and Integration
Market access constraints limit MSME growth prospects. Small enterprises often lack the resources to identify markets, meet buyer requirements, and manage logistics for distant customers.
Government e-Marketplace (GeM) has opened government procurement to MSMEs, providing a large and reliable customer base. Mandatory procurement quotas require government departments to source specified shares from MSMEs, ensuring demand.
Export promotion for MSMEs involves trade facilitation, quality certification support, and market development assistance. Participation in international trade fairs and buyer-seller meets connects MSMEs with global customers.
The survey's discussion of trade agreements creating market access for manufactured exports is relevant for MSMEs that supply export-oriented industries or export directly. The India-EU FTA, for example, can benefit labour-intensive MSME sectors like textiles.
Regulatory Environment
The regulatory environment significantly affects MSME operations and willingness to scale. Complex compliance requirements, multiple inspections, and uncertain interpretation of rules create costs and risks.
The Economic Survey 2025-26 discusses state-level deregulation efforts replacing inspection-based control with trust-based compliance. These reforms benefit MSMEs disproportionately, as they lack compliance departments that larger companies maintain.
Udyam registration provides a simplified registration process for MSMEs, replacing the earlier multiple registration requirements. The unified registration integrates with various government schemes and benefits.
Labour code consolidation, discussed in the survey, simplifies the employment regulatory framework. This can encourage MSMEs to hire more workers without fear of triggering complex compliance requirements.
UPSC Relevance: MSME Sector
MSMEs are important for UPSC across multiple dimensions:
- GS-III: Industrial policy, employment, manufacturing
- Economy Optional: Small-scale industries, industrial finance
- Current Affairs: Government schemes, credit policies
- Essay: Entrepreneurship, inclusive growth
Practice MCQs on MSME Sector - Economic Survey 2025-26
Q1. According to the Economic Survey 2025-26, MSME scaling is critical for:
(a) Agricultural growth
(b) Manufacturing competitiveness
(c) Service exports
(d) Financial sector development
Answer: (b) Manufacturing competitiveness
Q2. TReDS addresses which MSME challenge?
(a) Labour shortage
(b) Delayed payments from buyers
(c) Technology obsolescence
(d) Export documentation
Answer: (b) Delayed payments from buyers through receivables discounting
Q3. The MSME sector employs approximately:
(a) 50 million people
(b) 80 million people
(c) 110 million people
(d) 150 million people
Answer: (c) 110 million people
Q4. Credit guarantee schemes help MSMEs by:
(a) Providing direct subsidies
(b) Enabling collateral-free loans
(c) Reducing GST rates
(d) Exempting income tax
Answer: (b) Enabling collateral-free loans by guaranteeing lender losses
Q5. Industrial clusters benefit MSMEs through:
(a) Government ownership
(b) Knowledge spillovers and shared infrastructure
(c) Tax holidays
(d) Import protection
Answer: (b) Knowledge spillovers, shared infrastructure, and specialized labour pools
Conclusion
India's MSME sector represents both opportunity and challenge, as the Economic Survey 2025-26 analysis makes clear. The sector's contribution to employment and output makes its health critical for inclusive growth. Yet persistent constraints in credit access, scaling, technology, and market linkages limit realised potential. Policy initiatives including credit guarantees, TReDS, cluster development, and regulatory simplification address these constraints but require sustained implementation. For India to achieve its manufacturing ambitions, MSMEs must move from survival to scaling, becoming competitive participants in domestic and global value chains. UPSC aspirants should understand both the sector's importance and the specific policy interventions designed to unlock its potential.