SMEs get public procurement boost

Business Line, May 04, 2012

By Bulbul Sen and Archana Jatkar

Effective from April 1, 2012, the government will procure a minimum of 20 per cent of goods and services from the micro and small enterprises, with this becoming a mandatory requirement after three years

Procurement issues have received a lot of public attention in recent times, with procurement scams dominating the headlines. On April 12, the Cabinet approved the Public Procurement Bill, 2012. But a quiet revolution took place on March 23, perhaps changing the very parameters of public procurement in India.

The new norms are based on the report of the Prime Minister’s Task Force on the Micro, Small & Medium Enterprises, 2010, effective from April 1. The Central government has been set an annual goal of procuring a minimum of 20 per cent of goods and services from the micro and small enterprises, with this becoming a mandatory requirement after three years.

A sub-target of 20 per cent — or . 4 per cent within the 20 per cent — has been earmarked for procurement from SMEs owned by the Scheduled Caste/Scheduled Tribe entrepreneurs. Defence procurement has been exempted from the policy.

Addressing disadvantages

Undoubtedly, the policy arises out of the desire to redress various disadvantages historically affecting small enterprises in India — such as lack of capital and credit facilities, infrastructure deficit, higher fixed costs compared with the large-scale sector and lack of access to global markets.

The crucial socio-economic importance of the sector and the inadequacies of the earlier procurement policy may have also prompted this move. The sector accounts for 45 per cent of manufacturing output and 40 per cent of the total exports of the country, employs about 69 million people.

Yet, observations from a stakeholders’ survey from the ongoing project on government procurement show that the earlier price preference policy of 15 per cent over the large-scale sector and the mandatory procurement of 358 items from MSEs resulted in only 5 per cent of the value of public procurement contracts coming to this sector.

Concerns have been raised that a policy of a fixed quota for the SME sector in public procurement, when implemented, may lead to lowering of standards, since the SME sector, in most cases, may not be able to meet the stringent production standards and delivery schedules required.

In the economic literature, one of the identified negative impacts is the high transaction cost inherent in dealing with small firms, such as the cost of evaluating and monitoring of many small suppliers rather than a few large suppliers, and the risk/cost of the small enterprise defaulting.

The literature also highlights the “premium costs” incurred in awarding a contract to an SME by way of a higher price vis-à-vis an open invitation for bids. Likewise, there is a premium cost involved when the procuring agency accepts lower quality from an SME at a constant price.

From the perspective of international trade, discrimination by a government in favour of domestic producers is viewed as a non-tariff barrier.

However, governments the world over tend to acknowledge the higher costs in preferential treatment to this sector as a trade-off for a greater public good, though, the concept of public good varies.

The US policy is based on the concept of increasing competition in the domestic economy through a policy preference arising out of a historical concern to prevent industry concentration and ‘trusts’.

In South Africa, SME preferences are based on the policy of re-mediation of past discrimination and historical disadvantage.

Growth, with inclusion

In India, given the large employment generation by SMEs, specially in the disadvantaged/informal sector, the preference to SMEs is important for achieving the stated national objectives of ‘growth with equity and inclusion’.

The WTO’s Plurilateral Agreement on Government Procurement, 2011, has a special carve-out for developing countries to extend domestic preferences for the development of small scale and cottage industry.

Therefore, India has enough justification to implement the new SME policy in public procurement. One welcome aspect of the new policy is that it contains sufficient flexibility. The annual goal of procurement of 20 per cent of requirement from the MSEs includes sub-contracts to micro and small enterprises by large enterprises.

Further, any department facing problems in implementing the 20 per cent quota may approach a review committee for exemption from the quota. The capability and competitiveness of the SMEs varies from sector to sector.

It may be worthwhile to consider if a better balance between equity concerns and a market-oriented strategy could be arrived at by allowing each procuring department to negotiate its own target with the Department of MSME, regarding its annual procurement target to be sourced from the MSMEs.

The authors are with CUTS International and CUTS Centre for International Trade, Economics & Environment. The views are personal.

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