Many small businesses were not shocked when Q2 2025 GDP data showed India’s economic growth had fallen to a seven-quarter low of 5.4 percent, down significantly from 8.1 percent in the same period last year and 6.7 percent in the previous quarter. For them, the writing was on the wall: growth is slowing and the world’s fifth-largest economy is running out of steam.
India’s MSME sector, which was initially boosted by demand following the COVID-19 crisis, is now experiencing a sharp decline due to rising costs, weak demand and limited access to affordable credit. MSMEs contribute significantly to the country’s economy, generating around 40 percent of industrial production, 22 crore jobs and 40 percent of exports.
The slowdown is acute, especially in the manufacturing sector. Even Shaktikanta Das, the former governor of the Reserve Bank of India, in his MPC statement on December 5, highlighted the challenges faced by industrial sectors in the world’s fifth largest economy. Das said output grew at a sluggish 2.2 percent, with weather-related events, financial market volatility and geopolitical tensions posing significant risks of further inflationary pressures. Looking ahead, he warned that the outlook remains clouded by rising trends of protectionism, which could undermine global growth and drive up inflation.The struggle of MSMEs: rising costs, falling demand and credit crunchFor many small businesses, the problems started well before the second quarter of this fiscal year, and many issues are coming into play now.
“Economic activity started to stagnate as early as the first quarter of FY23. From the third quarter of FY23, consumer demand has fallen phenomenally and has stagnated at more or less the same level, without showing any sign of recovery. Most SME manufacturing companies have been operating with an occupancy rate of less than 50 percent since October 2022. From my personal experience and observation, we have never witnessed such a slowdown in consumption in the last 37 years,” says Rajata Mehra. Co-Chairman, CII UP MSME Panel and Director, Rajat Chemicals Industry.
Access to credit has been an ongoing problem. The total financing demand of India’s small and medium enterprises is approximately $1,955 billion. Debt-based financing demand totals $1,544 billion, with informal or financially unsustainable sources accounting for half. This leaves a debt demand of US$819 billion, of which US$289 billion is currently fulfilled by formal lenders such as banks. The remaining unmet demand of USD 530 billion represents a huge addressable market for banks, FinTechs and NBFCs.
Although the Reserve Bank of India and the government have periodically announced measures, the credit gap for SMEs has widened over time. “The government announced a provision in the budget for credit guarantees for SMEs, but nothing came of it. If MSMEs do not have affordable financing options, they will struggle to meet supply demand and benefit from future increases in demand,” he warns. Singh emphasizes the need for reduced interest rates or subsidies for domestic players, similar to export incentives.
On Wednesday, Director General of Foreign Trade Santosh Kumar Sarangi said the Commerce Ministry is “struggling” to convince the Finance Ministry of the relevance of the Interest Equalization Scheme (IES) and the extent to which it will improve the competitiveness of the maintains production.
According to Sarangi, numerous studies indicate that excessively high collateral requirements from financial institutions significantly hinder SMEs’ access to institutional financing and export markets.
Due to economic uncertainty, the lack of credit has far-reaching consequences. Vikas Singh Chauhan, director of Home Textile Exporters Welfare Association (HEWA), says the lack of cost-effective funds is derailing their plans to tap into business demand. He adds that regardless of global demand, small businesses in the home textile segment cannot benefit as cheaper funds are not available. “With domestic banks failing to offer competitive interest rates, many MSMEs are turning to NBFCs, where financing costs are significantly higher, further eroding margins, which ultimately increases costs and extends delivery cycles from 60 to 90 days,” Chauhan adds.
Chinese flood
As if the domestic problems weren’t enough, the flood of imports from China over the past two years has had a profound impact on many sectors. HEWA’s Chauhan expresses concern over cheap Chinese imports in the domestic market, which is pushing many SMEs to switch from manufacturing to trading. He shares the struggle of traditional textile centers like Solapur, Panipat and Karur, where locally produced cotton towels are losing ground due to the import of low-quality microfibres.
“When export demand is lower, it used to be offset by domestic demand, but now the domestic market is flooded with cheap quality microfiber cloths. This has consequences for the naturally made cotton towels from these clusters. The Indian market is flooded with Chinese-made goods that ultimately impact domestic demand. Many small and medium enterprises are closing their factories and turning to trading,” said Chauhan.
An Indore-based MSME promoter says around 5,000 daily use items are imported at cheap rates from countries like China, which continue to flood the Indian market with its products. “A striking example of this is the small rechargeable batteries that farmers use in flashlights and spray pumps. These batteries were once produced at 150 units in Indore alone, but now they are imported from abroad at a significantly lower cost. A product that costs Rs 100 in India is imported for just Rs 20, with GST and import duties applied to the lower value. This has led to a difficult financial situation for these units, with some even facing closure,” says this promoter.
Yogesh Mehta, president of Association of Industries Madhya Pradesh (AIMP), said, “MSMEs have lost their reserved status in the government procurement policy as the GEM portal has opened up these opportunities for traders too. Moreover, there have been instances where traders have exploited the GEM portal to sell Chinese products, further undermining the competitiveness of domestic MSMEs.”
Ineffective policies and corruption
Small businesses’ economic problems have also worsened in recent quarters as many government policies have had unintended consequences. For example, Puran Dawar, regional chairman of the Council for Leather Exports (North), says that the policy of 45 days payment to MSMEs, contrary to its intended purpose, has started to bleed MSMEs as most of their suppliers are unable to provide such fulfill obligations. difficult legal tangle.
Another reason he thinks the government plans are not achieving their goals is because freebees are big problems. “Corruption, especially in several states, is not decreasing at all. While barriers to importing consumer goods from China are understandable, restrictions on capital goods and crucial raw materials are detrimental to domestic manufacturers,” Dawar added.
Similarly, Gautam Kothari, president of Pithampur Audhyogik Sangathan, highlights the urgent need for improved coordination between state and central governments to simplify business processes for MSMEs. “Policy decisions need to be streamlined and issues affecting small businesses need to be addressed locally, rather than relying on state capitals. This would enable MSMEs to operate more efficiently and effectively, unlocking their growth potential,” Kothari added.
“A study conducted some time ago in the industrial area of Pithampur revealed a startling inefficiency: as much as 85 percent of MSMEs’ time is spent on non-productive activities, while only 15 percent is spent on actual activities. To increase productivity, government policies must prioritize strategies that increase this 15 percent productive time, allowing MSMEs to optimize their resources and unlock their full growth potential,” notes Kothari.
Bright spots, with caveats
Many problems stem from the fact that SMEs often do not play a role in the collection of RBI data and that there is a wide gap between the economic conditions of small businesses and those faced by larger companies. Improving data collection among SMEs is an ongoing challenge for the government and the central bank despite significant efforts.
However, not everyone in the SME sector is entirely pessimistic. Sanjay Singh, MD of Gurgaon-based TT Textiles, says, “As far as business demand is concerned, we have hit rock bottom and I don’t see things getting any gloomier from here.”
Similarly, Arun Shukla, MD of Vikramaditya engineering, a Baddi-based MSME engineering company, remains optimistic about a post-election recovery. “The economy has taken a nosedive, but it is an important reflection of the election period. Many spending decisions are put on hold due to the political cycle. Consumers of industrial goods are also postponing their decision after the election results. So, the slump that the RBI talked about will correct itself and the economy will bounce back soon. Once the uncertainty passes, I expect demand to improve,” he says.
Pallavi Vyas, founder of Indore-based agribusiness company Shanta Farms, sees robust demand for products in the agriculture sector in the near future. However, she emphasizes that the government must create the impression that it is in favor of value additions in this very critical sector, which is fast gaining global recognition to Indian players.
The sentiment among industry leaders is clear: SMEs are at a tipping point. While some industry players remain cautiously optimistic, the overall tone is both concerning and sobering. SMEs will face operational problems and stunted growth without affordable credit, export incentives and efficient policies.
