Research Note

Financial Constraints and Global The Indian Economic Journal

1–4
Value Chains Participation of Indian © 2020 Indian Economic Association
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DOI: 10.1177/0019466220946325
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Ketan Reddy1

Abstract
This brief note highlights the importance of micro, small, and medium enterprises in India and the gains
associated with the global value chain (GVC) participation for small and medium firms. The note also
sheds light upon financial constraints as a major obstacle faced by these firms in their decision to partici-
pate in GVCs. The stagnancy in Indian manufacturing and the potential that GVC holds for the country,
especially in line with the policy initiatives of Make in India, makes this a very pivotal area of research,
and this research note aims to promote more research related to GVCs in India.

JEL Codes: F14, F15, L25, F37

Keywords
Financial constraints, Global Value Chains, India, MSMEs

1. Introduction
The phenomenon of global value chains1 (GVCs) has dominated world trade over the past two decades.
Driven by fragmentation of the production process, the notion of GVC enables firms to participate in
global markets and consequently gain from it. In this regard, GVC provides an advantage over existing
means of participation in foreign markets since firms participating via GVC do not have to produce a
complete product (Escaith & Inomata, 2013). As a result, firms, especially small firms, can gain from
trade by becoming suppliers in facets of the production chain, producing goods in which they enjoy a
comparative advantage.
In the present-day trade parlance, participation and consequently gains through GVC integration are
not confined to large firms alone. The rise in trade of tasks and intermediates has facilitated the
participation of micro, small and medium enterprises (MSMEs) into GVCs as suppliers of intermediate
inputs or as subcontractors in the supply chain to lead firms. Hence, interaction with lead firms provides

1
Department of Humanities and Social Sciences, Indian Institute of Technology Madras, Chennai, Tamil Nadu, India.

Corresponding author:
Ketan Reddy, Department of Humanities and Social Sciences, Indian Institute of Technology Madras, Chennai, Tamil Nadu, India.
E-mail: ketankreddy94@gmail.com
2 The Indian Economic Journal

MSMEs with access to larger domestic and foreign markets. Further, given the stringent need to maintain
quality standards, there is a greater flow of information, managerial practices, blueprints, and
technological know-how from the lead firm, which leads to productivity and efficiency gains for MSMEs.
Similar notions are echoed in an OECD (2008) report, which highlights that even firms that do not
successfully integrate into GVCs and operate at the periphery also experience productivity gains,
stability, and expansion of business activities. Given the widespread consensus on gains associated with
small firms through GVC participation, it becomes important to examine the factors that have restricted
their participation in supply chains.
Although India is one of the fastest-growing economies in the world, it has failed to integrate its
manufacturing sector extensively into GVCs. A key component of India’s manufacturing is that of
MSMEs, which makes the bedrock of the Indian economy, contributing close to 30 percent of its gross
domestic product and providing employment to approximately 111 million workers (GOI, 2019).
Comprising over 63 million enterprises, MSMEs account for approximately 48 percent of India’s export
in 2018–2019.2 Despite the significant role of MSMEs, the sector is plagued by problems of access to
finance, which hinders the ability of these firms to participate in GVCs. The severity of financial
constraints is much graver for MSMEs since they lack established credit history and sufficient collateral,
which impedes them from obtaining loans from banks and capital markets (Cusolito et al., 2016).
Moreover, in a survey of MSMEs located in Bangalore, India, Charan and Kishinchand (2016) highlight
that high lending rates, insufficient collateral, and time involved in obtaining a loan are key challenges
faced by MSMEs in obtaining formal finance.
Moreover, in addition to plaguing day-to-day operations of MSMEs, financial constraints also act
as a significant impeding factor in MSMEs’ drive to participate in international production chains. In
this regard, the firm-level trade literature highlights sunk costs in the form of market research, research
and development, prior rent for land, wage bill, and other such expenditures restricting
internationalization of firms (Greenaway et al., 2007; Lu et al., 2018). Moreover, the added costs
associated with maintaining stringent quality requirements necessary to participate in production
chains makes it strenuous for firms aiming to participate in global markets (Criscuolo & Timmis,
2017; OECD, 2007). Consequently, the problem of financial constraints becomes more prominent for
MSMEs given their limited ability to raise capital from external sources. In this context, the limited
yet rising literature concerning financial constraints and GVC participation also posits similar findings
of financial constraints impeding GVC participation (ADBI & ADB, 2016). A recent report by
Kuzmisin and Kuzmisinova (2016) highlight that financial access to SMEs as a key factor in shaping
their participation in GVCs. Hence, it becomes important to examine the role of financial constraints
in shaping Indian MSMEs’ participation in the GVCs.

II. Data
Against the backdrop discussed above, it becomes important to examine the impact of financial
constraints on small Indian firms’ decision to participate in GVCs. To examine this nexus, I obtain firm-
level data from the Prowess database. It is a proprietary database maintained by the Centre for Monitoring
Indian Economy. The database is well employed in the literature for multiple microlevel analysis of
Indian firms. Following the Micro, Small and Medium Enterprises Development Act, 2006, I identify
MSME firms based on their investment in plant and machinery. As a part of the data-cleaning process, I
drop all firm-year observations with missing or negative values on sales, capital, and labour. I also drop
Reddy 3

observations with missing information on the firm’s debts and assets, which are essential for the
construction of the financial constraint measures.
After the data cleaning process, I have an unbalanced panel of 888 MSMEs for the period 2006–2016
for the empirical exercise. To derive a causal relationship, I employ panel data techniques accounting for
endogeneity concerns in the model. Specifically, I use panel probit regression, controlling for a host of
firm-specific variables such as firm productivity, age of the firm, ownership of the firm and size of the
firm. To further assuage the endogeneity concerns, I posit the robustness of my findings via a two-step
probit section model correcting for sample selection.

III. Results and Discussion

The empirical analysis discerns a negative impact of financial constraints on GVC participation of small
firms in India. The baseline findings indicate that financially constrained firms are seven to eight percent
less likely to participate in GVCs compared with non-GVC firms. The findings are robust to alternative
measures of financial constraints and definitions of MSMEs. These findings provide relevance to the
policy-makers as the country aims to become a $5 trillion economy by 2025, and integration of MSMEs
into GVCs holds the key in rejuvenating the stagnant manufacturing industry. In this regard, boosting
MSME participation in GVCs also complements the existing initiatives of ‘Make in India’ and ‘Digital
India’, which provides various avenues for small firms to gain access to better knowledge, technical
know-how and expanding the use fintech services. The Economics Survey 2019–2020 also highlights
that via GVCs, the Make in India initiative has the potential of generating 4 million jobs by 2025 and 8
million by the year 2030.
Moreover, Indian MSMEs’ participation in GVCs is characterized as a buyer-driven supply chain
(Gupta, 2018). Hence, there is a greater need for policies to push these MSMEs to have a much more
direct integration into GVCs to reap greater gains. Hence, improving the financial access of MSMEs
becomes of utmost importance. The perennial problem of delayed payments is one such issue that has to
be rectified to enable firms to finance themselves. It also calls for improvement in the country’s capital
markets, and the SME exchange is a welcome step. Moreover, the empirical analysis highlights that 60
percent of MSMEs are domestic firms, whereas 40 percent have access to global markets. Hence, the
financing needs of domestic firms would vary from those firms that internationalize. Therefore, the
policy initiatives need to take into account the differential need for finance across MSMEs.
This brief note highlights the importance of MSMEs in India and the gains associated with GVC
participation for small and medium firms. The note also sheds light upon financial constraints as a major
obstacle faced by these firms in their participation in GVCs. The stagnancy in Indian manufacturing and
the potential that GVC holds for the country, especially in line with the policy initiatives of Make in
India, makes this a very pivotal area of research, and I hope that this brief note would promote more
research related to GVCs in India.

Declaration of Conflicting Interests

The author declared no potential conflicts of interest with respect to the research, authorship and/or publication of
this article.

Funding
The author received no financial support for the research, authorship and/or publication of this article.
4 The Indian Economic Journal

Notes
1. Heuser and Mattoo (2017) define a global value chain as ‘the full range of activities that are required to bring a
product from its conception, through its design, its sourced raw materials, and intermediate inputs, its marketing,
its distribution, and its support to the final consumer’.
2. https://pib.gov.in/Pressreleaseshare.aspx?PRID=1579757

References
ADBI & ADB. (2016). Integrating SMEs into global value chains: Challenges and policy actions in Asia. Brookings
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Charan, S., & Kishinchand, P. (2016). Finance for micro, small and medium-sized enterprises in India: Sources and
challenges. Technical report, ADBI Working Paper No 409.
Criscuolo, C., & Timmis, J. (2017). The relationship between global value chains and productivity. International
Productivity Monitor, 32, 61–83.
Cusolito, A. P., Safadi, R., & Taglioni, D. (2016). Inclusive global value chains: Policy options for small and
medium enterprises and low-income countries. World Bank.
Escaith, H., & Inomata, S. (2013). Geometry of global value chains in East Asia: The role of industrial networks and
trade policies. World Trade Organization.
GOI. (2019). MSME annual report 2018−19, Ministry of Micro, Small and Medium Enterprise.
Greenaway, D., Guariglia, A., & Kneller, R. (2007). Financial factors and exporting decisions. Journal of
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Gupta, N. (2018). Constraints to linking into global value chains: Do Indian industries lack capacities and
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Heuser, C., & Mattoo, A. (2017). Services trade and global value chains. World Bank Policy Research Working
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