The Missing Middle of Indian Enterprise
Only 14% of India's MSMEs have formal credit, against a gap estimated between ₹25 and ₹30 lakh crore. Indian firms stay small because staying small is the rational response to the system around them.
India does not have a shortage of entrepreneurs. It has a shortage of firms that grow. The reason is visible in the credit data, and it is not a shortage of capital in the economy.
Deloitte's State of Financial Services in India report finds that only 14 per cent of India's micro, small and medium enterprises have access to formal credit, leaving the majority dependent on informal and usurious financing. It estimates the MSME credit gap at around ₹25 lakh crore as of March 2025, and notes that measured against the sector's contribution to GDP and a healthy credit-to-GDP ratio, the gap could be well over ₹50 lakh crore. A SIDBI study puts the addressable gap at about 24 per cent of demand, or roughly ₹30 lakh crore, with formal debt supply from banks and NBFCs at about ₹34 lakh crore against addressable demand of about ₹64 lakh crore.
Estimates differ because definitions of "addressable demand" differ, and this Review does not propose to adjudicate between them. The range itself — ₹25 to ₹30 lakh crore on conservative measures — is the finding.
Four findings anchor this analysis:
- Access is improving from a very low base. NITI Aayog's report with the Institute for Competitiveness records the share of micro and small enterprises accessing credit through scheduled banks rising from 14 to 20 per cent between 2020 and 2024, and medium enterprises from 4 to 9 per cent. Real movement; still a minority of firms.
- Payments infrastructure reached firms that credit did not. Around 89 per cent of Indian adults now have financial accounts, and over 90 per cent of surveyed MSMEs accept digital payments — yet only about 18 per cent have taken a digital loan. India solved the transaction problem and left the underwriting problem largely intact.
- Informality is both cause and effect. Roughly 35 per cent of surveyed MSMEs remain unregistered. An unregistered firm cannot access formal credit or schemes; a firm without credit has little incentive to bear the cost of registration. The loop closes on itself.
- The gap is worse for women-led enterprise. SIDBI estimates the credit gap at about 35 per cent for women-owned MSMEs against 24 per cent overall — a differential that persists even among women-led firms that do have some access.
Why firms choose to stay small
The standard explanation is that small firms lack collateral and records. True, and incomplete. The deeper issue is that Indian regulation is banded by size, and each band carries a step change in obligation.
Crossing a size threshold brings labour law obligations, statutory compliances, tax regimes and inspection exposure that arrive as a cliff rather than a slope. A firm just below a threshold faces a choice between staying below it or absorbing a discontinuous jump in cost and risk. Many rationally split into several smaller entities instead of growing into one larger one — which is why India has an enormous number of tiny firms, a reasonable number of large ones, and a conspicuously thin middle.
This matters because productivity, formal jobs, exports and the ability to service credit all live in the middle. A country of micro-enterprises generates livelihoods but not the productivity growth a demographic window requires.
What cash-flow lending changes, and what it does not
The most promising development is the shift from collateral-based to cash-flow-based underwriting, using the Account Aggregator framework, GST returns and digital payment histories. This is genuinely transformative for the firm that transacts digitally and files returns: its cash flow is now legible without a balance sheet or a mortgage.
Two cautions belong alongside the optimism. It reaches the registered and digitally transacting firm — which is, by construction, not the 35 per cent that are unregistered or the smallest micro-enterprises operating in cash. And underwriting on recent transaction history is inherently pro-cyclical: it lends generously into a good year and withdraws sharply in a bad one, which is the opposite of what a small firm needs from a lender.
What we would do
- Replace regulatory cliffs with slopes. Phase obligations in over three to five years after a firm crosses a threshold, rather than applying them in full on day one. This single change would do more for firm growth than any credit scheme, and it costs the exchequer nothing.
- Make registration worth its cost. Registration should carry an immediate, tangible benefit — a credit line, a procurement preference, a faster refund — rather than functioning primarily as an entry into the compliance system.
- Use public procurement as the credit event it already is. Government is the largest buyer from Indian MSMEs. A confirmed, dated public purchase order is excellent collateral, and delayed public payment is one of the largest sources of MSME working-capital stress. Enforcing payment timelines and enabling receivables discounting against public orders converts a liability into a financing instrument.
- Set an explicit women-led enterprise target with published data. A 35 per cent gap against a 24 per cent baseline is specific enough to be a departmental objective. It currently belongs to nobody.
- Report credit-gap closure at district level. National aggregates hide the fact that credit access varies enormously by district. A published district series would let states direct their guarantee and interest-subvention capacity where it actually binds.
India's small firms are not undercapitalised because Indian banks lack money. They are undercapitalised because the system cannot see them, and because the ones it can see have good reason not to grow into full visibility. Both are design choices, and both are reversible.