While the middle-level corporates have managed to avoid any serious worsening of their financial situation, it is the smaller companies whose performance has been worse than in the previous year. Sales as well as profits have declined, compared to 1996-97 levels. Margins have been severely squeezed.

In part, this trend merely reflects the obvious fact that small businesses are the worst sufferers in any economic slowdown. This is due, among other things, to the tendency of the larger companies to pass on their troubles to the smaller ones. If a large company faces a cash flow problem, it merely delays paying its small creditors. Large companies enjoy a degree ofmonopoly power with regard to their small scale suppliers, and the playing field is anything but level. But apart from the consequences of the industrial slowdown, small companies have also been affected due to the restructuring going on within Indian industry. By far the greater number of our small scale enterprises is characterised by miniscule capacities and resultant diseconomies of scale. Outdated technology and lack of finance complete the dismal picture. And yet, in many countries, small enterprises have been a dynamic sector of the economy, their flexibility being their strong point.

There are two approaches to the small scale sector. The first is to develop close links between the banks, local government and these enterprises, and enable them to become world-class in their niches. This is the approach which has led to the development of the German Mittelstand. At the other end, the US model emphasises ease of entry and exit, with the result that, while thousands of small businesses die every year,new ones are born in their place. In India, our approach to the small scale sector is one major factor for its stagnation. Reservations for these enterprises merely ensures that innovation is strangled, and there is no incentive for them to attain economies of scale. Although banks are supposed to help with easy credit, non-performing assets are high in the sector, inhibiting funds for start-ups. Perhaps the best approach in the Indian situation would be to relax the laws to ensure ease of entry and exit for small scale enterprises, while gradually doing away with reservations. That would enhance flexibility, while removing the penalties for growth.