Formalisation to financing: Understanding digital public infrastructure's role in bridging MSME gaps

India’s micro‑, small‑ and medium‑enterprise (MSME) sector remains the lifeline of the nation’s economy, employing more than 100 million people and contributing roughly a quarter of the country’s gross domestic product (GDP). Yet the sector continues to grapple with a persistent “formalisation‑financing gap”: a large portion of MSMEs remain unregistered or operate informally, and those that are formalised still struggle to access the credit and market linkages they need to grow. The article from Financial Express (published 23 August 2024) argues that the solution lies not in new regulatory frameworks alone, but in a suite of digital public infrastructures (DPIs) that can streamline formalisation, improve transparency, and enable data‑driven risk assessment for lenders.

Below is a detailed, 500‑plus‑word recap of the article, including its key take‑aways, illustrative case studies, and the broader policy context that frames this discussion.

1. The Problem Landscape: Why Formalisation Doesn’t Equate to Financing

1.1 Informality Still Dominates

Registration gaps: Only about 20 % of the estimated 50 million MSMEs are formally registered, with a further 10 % incorporated but largely non‑compliant with statutory filing norms. The remainder either operate as unregistered sole proprietorships or operate under a “shadow‑corporate” structure to dodge tax and regulatory scrutiny.
Credit constraints: Formalised MSMEs that have the requisite documents still face steep credit terms because banks rely on limited data sets that are difficult to reconcile across disparate state‑level registries.

1.2 Information Asymmetry and High Transaction Costs

Lack of audit trails: Traditional bookkeeping in many MSMEs is manual or nonexistent, making it hard for banks to verify revenue claims or assess financial health.
High onboarding costs: For a small firm to satisfy KYC (Know Your Customer) requirements, it often needs to procure PAN, GST, and digital signature certificates—processes that can be both time‑consuming and expensive.

1.3 Digital Divide Among SMEs

Geographic and skill gaps: Rural MSMEs, the most numerous segment, frequently lack reliable internet connectivity or digital literacy, thereby preventing them from participating fully in digital ecosystems.

2. Digital Public Infrastructure as a Game‑Changer

2.1 Key Digital Public Infrastructure (DPI) Pillars

Unified Digital Identity (Aadhaar) & Digital Signature
- Aadhaar now powers e‑KYC for most banks and public‑sector schemes. The Digital Signature Certificate (DSC) facilitates digital filing of tax returns and compliance documents, reducing paperwork.
Common Service Centers (CSCs)
- CSCs act as front‑door portals for rural MSMEs, offering services ranging from e‑filing of GST returns to loan applications and digital payments. The article cites the 2024 “National Digital MSME Portal” that aggregates data from multiple CSCs.
Unified Payments Interface (UPI)
- UPI’s low‑cost, real‑time payment infrastructure is already being used by many MSMEs to settle supplier invoices. The portal also supports “UPI credit scoring” experiments that map transaction patterns to creditworthiness.
Government Digital Service (e‑Gov)
- The “e‑GST” portal standardises the tax filing process, while the “e‑LPG” and “e‑FSSAI” portals help MSMEs obtain essential licences electronically.
Credit Information Companies & Open‑Banking APIs
- The article notes an uptick in the use of APIs that let banks pull real‑time cash‑flow data from the MSME’s POS devices or e‑commerce platforms, thereby providing a richer data set for credit decisions.

2.2 Impact of DPI on Formalisation

Lowered Barriers to Registration: Digital forms and one‑click KYC reduce the time and cost for an MSME to register with the Ministry of MSME, GST, and other statutory bodies.
Auditability and Trust: A digitised ledger of all compliance activities provides an immutable audit trail, enhancing trust between MSMEs and lenders.

2.3 Impact of DPI on Financing

Data‑Driven Credit Risk Models: By integrating transaction data from UPI, POS devices, and e‑GST, banks can construct credit scoring models that better capture the cash‑flow realities of small firms.
Credit Line Expansion: The article cites a pilot with NABARD that, using UPI‑based transaction data, offered micro‑loans to 1500 rural MSMEs with a 45 % higher repayment rate compared to conventional scoring.

3. Case Study: “Sona’s Handloom” – From Informality to Digital Formality

The article follows a handloom weaver named Sona from Uttar Pradesh who had a family business generating ₹15 lakh annually but never registered. Through a CSC in her village, she:

Got an Aadhaar‑based e‑KYC – 15 minutes online, no paperwork.
Received a GST registration – Using the e‑GST portal and a DSC.
Accessed a 12‑month micro‑loan – Approved by a digital‑first bank after the bank accessed her POS transaction data.
Implemented a UPI‑based payment system – For both customers and suppliers, boosting cash‑flow visibility.

Within a year, Sona’s revenue rose to ₹20 lakh, and she was able to hire two apprentices. The article frames her story as a micro‑cosm of the DPI’s potential.

4. Policy Measures to Accelerate DPI Adoption

4.1 Strengthening Inter‑Agency Data Sharing

Single Window System: The article stresses the need for a unified portal where data from the Ministry of MSME, GST, Income Tax, and the Reserve Bank of India (RBI) can be accessed by licensed financial institutions under strict privacy protocols.
Standardised Data Formats: Adoption of the “Digital Standard of MSME” (DSM) that codifies financial, compliance, and operational data fields.

4.2 Incentivising Digital Adoption

Digital MSME Incentive Scheme: The government is piloting a Rs 1 lakh grant for MSMEs that complete digital onboarding within 30 days of registration.
Tax Credits for Digital Services: Companies that provide digital platforms (e.g., UPI apps, e‑GST solutions) can claim tax credits for every MSME they onboard.

4.3 Addressing the Digital Divide

Rural Connectivity Grants: The article cites a 2024 government initiative allocating ₹500 crore to extend 4G/5G infrastructure to underserved MSME clusters.
Digital Literacy Programs: “Tech Shikshak” initiatives aim to train 10 million MSME workers in basic digital tools by 2027.

5. Challenges and Risks

5.1 Data Privacy and Security

Regulatory Compliance: With the RBI’s upcoming “Data Protection for FinTech” guidelines, MSMEs must ensure that their data is stored in encrypted formats and that personal data is not misused.
Cyber‑Threats: The article warns that as more MSME data migrates online, the risk of cyber‑attacks rises. A dedicated “Cyber MSME Shield” fund has been proposed to support incident response.

5.2 Inter‑operability Gaps

Legacy Systems: Many state governments still rely on paper‑based registries that are not seamlessly linked to national databases. The article calls for a phased migration plan, starting with high‑growth sectors like textiles and food processing.

5.3 Financial Inclusion Concerns

Over‑Credit Risks: With easy access to credit, there is a risk of over‑leveraging. The article suggests robust stress‑testing protocols for banks, especially for “moral hazard” scenarios where MSMEs might default if a major client disappears.

6. Looking Ahead: The Road to a Fully Digitised MSME Ecosystem

The Financial Express piece concludes with an optimistic outlook: “If India can align its digital public infrastructure with a coherent formalisation framework, it can unlock an unprecedented wave of SME growth, drive innovation, and cement its place as a global manufacturing hub.”

Key next steps identified by the article:

Digital MSME Certification – A new accreditation that assures lenders that a firm is digitally compliant, akin to “ISO 27001” for information security.
AI‑Based Financial Health Dashboards – Real‑time dashboards for MSMEs to monitor cash‑flow, tax liabilities, and credit scores, integrated into the common digital platform.
Public‑Private Partnerships – The government will partner with fintech giants like Paytm and Razorpay to co‑develop APIs that feed into RBI’s credit decision engines.

7. Bottom Line

Formalisation and financing are not independent variables; the former enables the latter, but only if the underlying data ecosystem is robust, secure, and interoperable.
Digital public infrastructure is the catalyst that can reduce compliance friction, improve data availability, and enable lenders to make better, faster, and more inclusive credit decisions.
Policy coherence and stakeholder coordination (across ministries, banks, fintechs, and state governments) are essential to operationalise these digital tools at scale.

With the right mix of technology, regulation, and incentives, India’s MSME sector can transition from a fragmented, informal network to a digitally connected, data‑driven powerhouse that fuels inclusive growth for the next decade.

Read the Full The Financial Express Article at:
[ https://www.financialexpress.com/business/sme-formalisation-to-financing-understanding-digital-public-infrastructures-role-in-bridging-msme-gaps-3876863/ ]

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