In recent years, Environmental, Social and Governance (ESG) factors have emerged as critical metrics for evaluating a company’s sustainability and ethical impact. While large corporations have been quick to adopt ESG practices, Micro, Small and Medium Enterprises (MSMEs) in India are increasingly recognizing the value of ESG ratings. This blog explores why MSMEs in India should prioritize obtaining an ESG rating and how it can drive long-term growth, competitiveness and resilience.

Understanding ESG Ratings

ESG ratings are metrics used to evaluate a company's performance across three key dimensions:

i. Environmental: Assesses how a company manages its environmental impact, including energy use, waste management and carbon emissions.

ii. Social: Evaluates how a company treats its employees, customers, suppliers and communities, focusing on diversity, labour practices and human rights.

iii. Governance: Examines a company's internal practices and policies, focusing on board diversity, transparency and ethical business practices.

These ratings provide stakeholders, including investors, customers and regulators, with a clear picture of a company’s commitment to sustainable and responsible business practices.

Why ESG Ratings Matter for MSMEs?

ESG ratings are no longer just a tool for large corporations—they are becoming a crucial asset for MSMEs looking to thrive in today’s business landscape. A strong ESG rating signals commitment to sustainability, ethical governance and social responsibility, opening doors to multiple opportunities that can drive long-term success. Here’s why every SME should consider getting an ESG rating:

1. Build Goodwill: An ESG rating boosts an MSME’s reputation by showcasing transparency, ethical responsibility and sustainability. This builds trust with investors, customers and regulators.

2. Attract Clients: ESG-rated MSMEs appeal to both domestic and international clients by aligning with sustainability standards. As large corporations prioritize ESG-compliant suppliers, MSMEs with strong ESG credentials are more likely to secure contracts.

3. Get Ready for IPO (Initial Public Offer): For MSMEs planning an IPO, ESG compliance is becoming essential. Investors and regulators expect companies to integrate ESG into their operations. A strong ESG rating enhances governance, risk management and compliance, making MSMEs more attractive to institutional investors and ensuring a smoother IPO process.

4. Access to Capital: In today’s business environment, investors are increasingly prioritizing sustainability.  According to a 2023 report by Morningstar, global ESG-focused funds crossed $2.7 trillion in assets, reflecting the growing demand for responsible investments. MSMEs with an ESG rating can attract funding from banks, venture capitalists and private equity firms that factor ESG into their decisions. Even if the initial rating highlights gaps, it provides a roadmap for improvement, enhancing credibility and long-term access to better loan terms and investment opportunities.

5. Competitive Advantage: Large corporations are embedding sustainability into their supply chains, preferring to work with ESG-aligned suppliers. MSMEs with high ESG ratings can secure contracts with global and domestic enterprises, gaining a competitive edge. Moreover, as consumers actively choose brands that align with their values, an ESG-rated MSME can enhance customer trust and loyalty, differentiating itself in the marketplace. In fact, a recent study found that 85% of millennials prefer to buy from companies with strong ESG performance, reinforcing the growing consumer demand for responsible business practices.

6. Regulatory Preparedness: India’s ESG regulations are tightening, with SEBI’s BRSR mandating disclosures for the top 1000 listed companies. While MSMEs are not yet required to comply, early ESG adoption can future-proof their business. Global policies like the European Union’s CBAM (Carbon Border Adjustment Mechanism) and CSDDD (Corporate Sustainability Due Diligence Report) are already impacting Indian exporters, imposing carbon tariffs and stricter sustainability criteria. An ESG Rating helps MSMEs assess their ESG performance and strengthen credibility, improving market access and ensuring readiness for evolving regulations.

7. Employee Attraction and Retention: Employees today seek workplaces that prioritize their well-being, diversity and ethical practices. ESG ratings can serve as a powerful tool for MSMEs to showcase their commitment to these values. This is especially relevant as a recent study shows that 87% of millennials want to work for companies with high ESG ratings, making sustainability a key factor in attracting and retaining top talent. Furthermore, 43% of millennials are also keen on investing in ESG-aligned companies, highlighting the broader impact of ESG on workforce engagement and long-term business success. 

8. Operational Efficiency & Cost Savings: MSMEs with strong ESG ratings demonstrate commitment to efficiency, which translates into cost savings, increased productivity and a more resilient business structure. Even if the initial ESG rating is not high, it serves as a baseline to develop targeted improvements that enhance efficiency, lower operational costs and foster employee engagement. By actively addressing ESG-related challenges, MSMEs can create a more resilient business model, reduce long-term risks and ultimately achieve better financial performance.

The Growing Impact of SMEs in India’s Economy and ESG Landscape

Small and Medium-sized Enterprises are often hailed as the backbone of the Indian economy, contributing nearly 27% to the nation's Gross Domestic Product (GDP). According to Forbes, a staggering 96% of industrial units in the Indian economy are attributed to small-scale enterprises. Beyond their economic contributions, SMEs play pivotal roles in job creation, accounting for the creation of 360.41 lakh jobs out of a total of 11.10 crore jobs. Furthermore, they are key players in export promotion and fostering regional development. With an average growth rate of 10%, these enterprises are instrumental in driving India's economic engine.

A survey conducted by DBS and Bloomberg Media Studios in August 2022 highlighted that Indian SMEs are increasingly prioritizing ESG measures. The survey, which encompassed 800 SMEs across six Asian markets, revealed that over 92% of Indian SME business leaders consider ESG a high priority for their operations. This commitment stems from the recognition that ESG practices can enhance competitive edge, bolster company reputation and attract investors.

Challenges Faced by SMEs in Adopting ESG Practices

1. Limited Awareness and Financial Constraints: Implementing ESG initiatives requires substantial investment and a clear strategic approach—both of which can be challenging. Many MSMEs struggle with the high costs of ESG adoption while also lacking the necessary expertise for effective implementation. A 2022 survey by DBS Bank and Bloomberg Media Studios found that 57% of Indian SMEs identified cost as a major barrier, while only 37% had a well-defined roadmap to achieve their ESG goals.

2. Regulatory Ambiguity: Uncertainty regarding ESG reporting standards and compliance requirements poses challenges. The same research indicated approximately 56% of Indian SMEs struggle with engaging government bodies and obtaining clarity on reporting standards.

3. Technological Limitations: Adopting ESG practices may necessitate technological upgrades, which can be challenging for MSMEs with limited digital infrastructure.

 Strategies to Overcome these Challenges

i. Collaborate with Consulting Companies: Partnering with ESG consulting firms can help MSMEs navigate the complexities of ESG implementation. These experts provide tailored solutions, from sustainability reporting to regulatory compliance, ensuring MSMEs align with global and Indian ESG standards. Consultants also help identify material ESG risks, set measurable targets and integrate sustainable practices into business operations. With ESG regulations evolving rapidly, collaborating with experienced advisors ensures MSMEs stay ahead of compliance requirements and maximize the long-term benefits of ESG adoption.

ii. Leverage Government and Financial Institution Support: MSMEs can capitalize on government schemes and financial incentives designed to promote ESG adoption. As per a survey by DBS Bank and Bloomberg Media Studios, approximately 81% of Indian SMEs consider such support crucial for their ESG initiatives.

iii. Collaborate with Industry Bodies: Engaging with industry associations can provide guidance on ESG implementation and facilitate knowledge sharing. These collaborations can help MSMEs navigate regulatory landscapes and adopt best practices.

iv. Invest in Capacity Building: Participating in training programs and workshops can enhance understanding of ESG practices. Capacity-building initiatives educate entrepreneurs on sustainable business models and equip them with skills to measure and report ESG performance.

v. Leverage External Expertise: Engaging consultants specializing in ESG can guide MSMEs in the development and implementation of their ESG strategies.

vi. Utilize Digital Tools: Adopting digital solutions can streamline ESG reporting and monitoring making the entire process more manageable.

vii. Explore Alternative Financing Options: MSMEs can seek funding from impact investors and green financing schemes that prioritize sustainability. Building a strong ESG profile can attract investors interested in responsible business practices.

Through these strategic actions, MSMEs can successfully integrate ESG into their operations, leading to sustainable growth and a competitive edge in the evolving business landscape.

Why ESG Ratings Matter

Incorporating Environmental, Social, and Governance (ESG) considerations into business practices is no longer exclusive to large corporations. For Indian SMEs, obtaining an ESG rating can unlock numerous advantages, including facilitating investment, enhancing market valuation, securing favourable loan terms, and boosting export potential.

1. Assists in Raising Investment

A strong ESG rating can significantly boost an SME's appeal to investors. Globally, ESG-focused investments have surged, with assets applying ESG data exceeding $40 trillion in 2020. In India, ESG assets under management grew from $330 million in 2019 to $1.3 billion by June 2023. This trend underscores the increasing investor preference for companies committed to sustainable practices.

2. Enhances Market Valuation

Companies with robust ESG performance often experience enhanced market valuations. Research indicates that ESG data sharing can improve brand image, attract funding, reduce financing costs, and increase valuation.

3. Access to Loans at Lower Interest Rates

SMEs with strong ESG credentials may benefit from favourable financing terms. Sustainability-Linked Loans (SLLs), for instance, offer reduced interest rates when borrowers meet specific sustainability targets, such as reducing emissions or increasing the use of recycled materials.

4. Aids Exports

Strong ESG performance boosts SME export resilience by enhancing reputation and easing financing constraints. A December 2024 Journal of Environmental Management study confirms ESG initiatives improve export competitiveness. For Indian SMEs, ESG compliance is crucial as EU regulations like CBAM impose tariffs on high-emission imports, while CSDDD prioritizes ESG-aligned suppliers. A strong ESG rating helps SMEs navigate these regulations, reduce trade barriers, and secure global contracts.

How ESG Rating Providers are Essential for MSMEs

ESG rating providers play a crucial role in helping MSMEs integrate sustainability into their business models while gaining a competitive edge. Their assessments offer structured, data-driven insights that enable MSMEs to build resilience and attract investment. Engaging with ESG rating providers is essential because it helps MSMEs:

1) Identify Areas for Improvement – ESG ratings providers conducts in-depth audit of the company’s initiatives and performance across various ESG parameters to identify various areas of improvement and highlight gaps in comparison with the industry peers.

2) Enhance Credibility – A third-party ESG rating strengthens trust with investors, customers and supply chain partners, showcasing transparency and commitment to sustainability

3) Strengthen Market Position – As large corporations prioritize ESG-aligned suppliers, MSMEs with strong ESG ratings gain better business opportunities and market access.

4) Facilitate Regulatory Readiness – With ESG regulations tightening in India and globally, ESG ratings help MSMEs align with compliance requirements and future-proof their business.

By working with ESG rating providers, MSMEs can unlock growth opportunities, attract responsible investors and build a resilient, future-ready business.

The Road Ahead

ESG ratings serve as a vital tool for MSMEs to assess and communicate their commitment to sustainable and ethical practices. For Indian MSMEs, integrating ESG considerations is not just about compliance or reputation management; it's about building a future-ready enterprise that values long-term resilience, innovation and stakeholder trust. As global and domestic stakeholders increasingly prioritize sustainability, MSMEs that integrate ESG into their core strategies will be better positioned to thrive in the evolving business ecosystem.

References

https://www.crif.in/blog/esg/why-esg-matters-for-smes-and-msmes?utm_source=chatgpt.com

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https://bfsi.economictimes.indiatimes.com/news/financial-services/92-smes-in-india-focused-on-adopting-esg-measures/95524232?utm_source=chatgpt.com

https://www.livemint.com/money/personal-finance/92-of-indian-smes-focused-on-adopting-esg-measures-survey-11668408896767.html?utm_source=chatgpt.com