India's policy support for micro, small and medium enterprises (MSMEs) has long placed considerable emphasis on encouraging entrepreneurial initiative and improving firms' access to capital. The logic is straightforward. Give driven entrepreneurs the resources to invest and grow, and stronger, more competitive firms should follow. But as Indian manufacturers face rising sustainability expectations from global buyers, the harder question is whether firms have the organisational capability to turn that investment and entrepreneurial drive into sustained performance.
The stakes are considerable. MSMEs account for 31.1 percent of India's GDP and 35.4 percent of manufacturing output, according to the Economic Survey 2025-26. They are therefore central to India's manufacturing ambitions, even as sustainability requirements move deeper into global supply chains. Meeting those requirements will require firms to respond to buyers and suppliers, adopt new technologies and continuously improve their processes. Capital can finance a new machine, software system or environmental upgrade. It cannot by itself give a firm the ability to recognise changing requirements, learn from experience and reorganise its operations in response.
From Capital to Capability
This is where a gap in MSME policy becomes visible. Existing support already recognises that upgrading extends beyond financing physical assets. Uttar Pradesh's MSME Promotion Policy 2022, for example, reimburses energy and water conservation audits, supports equipment recommended through those audits and provides assistance for establishing environment management systems. It also supports ERP and information and communication technology solutions. At the national level, the Self-Reliant India Fund has provided substantial equity support to MSMEs, reinforcing the broader emphasis on improving firms' access to capital.
The issue, therefore, is not whether MSMEs need more capital or whether existing support should be withdrawn. It is whether investment is being accompanied by the capabilities needed to make that investment productive over time. A subsidy may help a firm purchase an energy-efficient machine. It does not necessarily leave the firm better able to track changes in buyer requirements, learn from suppliers, review its own performance or decide when its processes need to change.
What Turns Entrepreneurial Drive into Performance
Evidence from 238 manufacturing MSMEs in Uttar Pradesh suggests that entrepreneurial orientation alone does not explain sustainable performance across environmental, social and economic outcomes. It takes hold only when firms convert that drive into knowledge management and organisational capability.
The implication for policy is important. Entrepreneurial intent can create the willingness to innovate, take calculated risks and respond to opportunity. It does not, on its own, determine whether a firm can turn that intent into sustained results. The missing link lies in what happens inside the firm.
Two capabilities are particularly important. Knowledge management allows a firm to capture and organise what it learns from customers, suppliers, markets and its own operations. For a small manufacturer, this could mean systematically identifying a change in buyer requirements or learning from production experience rather than allowing that information to remain dispersed or informal.
Dynamic capability goes a step further. It determines whether the firm can use that knowledge to change its processes, redeploy resources or respond to new requirements. The sequence is important: firms need to learn, but they also need to be able to act on what they learn.
The evidence reflects this relationship. Entrepreneurial orientation is associated with stronger knowledge management, which in turn is associated with stronger dynamic capability. Dynamic capability emerges as the strongest predictor of sustainable performance, ahead of entrepreneurial orientation itself. Entrepreneurial drive creates potential, but the ability to learn and adapt determines whether that potential translates into sustained performance.
Make Capability Part of MSME Upgrading
This suggests a different way to think about MSME upgrading. Capability-building need not become another training programme operating alongside financial support. It can be embedded in the upgrading process itself.
Uttar Pradesh's green-audit provision offers a useful institutional foothold. Support for audits, environmental management systems and ERP solutions already shows that upgrading policy need not stop at financing machinery. The same principle could be extended across selected MSME programmes so that technology and environmental investments also help firms establish the organisational practices needed to sustain them.
The Ministry of Micro, Small and Medium Enterprises and state industry departments could, for example, link selected upgrading programmes with practical support for tracking customer and supplier requirements, documenting production and environmental information, reviewing operational performance and responding to changes in markets, technology or regulation. Technical universities, incubators and industry bodies could help smaller firms establish capabilities they cannot easily develop internally.
The emphasis should be on adoption and use rather than attendance at a training programme. Nor should capability-building become another layer of documentation or eligibility compliance for small firms. The objective should be to help firms establish a small number of usable routines and determine whether those routines are improving their ability to learn and adapt.
This would also make better use of existing policy instruments. A firm receiving support for technology or environmental upgrading could receive accompanying assistance to build the practices needed to monitor the investment, learn from its performance and respond when conditions change. Policy would then support the immediate upgrade while strengthening the firm's ability to keep upgrading.
The more important question is whether firms can turn the support they receive into sustained performance.