The latest Free Trade Agreement (FTA) that India has signed is with New Zealand. Prior to this, India concluded similar trade agreements with the UK and EU while a trade deal with the US is currently under negotiation. These trade deals promise significant benefits for Micro, Small, and Medium Enterprises (MSMEs) through reduced and/or zero-duty access on labour-intensive exports, lowered trade barriers, and enhanced global supply chain integration.

However, they also come with significant structural and operational challenges and expose Indian MSMEs, which often operate on low margins, limited technology, and thin capital buffers, to non-tariff barriers. These non-tariff barriers range from stringent environmental, social, and governance (ESG) standards (including carbon footprint requirements like EU’s Carbon Border Adjustment Mechanism) to Sanitary and Phytosanitary-SPS measures. Thus, while FTAs are reducing/eliminating tariff barriers, it is the non-tariff barriers that are going to become more critical for realising the full benefit/potential of FTAs.

The Economic Survey of 2025-26 states that MSMEs accounts for 48.6 per cent of India’s exports and are vital for fostering local value addition and enabling India’s effective integration with global manufacturing supply-chain. However, global buyers and regulators increasingly demand verifiable ESG (Environmental, Social, Governance) practices across supply chains because resource-intensive manufacturing sectors have very high environmental and social footprint.

As a result, buyer procurement rules, new laws in importing regions, and investor scrutiny — all of which are rapidly moving ESG from a “nice to have” to a market access precondition. Thus, compliance related responsibility is increasingly falling on upstream players in the value chain that is MSME producers and suppliers. Non-compliance to ESG issues is now being factored into financing and insurance also as banks, insurers and export credit agencies are beginning to price in ESG risks into their calculation and due diligence.

ESG factor

Compliance gaps on ESG therefore have now become material enough to raise cost of capital for MSMEs and/or even deny them buyer contracts.

Current level of awareness and preparedness about ESG issues among MSMEs is uneven and generally low. Though many mid-sized exporters and aggregators have invested in environmental and social compliances to meet global buyer demands, they are finding it difficult to remain profitable.

Also, exploring domestic markets where low cost is often the primary purchasing factor for consumers makes switch from global to local market difficult for these exporters. This challenge of meeting rising investments in ESG compliance, therefore, can make MSME exporters uncompetitive both in the global and domestic market.

The regulatory environment, consumer demand for ethical sourcing and buyers to increasingly demand ESG certification/performance is going to get stronger with each passing day. Therefore, if India wants to take full advantage of the recently signed FTAs and emerge stronger from the current disruptive geo-political environment, then a policy framework with a clear road map for enabling MSMEs to meet the emerging global compliance has to be put in place.

This is important lest MSMEs exporters begin to feel that they are losing orders to competitors due to non-compliance on ESG and/or other parameters that are often non-negotiable. Global buyers, driven by their own regulatory environments and consumer demand, increasingly require suppliers to demonstrate strong ESG performance, transparency and traceability standards.

Strong ESG alignment offers long-term benefits such as energy savings, enhanced brand reputation, and access to green financing. However, MSMEs are mostly focused on immediate survival. Their inability to make the upfront ESG investment (wastewater treatment, cleaner dyeing, pollution control, better worker welfare facilities, digital traceability etc.) creates a significant barrier to their long-term resilience. Although the government has taken several steps such as export credit support, market diversification and is negotiating trade agreements with various countries, a more targeted approach is needed for MSME exporters.

Measures suggested

To improve their ESG preparedness the following may be done:

(i) Access to blended finance so that they get concessional finance windows or guarantees (public/private) for their ESG investments;

(ii) Cluster approach for capital and infrastructure which include common effluent treatment plants, common chemical-storage facilities, and renewable energy off-take;

(iii) Capacity building via buyer-industry partnerships so that their knowledge of evolving compliance framework improves and they learn how to operationalise them. For example, EU due-diligence rules require businesses to determine that their products are deforestation-free and must therefore provide information to support the claims. Similarly, Higg Index, GOTS, OEKO-TEX, BCI are globally recognised, independent certification system for the textile and leather industry that tests for harmful substances and verifies sustainable production. Obtaining these certifications improve the market access and competitiveness of manufacturers/suppliers.

(iv) A two-stage ESG compliance mechanism needs to be put in place so that compliance intensity would match company size and risk. Baseline practices such as worker contracts, employment records, proper disposal of hazardous waste, monitoring of energy/water usage, safety protocols for chemical handling, record keeping of safety incidents etc. become mandatory for all and a more rigorous and exhaustive ESG reporting is done by larger entities using Global Reporting Initiative/Carbon Disclosure Project/Task Force on Climate-related Financial Disclosures template. This tiered ESG compliance approach would help larger entities to convert baseline practices into contractual requirements and push their suppliers base, predominantly MSMEs, towards ESG maturity.

Getting exporting MSMEs ESG-ready isn’t just compliance, it’s essential to preserve export markets, secure jobs, and move India’s MSMEs up the value chain.

The writer is Professor of Economics at Institute of Development and Communications (IDC), Chandigarh. Views expressed are personal

Published on May 8, 2026