The challenges that MSMEs face are multi-faceted and therefore, policy makers should also embrace greater diversity in solutions that supplement the efforts already underway.
MSMEs are heralded as the new engine of growth for the Indian economy. They drive approximately 30% of national GDP, and their growth will be critical to the ambition of a $5 trillion economy. Yet the ominous clouds of financial constraints loom large over this sector of the economy, and since the beginning of the pandemic, small businesses in India have seen significant distress with a third of all micro-enterprises reporting layoffs as their narrow well of cash reserves went dry.
Cash flow cycles for MSMEs that are part of the supply chains of large companies are stretched due to stuck and delayed payments, reflecting lopsided bargaining power vis-à-vis large buyers. It has been estimated that MSMEs are owed an aggregate of Rs 15-lakh-crore at a point of time. This number is only indicative of the working capital deficit faced by the small number of registered MSMEs in the country, amounting to just 13% of the existing small businesses. This problem is more severe for micro-enterprises, approximately 80% of whom see payments delayed beyond the statutorily defined 45 days and approximately 45% see payments delayed beyond 180 days after they deliver products or services. It will take more than a business-as-usual approach to keep MSMEs afloat and enable them to grow to their fullest potential.
The good news is we are at an inflection point for change. Several innovations and solutions have achieved a proof-of-concept maturity and are being viewed as scalable today. It is also the result of ecosystem-wide changes having taken place that help bridge the gap between MSMEs that are part of supply chains and large corporates, and also create a robust data ecosystem that enhances the flow of credit from banks and financial institutions.
For real change to be affected for MSMEs that are part of corporate supply chains, however, it’s important that the two sets of stakeholders that most affect the survival or ability to thrive in MSME’s: large companies and governments, show greater willingness to adopt good, workable solutions that are now within reach. They must see that these shifts are desirable and necessary, not just for MSMEs, or for big business to flourish, but for the economy and society at large. What the covid era, with its breakdown of supply chains made obvious, is the interrelation between healthy small and large businesses, but also healthy families and healthy economies. The recent policy focus and actions by the government, as also detailed below, have been quite encouraging, but the opportunity exists to do much more.
The financial reasons that MSMEs run into trouble are well documented. Running a small business requires having access to working capital, without which the day-to-day operations as well as long term planning and profitability are jeopardized. Besides driving a working capital crunch, payment delays also lead to reduced investments and growth among small businesses, as well as risk aversion in entrepreneurs over time. The alternative for small businesses is to seek credit, however, small businesses already navigate significant issues with regards to access to formal finance. They may require working capital loans to tide them over delayed payment cycles, which entails a prohibitive interest rate. Passing on the higher cost to customers poses the risk of losing business and competitive advantages. Delays affect the MSME’s ability to repay the working capital loan and their creditworthiness, pushing them closer to financial distress and bankruptcy.
While policy exists to address delayed payments, and the intentionality is in place to help small business owners, there are inherent issues that prevent successful implementation. For instance, the MSMED Act in 2006 mandated that payments to MSMEs be made within 45 days, but ambiguities around this statute–for instance, it is not stated when the 45-day period begins–mean MSMEs do not pursue it ardently. Moreover, the transactional dynamic is clearly in favour of larger firms, the ones who buy from these MSMEs, enforcing a structural constraint. With this lopsided bargaining dynamic, MSMEs find themselves forced to maintain a good relationship with big buyers and sustain their business or risk losing out entirely on future work.
Similarly, factoring platforms, TReDS, and the dispute resolution platform SAMADHAAN have the potential to become game changers, but remain severely under-penetrated solutions that require a fillip. While the buyer base using two major TReDS platforms doubled during the pandemic, less than 25% of buyers with a turnover of Rs 500 crores or more transact on TReDS today. Samadhaan, on the other hand, continues to be challenged by low capacity, with 60% of the 80,000 delayed payment grievances pending.
Fortunately, major changes are underway to bolster the foundations of MSME finance. The first is to do with an ecosystem shift taking place because of technological penetration and increasing formalization of businesses. The way MSMEs conduct business is no longer out of sync as it was in the past, with rapid digitalization of operations (for example, through utilization of accounting software) and increasing formalization and digitalization of the transactions ecosystem (for example, through regulatory changes like the advent of GST). The information gap that resulted in excess caution by financial institutions while dealing with MSMEs and created opacity for them and large corporates in their dealings with MSMEs is being plugged, allowing for the emergence of innovative financing solutions.
The second shift, related to the first, has to do with the suite of innovative trade financing solutions available today. It is a well-known that being in trade with reputable names and roping in big buyers can unlock credit for smaller MSMEs since banks can offer credit based on a large buyer’s creditworthiness. In this way, supply chain financing can open the doors to a better future for Indian MSMEs. However, while previous thinking on solutions was more localized, focused mostly on large MSMEs, and spanned a few corporates at a time, the last couple of years have seen a dramatic rise in a suite of innovative solutions targeting a larger set smaller MSMEs, which can be scaled at a state or even national level.
Innovations are percolating around this problem to align the incentives of key stakeholders in this ecosystem – buyers, bankers, and entrepreneurs. Solutions have emerged to address information asymmetry between big buyers and suppliers down the chain to facilitate financing against invoicing for tier-2/3 suppliers (for example, Vayana Networks), utilize diverse supply chain documents & data, including integration with accounting software like Tally, to extent collateral-free and reasonably priced financing to MSMEs (for example, CredAble). For MSMEs and entrepreneurs, data and collection services offered by organizations like Recordent and CredFlow allow better visibility on receivables and collection services.
Innovations in alternative dispute resolution (ADR) mechanisms can boost efficiency significantly. The Supreme Court ordained mediation committee to draft legislation for the growth of ADR is a welcome, and so are private sector campaigns like “Suljhao, Magar Pyaar Se”, which expose a greater number of startups and businesses to online ADR.
Beyond addressing delayed receivables, supply chain financing can bring MSMEs into formal financing by starting them off with no collateral, low interest rate, and quick turnaround working capital credit. We need to rally around such win-win opportunities as large buyers, policy makers, bankers, and MSMEs to help unlock essential liquidity for our entrepreneurs. So how can the two most important stakeholders in the MSME equation be more transformative in their approach?
The Central Government can help catalyze and guarantee these programs through special windows under CGTMSE, while state governments can leverage their entrepreneur network and data to open opportunities for solution providers to directly market their products to MSMEs. TReDS can be turbo-charged and utilized as broad platforms for integrating new products, innovations, and business models. The challenges that MSMEs face are multi-faceted and therefore, policy makers should also embrace greater diversity in solutions that supplement the efforts already underway.
Similarly, a lot depends on large corporates being motivated to change their business practices, and in recognizing that financial resilience of MSMEs in their supply chain is a win-win. The Covid era has abundantly demonstrated the impact external shocks can have on the fragile financial situation of MSMEs and the real business cost of not addressing this opportunity to offer MSMEs a fair deal. In the long run, fairer financing will reduce cost of business for corporates and allow them access to a resilient, high quality supply chain, resulting in lower cost of supply chain management and ultimately, lower risk to business continuity. Rallying around MSMEs has never been easier, or more urgent, than it is today.
(Tushar Thakkar is Associate Partner, Dalberg Advisors and Ashwin Chandrasekhar is VP Finance and Ease of Doing Business, Global Alliance for Mass Entrepreneurship)