Working Capital Shortfall Drives MSMEs to Seek Credit

Rising operational costs and lower capacity utilisation have created a severe liquidity crunch for MSMEs, enhancing the demand for credit from banks and financial institutions.

For the past two years, the Government of India (GOI) has been reaching out to the long-beleaguered Micro, Small and Medium Enterprises (MSMEs). The MSME sector, which is a significant contributor to the Indian economy and the largest job provider in the country, has been facing numerous challenges lately.

The increase in commodity prices is one of the most crucial challenges facing MSMEs today. A surge in the price of commodities like textiles, chemicals and dyes, metal castings, plastic packaging, engineering goods, ferrous and non-ferrous metals, among others, has made production costs skyrocket. 

Commenting on the rise in commodity prices, Basant Kaur, Managing Director, C2FO India said, “Most raw materials are 25%-40% more expensive than in pre-COVID times. At the same time, ferrous alloys and foundry chemicals have surged by 50%-300%. For MSMEs, this means arranging much more working capital to sustain operations than before.” 

MSMEs now have to shell out more money on overheads, such as COVID-19 safety protocols, and escalating fixed costs. Inventory costs have also seen a massive jump. In addition, skyrocketing diesel and energy rates have led to units cutting down on their hours of operation, leading to lower capacity utilization, which has further affected cash flows.  

On top of that, a severe shortage of containers is leading to unprecedented shipment delays nowadays. Because MSMEs receive payments after their shipments reach their destinations, they are being paid 45-60 days late. All this has severely impacted the cash flows of MSMEs. 

The extent of the financial trouble in the MSME sector can be gauged from a survey conducted by the Small Industries Development Bank of India (SIDBI) during September 2021-January 2022 on a sample size of 1,029 MSME units. According to the survey, more than 50% of MSMEs witnessed a 25% or more decline in revenue in FY21, and 66% reported a decrease in profitability due to stable fixed costs and a dip in revenue.

Credit availability for MSMEs isn’t enough

Accessing credit is one of the biggest challenges facing MSMEs today. According to a May 2021 report by LiveMint, only 34 million to 36 million out of 63.3 million MSMEs have access to formal credit. This lack of access is primarily because loan approvals for MSMEs usually have longer timelines. 

The Economic Survey 2021-22 sheds further light on the ease of accessing credit for MSMEs. The survey shows that only INR 2.28 lakh crore was disbursed to 95.2 lakh MSMEs under the Emergency Credit Line Guarantee Scheme (ECLGS) as of Nov. 19, 2021, and INR 59,858 crore was sanctioned under the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) in FY21 and FY22 (up to Nov. 30, 2021). As there are 6.34 crore MSMEs in India currently, the credit has reached just 15% of them. 

Since most MSMEs are micro and operate on cash, they require direct support to cope with adverse cash flow situations. Because large lenders and fintech firms often use tax return documents and bank statements to underwrite loans, there is a need to enhance the credit data infrastructure. The formalization of the balance sheets of MSMEs could prove to be a significant credit growth driver. 

GOI has launched several initiatives to ease the cash flow crunch that MSMEs face today.

The ECLGS is a crucial credit lifeline that effectively helps them counter financial adversities and build resilience to unforeseen economic volatilities. The Budget 2022 extended the ECLGS up to March 2023, with its guarantee cover expanded by INR 50,000 crore to touch a total of INR 5 lakh crore.  

The decision to allow surety bonds as a substitute to bank guarantee in government procurement announced as part of the Budget 2022 was also well received by MSMEs. Surety bonds will help MSMEs reduce their overall costs because they are free from collateral and renewal and are likely to be in force for the project’s life. 

Despite these measures, the credit availability for MSMEs isn’t enough. Banks are not extending working capital loans, which makes sustaining operations difficult for MSMEs, leading to downsizing operations and, in other instances, complete shutdown.

The technology gap 

Poor technology adoption in the MSME sector is another area of concern. Most MSMEs struggle with cumbersome manual processes, which are time-consuming and do not provide a comprehensive view of their cash flow situation. In line with this, MSMEs need to opt for a digital-first cash flow management platform that is intuitive and user-friendly. 

Banking and accounting systems working in silos are also detrimental for MSMEs. Scattered information, multiple accounts and a lack of ready financial health history lead to a poor understanding of MSMEs’ finances. Due to this reason, banks and financial institutions find it difficult to assess MSMEs’ creditworthiness properly, restricting their access to much-needed credit. Moreover, an acute lack of awareness about government-aided policies, subsidies and supportive digital infrastructure for MSMEs is further aggravating their access to credit. 

The above scenario is illustrated in the poor registration figures on the Udyam registration portal. The total MSME registrations are pegged at 77,31,766 (as on March 16,2022), which means just 11.34% of MSMEs are registered and have access to formal credit. Therefore, it is crucial to bring MSMEs operating in the informal and unorganized sectors under a formal umbrella credit scheme. This will help them avail the benefits of MSME schemes and priority lending.

What experts have to say 

In light of the recently announced Union Budget 2022, many financial experts have come forward with long-term solutions to help MSMEs navigate such turbulent phases. In their view, the present times call for a two-pronged approach: to boost demand-supply generation and take actionable steps to improve and establish self-reliance.

Fueling demand-supply generation

According to experts, the government should encourage the purchase of high-end IT products to fuel large-scale tech adoption. Rationalising Goods and Service Tax (GST) rates on raw materials is another focus area that can help provide relief to MSME units while strengthening their balance sheets. 

Incentivising the use of ‘Made in India’ products across data-centric institutions will be a big boost to the ‘Aatmanirbhar Bharat’ initiative. It will enhance demand generation for native cutting-edge technology while effectively addressing the nation’s security concerns. In addition, enhanced focus on capital expenditure (CAPEX) spending and scaling up the Production Linked Incentive (PLI) scheme on white-label goods could further bolster the ‘Make in India’ initiative.

Strengthening ‘Aatmanirbhar Bharat’

Improving consumerism should be an area of enhanced focus, according to experts. Hence, a stable GST slab is imperative to promote more independent manufacturing units. For smooth and hassle-free trade operations, it is essential to keep custom duties unchanged and enhance regulatory measures for port cargo operations to improve trade operations and relations. Furthermore, PLI schemes for the manufacturers of semiconductor chips and display panels could pave the way to producing high-quality electronic goods in India and boosting their global competitiveness. 

How fintech plays a vital role 

The turbulence that MSMEs are experiencing has enabled them to consider financial resilience on par with business resilience. As a result, MSMEs are increasingly seeking easier access to capital at lower interest rates. The GoI has launched several monetary policies and schemes to empower MSMEs through improved access to working capital, digital adoption and resilient methodologies. The fintech sector, in such a scenario, can play a pivotal role by becoming the central access system to MSMEs, driving enhanced working capital availability, improved cash management, seamless process efficiency and predictive analysis of financial resilience.

Conclusion

A global player in working capital solutions, C2FO can help empower MSMEs through its Early Payment program, which provides unified cash flow management and credit access. Being a digital-first platform, C2FO enables MSMEs to make smart and proactive choices regarding the financial requirements of their businesses.

Access to cash flow and credit flexibility can help small enterprises mitigate their cash flow challenges, put their businesses into action, and protect the jobs and livelihoods of their employees. But, most importantly, the scale and outreach of the GOI-introduced schemes can go a long way in helping MSMEs sustain their business operations and sail through troubled times.

To learn more, please get in touch with a C2FO supplier relationship manager at +91 7035 7035 93 or drop an email at [email protected].