Why MSMEs Need More Liquidity

Micro, small, and medium enterprises (MSMEs) are often considered the cornerstone of any developing economy and the case is no different for India which was well-voiced in the Union Budget speech of Union Finance Minister Nirmala Sitharaman. Recent estimates spotlight their significance as six crore MSMEs contribute 33.5% to India’s annual GVA (gross value added is the measure of the value of goods and services produced in an economy; it is Gross Domestic Product minus net taxes on products) and employ nearly 11 crore workers. Interestingly within the MSME sector, micro-enterprises provide 97% of total employment. Considering India’s demographic advantage and the focus on Atmanirbhar, the growth of the MSME sector is crucial for providing meaningful employment for its young workforce. And for MSMEs to be the torchbearers of India’s growth story, it is important to create an ecosystem that facilitates their growth is the urgent need of the hour.

In this regard, access to formal finance is a well-recognized constraint for MSMEs and since the onset of the Covid-19 pandemic, there has been an attempt to initiate a policy push to overcome the supply-side bottlenecks. However, another perennial issue plaguing this sector is the problem of delayed payments. According to a  recent report by  GAME with Dun & Bradstreet and Omidyar Network India, an estimated Rs 10.7 lakh crore (5.9 % of GVA) remains held up in delayed payments. Further, the burden of the delayed payments falls on the micro and small enterprises, with these enterprises facing delayed payments to the tune of Rs 4.44 lakh crore and Rs 4.29 lakh crore, respectively. The report also notes that nearly 66 % of micro-enterprise sales, 31 % of small, and 25 % of medium-enterprise sales are stuck as delayed payments receivables. These figures unambiguously highlight that delayed payments have a significant impact on MSMEs.

Drawing insights from the recently released World Bank Enterprise Survey Data, we find that of the 2042 (48.14%) MSMEs[1] respondents cite the problem of delayed payments. Within the sample of firms citing delayed payments, 60% report that this issue has created financial difficulties for them. The number of applications filed by MSMEs on the delayed payment monitoring system (MSME Samadhaan) has crossed the 1.3-lakh mark. Further, according to the IFC 2018 report, 75 % of the micro-enterprise credit demand and 80 % of the small-firm credit demand remains unmet.  As a result, the burden of delays becomes harsher for MSMEs, a point that resonates with the UK Sinha Committee report. The implications of such delays are that it adversely affects the cash cycle of MSMEs which in turn impacts their ability to survive. In the long run, working capital constraints limit their scale of operation and growth. Consequently, it comes as no surprise that of the 6 crore MSMEs, 95% fall under the category of microenterprises. In addition, the delay in payments also affects the production ability of the firm which in the present global value chain production paradigm results in supply chain disruptions. Further, with disruptions in supply chains, it becomes strenuous for MSMEs to become part of global value chains and become the catalyst in transforming India as the global manufacturing hub.

The announcement in this year’s budget that restricts buyers from claiming income tax deductions until payments have been made to MSMEs is a welcome step. The motive behind this move is certainly welcome, however, whether it brings the desired results and provides a much-needed liquidity boost to MSMEs remains to be seen. Furthermore, the efficient functioning of such changes requires monitoring systems that certify and acknowledge that payment has been made against an invoice. This will also ensure that the scope of the policy initiative does not get restricted to a few cases alone. On a related note, expanding the scope of TReDS (Trade Receivables electronic Discounting System is an online electronic platform and an institutional mechanism for factoring of trade receivables of MSME sellers). platforms to include insurance companies is also a welcome move. However, more needs to be done. For instance, according to the MSMED Act 2006, the legal number of recommended days for repayment is 45 days. However, the UK Sinha Committee report highlights that the number of debtor days has increased to 220 days. In the presence of such delays, the provision of a grace period for GST payments will certainly help MSMEs. Further, a mechanism that develops credit scoring for MSMEs could help reduce the information asymmetry in the credit market making formal finance more inclusive for MSMEs.

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