India’s MSME Odyssey: the enticing landscape of cross-border trade
With India poised to become the third-largest global economy, cross-border trade offers significant advantages for Indian MSMEs. This includes expanding their market presence and achieving better margins without the need for extensive marketing infrastructure.
India has set its sights on becoming a $5 trillion economy and has been progressing steadily with a robust growth rate to become the third largest economy in the next couple of years. This ambitious goal is underpinned by India’s favourable demographics, rapid advancements in the financial sector, infrastructure, healthcare, education, government initiatives like “Make in India”, regrouping of global supply chains, path-breaking initiatives in technology and space, etc.
It is a less discussed fact, but pertinent to mention that India is already the third largest economy in the world in terms of GDP based on PPP (Purchasing Power Parity) and far ahead of Japan and Germany. While we are elated to witness our economy grow at a pace much better than many peers, we still have a long way to go in terms of increasing our per capita income.
To surpass the $10,000 GDP per capita income hurdle, sustaining consistent growth over the next two decades is imperative. The Micro, Small, and Medium Enterprises (MSMEs) in our country will play a pivotal role in both GDP expansion and job creation. These entities contribute around 30% to the GDP, constitute 45% of exports, and offer employment to 111 million individuals, representing 20% of the working population.
Supporting MSMEs financially is crucial not only for achieving the ambitious $5 trillion economy goal, but also for reaching the $2 trillion export target by 2030, thereby significantly boosting employment opportunities.
Despite the government’s efforts to create a conducive environment for MSMEs to thrive across diverse sectors, including agritech, biotechnology, oceanography, and space, providing adequate and timely working capital still needs to be addressed. This is evident from the fact that only 11% of the 63 million MSMEs of the country have access to formal credit and of the total credit exposure of the country, MSME exposure is less than 20%.
While we are aspiring to achieve exports of $2 trillion, which is about 20% of the projected GDP, total credit exposure to exports as on date is less than 5% of the overall bank credit. If we come to export credit to MSMEs, it is abysmally low when compared to the segment’s overall contribution to the country's exports. So, a lot needs to be done as we all wish to achieve what we have set for ourselves as a nation in the next five to six years.
Cross border financing: empowering MSMEs in foreign trade
As the global geopolitical landscape evolves and nations worldwide focus on reshaping supply chain corridors through friend-shoring, nearshoring, and on-shoring, the financing of cross-border trade becomes increasingly complex. However, this complexity simultaneously unveils new opportunities, with emerging alliances and forums creating potential markets.
The Global South and BRICS countries, as they expand and strengthen, add to the dynamic shift.
With India poised to become the third-largest global economy, engaging in both new and established alliances, cross-border trade offers significant advantages for Indian MSMEs. This includes expanding their market presence and achieving better margins without the need for extensive marketing infrastructure.
Crucial challenges in financing
To achieve $2 trillion in exports from the present level of $750 billion would require multiple enablement on an urgent basis, the major one being adequate financing solutions to the exporters.
Despite the commendable efforts being made by all the banks, central and state governments, Export Promotion Councils and all other forums available to support exports from India, to more than double the exports in the next five years would call for reimagining channels of financing to this segment.
- Financing of Service Exports: A major portion of our exports is service exports (from April-Nov 2023, of the total exports of $499.46 billion, $220.66 billion is service exports), which is around 44% of the total exports. At present, the financing options for entities in this segment are scant, especially, for the MSME service exporters. To support this segment, financial institutions need product innovation and credit insurance coverage.
- Factoring: Factoring as a financing solution is apt for MSMEs as it is flexible, unsecured, and mostly without recourse to the exporters. It is easy to adopt and understand by the MSMEs. As per FCI (Factoring Chain International) data, Singapore does around $25 billion and Taiwan $35 billion of international factoring annually as against $700 million by India.
- Credit Insurance for Factors / Banks: Encourage credit insurance companies in India to come out with products available abroad to factors / banks to cover credit exposures through credit insurance and allow capital relief against such exposures of factors / banks.
- Indian NBFCs to set up offices in IFSC, GIFT City: Encouraging existing NBFCs to set up offices in IFSC, GIFT City and get into international factoring of export receivables for Indian exporters as well as South East Asian neighbouring countries. This has tremendous scope in countries like India, Bangladesh, Malaysia, Indonesia, Vietnam, and Sri Lanka.
- Tie up with FCI (Factoring Chain International): FCI is a global association of banks and financial institutions focusing on the growth of factoring, supply chain finance and receivable finance industry globally. It represents close to 400 member banks and non-bank financial institutions located in over 90 countries. Recognising its two-factor model along with GRIF (General Rules for International Factoring) will help spread factoring as a financing tool in India to thrive.
- Adoption of MLETR (Model Law of Electronic Transferable Records): MLETR enables the use of Electronic Transferable Records (ETRs) for both domestic and international trade, legally recognizing their equivalence to traditional paper-based documents. Already adopted in Singapore, the UK, and a few other countries, it is currently being embraced by France, Italy, Germany, and the USA. This advancement ensures safer, seamless, and fully digital financing processes, resulting in significant cost reduction, heightened security, and increased adoption.
- ITFS Platforms: ITFS (International Trade Finance Service) platforms, set up under licence from IFSCA (International Financial Services Centres Authority, GIFT City, Gujarat), have emerged as a unique solution for exporters to avail financing against their receivables with an end-to-end digital journey. These platforms facilitate factoring of export receivables on an unsecured and without recourse basis by connecting them with financiers globally. The ITFS Platforms also ensure the best possible rates to exporters through a transparent auction mechanism.
- Open Account Transactions: Financing of open account transactions is still an area in which most of the financiers in India do not venture. But statistics show that globally more than 45% of cross-border trade is now on an open account basis and it is growing day by day. So, it is time for Indian financiers and entities concerned to look into this more seriously and come out with products that serve the exporters doing cross-border trade on an open account basis.
- Expanding participants in Export Finance: It’s time to expand beyond banks in export finance. Can we involve institutional investors such as pension funds, asset managers, foundations, endowment funds, mutual funds, family offices, etc.? With digital marketplaces like ITFS and supportive laws like the ETD Act in the UK, this is a viable possibility worth exploring.
- Trade Assets as an Investable Asset Class: Trade finance is extremely important for any economy to flourish and hence adequate liquidity for trade assets is critical to ensure growth. Trade assets are short-term, self-liquidating, non-speculative, having lower default rates with reasonable yield. It is time we look at trade assets as an investable asset class and create a primary and secondary market for such assets to be traded digitally and seamlessly.
Fostering export growth: impact on India’s economy
Export-focused strategies have been pivotal for global success stories, from post-World War II Japan and Germany to Mexico and certain Latin American nations in the 1970s, followed by the successes of Singapore, Taiwan, South Korea, Hong Kong, and more recently, China. The emphasis on exports has consistently driven high and sustained economic growth, bringing widespread benefits to the populations of these nations.
The Aatma Nirbhar Bharat vision is reflected in our focus to expand India's participation in global trade, which has actually come down over the years from around 2% post-independence to less than 1% in the 1990s and has again reached around 2% in 2022. The aim is to take it to 10% by 2047. Our service exports have a global share of 4.4% and have been growing steadily the need is to ramp up merchandise exports and ensure continued growth in service exports over the next two decades.
The Government of India has a focused approach to increase both service and merchandise export at a much faster pace and it is reflected in the recently introduced Foreign Trade Policy (FTP). The target of reaching $2 trillion of exports by 2030 will be led by MSMEs and the various incentives like ECGC cover at lower cost, extension of the subvention schemes will certainly help in achieving this target and ensuring nominal GDP of $5 trillion in the next four years.
To Cap it off
In conclusion, as we navigate the challenges of cross-border trade, the key lies in balancing domestic demand, export growth, and calibrated imports. Amid geopolitical volatility and evolving supply chain dynamics, the world is witnessing a division into round tables, some with clear leaders and others without. Navigating these complexities requires complete digitization of trade documents for a seamless and secure experience, especially in financing.
According to our Prime Minister’s apt description, the next twenty-five years for India represent our “Amritkal”, with 65% of the population falling within the working age group, and one in every five individuals of working age projected to reside in India during this period. Ensuring inclusive growth, including employment, increased per capita income, GDP, and the growth of MSMEs and exports, is not just an option but a necessity for India.
Edited by Megha Reddy