How supply chain financing can help bridge the MSME credit gap

In the current post-pandemic environment, life is making a gradual return to normal.

For Indian businesses, this means a move back to a situation where customers are returning and patterns of spending are returning to normal. This represents both an immense opportunity and challenge for the millions of MSMEs in India, as well as larger corporates.

At a time when credit is still at a premium and cash flow is a key challenge to growth and, indeed survival, methods need to be considered both by corporate and the government to ensure that small businesses have the cash on hand to grow, purchase inventory, and continue day-to-day operations.

Credit schemes are one option that have considerably helped MSMEs over the past year. The Emergency Credit Line Guarantee Scheme (ECLGS) has seen multiple expansions and tweaks to enable MSMEs to pay back credit on viable terms.

However, credit guarantee schemes are not a sustainable long-term approach to ensure cash flow. The disbursements of such credit schemes require a certain timeframe as well, which is a loophole that requires immediate attention to ensure quick economic recovery.

Supply chain financing is a readily available solution that offers a sustainable alternative, both for the immediate present where cash on hand is at a premium, and in the future, as Indian MSMEs look to grow.

Let us compare supply chain financing to credit schemes to understand their relative advantages and drawbacks, and to find out what is a better long-term option for the Indian economy and MSMEs.

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Payments terms are significantly longer for credit schemes

One key point of difference between supply chain financing and loans backed by standard credit guarantee schemes is with regards to payment terms. When applying for and receiving credit, MSMEs pay off the credit amount over months or years. The ECLGS, for instance, calls for 36 monthly instalments.

Credit schemes often have relatively low interest rates, meaning that MSMEs can make monthly payments without significantly hampering cash flow. But alongside credit schemes, supply chain financing can complement MSME day-to-day cash flow needs by offering a source of shorter-term financing.

In contrast, supply chain financing treats invoices not as collateral, but essentially as a commodity sold by MSMEs to financiers at a discount.

This means that MSMEs get immediate access to a fair amount of cash, but a recurring monthly payment commitment. This makes supply chain financing a great option from the MSME perspective.

Close links between MSMEs and the corporate sector

Credit schemes are primarily backed by the government and financial sector. However, NPAs remain a key challenge in the Indian financial sector and limit the risk appetite of financial institutions, even in today’s environment where cash on hand is critical for MSMEs.

Although credit schemes offer great support for financing, the current environment does put a bit of limit on the volume of credit that the public sector and private financial institutions can disburse, at least until recovery is fully under way.

Supply chain financing gives a key role to corporate India and unlocks an additional major, long-term source of private capital for MSMEs, in addition to short-term credit schemes.

Supply chain financing builds closer connections between MSMEs and large corporates both upstream and downstream from them on the supply chain.

And because SCF is tied to invoices payable within a definite period of time, the NPA issue affecting the financial sector’s credit appetite is to a large extent mitigated. While the economy rebuilds and as credit appetites slowly increase, supply chain financing offers a sure-fire option for MSMEs to get the cash on hand they need.

A recurrent source of liquidity

Many MSME credit schemes are structured in such a way that they provide a one-off, nonrecurrent boost to liquidity. While MSMEs can avail multiple loans, they would still need to make monthly payments.

In contrast, supply chain financing - because it’s dependent on monthly invoices receivable - gives MSMEs a recurrent source of added liquidity with greater flexibility.

As MSME cash flow needs change in the months to come, and as they scale growth and production back to pre-pandemic levels, this added flexibility will allow them to better service dynamic needs.

In today’s market, cashflow is the key priority for India’s MSMEs. With economic growth set to breach 9.5 percent this year, MSMEs have a challenge in front of them to scale production and grow to meet increasing consumer needs. They’ll need easy, recurrent access to liquidity to meet this goal.

Credit schemes have played a great role in the immediate aftermath of the pandemic, getting cash to MSMEs that needed it the most. But in the months and years to come, supply chain financing offers another viable, long-term channel to empower MSMEs to meet their recurrent cash flow needs.