The unaddressed credit demand is leading to liquidity issues and inadequate working capital, which impede daily operations and growth potential of micro, small and medium enterprises (MSMEs) which are already facing issues such as debt and delayed payments, experts told BW Businessworld.
India has over 70 million MSMEs, pivotal in creating over 111 million jobs and contributing nearly 30 per cent to the nation’s GDP. However, small businesses face a significant hurdle such as limited access to timely finance, with only 12 to 14 per cent of formal credit allocated to them, resulting in a substantial credit deficit of around Rs 45 trillion.
“Well, the debt burden is not a core challenge as only about 14 per cent of MSMEs access formal credit. A more significant challenge is the lack of access to formal credit itself which pushes many small business entrepreneurs towards unscrupulous practices leaving them vulnerable to overindebtedness and no borrower protection,” said Hardika Shah, Founder and CEO of Kinara Capital.
MSMEs typically operate with limited assets to leverage as collateral, making it challenging to secure loans from traditional lenders. Many new businesses also lack an established credit history, which further hinders accessibility, keeping them outside the ambit of financial inclusion and formal financing. Informal lenders often become the only option for MSMEs struggling to obtain financing.
“These businesses are then victimized by high interest rates charged creating a debt burden. Limited financial literacy among many MSME entrepreneurs also plays a role, as lack of financial knowledge can lead to uninformed decisions, like inefficient loan utilisation, worsening their financial situation,” said Shah.
The inability to access affordable financing restricts investment in expansion, innovation, and working capital, stifling overall growth. High debt levels make MSMEs more vulnerable to economic downturns, as they struggle to meet loan repayments during challenging times. This financial strain can limit job creation, impacting the overall growth of the economy. It is crucial to equip MSMEs with the right tools to access formal financing through the right channels and use it efficiently.
“MSMEs in India are underfinanced and unserved, and a huge addressable credit gap exists. SME-focused NBFCs and new-age digital lenders can play a critical role in reducing this gap through their deep market penetration, strong customer connections and innovative technology and digital offerings. Access to capital to these players by the government can play an important role in enabling inclusive growth of MSMEs,” added Nayyar.
Delayed Payments
Amid varied reactions to the Centre's 45-day payment rule, many MSMEs still face delays in receiving payments. The government's introduction of a 45-day payment rule aimed at safeguarding MSMEs from bad debt is a crucial step. This regulation mandates that buyers settle invoices within 45 days, with non-compliance resulting in tax liability on the unpaid amount. The cash-strapped sector has an estimated Rs 10.7 lakh crore which is 5.9 per cent of the gross value added (GVA) of Indian businesses is locked up annually as delayed payments from buyers to MSME suppliers, according to a report by D&B and Game.
“Delayed payments pose a significant challenge to managing working capital and cash flow, essential for day-to-day operations. Adequate funds are vital for maintaining productivity, underscoring the critical need for punctual payments in supporting MSMEs.
Due to their smaller size and limited negotiating power, MSMEs often accept less favourable payment terms to secure business with larger corporations. This power imbalance allows larger entities to dictate extended payment schedules that favour their interests over those of their suppliers,” stated Swetha Kochar, Founder and Partner, PKC Management Consulting.
Kochar added that MSMEs frequently transact with other MSMEs facing similar liquidity constraints, leading to cascading delays in payment schedules. Unlike SaaS platforms that can suspend services for non-payment, many MSMEs lack the leverage to enforce timely payments. These factors illustrate why MSMEs commonly experience delays in payments, highlighting the challenges they face in maintaining financial stability amidst such practices.
A recent NeoGrowth NeoInsights report titled ‘MSME Business Confidence Study 2024’ highlighted that MSMEs remain pivotal in job creation, aiming to hire more talent across diverse demographics, including women and individuals with disabilities, with 44% planning to expand their workforce.
Recognising the importance of digital integration, 82 per cent of MSMEs are actively embracing digital tools to enhance operational efficiency and bridge online and offline retail experiences. A significant majority (60 per cent) of MSMEs look forward to expanding their market presence by opening new stores and introducing innovative products and services.
Also, the Indian government has taken steps to support MSMEs with schemes such as the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) and the Pradhan Mantri Mudra Yojana (PMMY) provide financial support to MSMEs, while initiatives like the Udyam Assist Platform have facilitated the formalisation of these businesses and increased their access to various benefits.
For instance, by shouldering the risk to encourage lenders to offer more MSME loans, the CGTMSE scheme has improved access to business credit for MSMEs. Similarly, PMMY offers loans up to Rs 10 lakh to micro and small enterprises, supporting different stages of business development for these entities.
The Udyam Assist Platform facilitates the registration of MSMEs, boosting their credibility through formalization, which is crucial for availing of government schemes and subsidies. Including MSMEs as part of Priority Sector Lending (PSL) has also been a game-changer. This has ensured that a significant portion of bank credit goes to these enterprises, catalyzing their growth.
“While these measures are commendable, more needs to be done to address the myriad challenges faced by MSMEs. As credit access is one of the main issues that continue to plague these small businesses, the government should take measures to facilitate adequate fund flow from banks to NBFCs, especially for last-mile financial inclusion. The percentage of bank credit to NBFC for onward lending should be increased to 10 to 15 per cent ranging from the current 5%. Moreover, the bank credit to NBFCs for onward lending to build social infrastructure and funding renewable energy should be offered at lowered credit cost to enable sustainable financing for the MSMEs,” Shah added.
Kochar added that the government can focus more on implementing single-window clearance systems for all regulatory approvals and licenses to speed up the process of starting and running a business. Expand skill development programs tailored to the needs of MSMEs, focusing on digital skills, business management, and technical expertise. Provide grants and incentives for MSMEs to invest in R&D and innovation by collaborating with Academia to drive innovation and technology transfer.
India has emerged as the world's fourth-largest economy, surpassing the UK, supported by a robust GDP growth rate of 7.6 per cent in FY 2023-24 and experts said that MSMEs served as a significant driver of this expansion. These enterprises are crucial for generating employment across urban and rural areas and contribute to inclusive growth. India's ambition to achieve a USD 5 trillion economy is closely linked to the growth and formalisation of its MSME sector, which benefits from supportive government policies and initiatives.
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