It is a well-known fact that the economic success of developed economies is driven significantly by micro, small and medium enterprises (MSMEs). MSME development, especially access to finance, has been a focus area in India too.

However, despite being a prime policy focus, MSME access to finance remains a vexed challenge. In fact, credit extended to MSMEs actually declined by approximately 3% over the last two years.

As per Reserve Bank of India (RBI) analysis, against an estimated total finance demand of Rs32.5 trillion (Rs26 trillion in debt and Rs6.5 trillion in equity), the total loan disbursement as of March 2016 was only Rs11.1 trillion.

The declining bank credit to the MSME segment can be attributed partly to risk aversion among banks due to rising non-performing assets (NPAs). Interestingly, more than 80% of NPAs are attributed to large corporate entities. Consequently, MSMEs are suffering from a credit squeeze that has arisen largely from the failures of large companies.

For Indian MSMEs, difficulty in accessing finance reduces their competitiveness. The lending rate to MSMEs in India varies between 11% and 18%, versus a rate of about 3% in the US and UK and about 8% in China.

But while access to finance is indeed a concern for MSMEs, it raises the question—why is there such a need for finance? Given their smaller balance sheets, MSMEs depend acutely on cash flow from customers—large corporate entities in particular. Consequently, the payment habits of large companies have a significant impact on MSME cash flows.

In this context, we looked at the Dun & Bradstreet database to find out whether MSMEs receive payments on time.

Sample data from 2016 reveals that micro businesses (turnover < Rs10 crore) had a greater burden of delayed payments with median days sales outstanding (DSO) of 79 days, followed by small businesses (turnover <Rs50 crore) at 72 days. Comparatively, large companies enjoyed much quicker payments at a DSO of 56 days. The construction sector was the worst hit, with micro businesses waiting 180 days to receive payments. In manufacturing, micro businesses had a DSO of 85 days compared to 54 days for large corporate entities.

Evidently, smaller businesses have less bargaining power when it comes to getting their dues on time. In contrast, large corporations not only receive their dues faster, but also benefit from cheaper bank finance. Therefore, MSMEs face a considerable challenge when it comes to working capital, often threatening their survival.

There exists legislation for tackling delayed payments in the MSME Development Act of 2006, which effectively makes it mandatory for buyers to pay MSMEs within a period of 45 days. However, as the data shows, MSMEs prefer to wait for payments rather than taking legal action, given the difficulties in enforcement.

Notably, other countries such as the UK and US have done better in tackling the problem. The UK has developed a vibrant factoring market, with a turnover of about €377 billion as of 2015, which is estimated to be 100 times bigger than that of India. The US launched the Quick Pay initiative in 2011 which accelerated payments of over $220 billion to federal contractors. In 2014, the Barack Obama administration launched the Supplier Pay initiative, which was the private sector’s equivalent of the Quick Pay initiative.

In India too, the RBI has championed the Trade Receivables Discounting System (TReDS). TReDS will enable MSMEs to sell their receivables at market prices to multiple financiers.

Even as regulatory and systemic initiatives are under way, there remains a need to correct the often cited problem regarding MSME finance—lack of adequate information or information asymmetry. Within the ambit of banking credit, the development of credit bureaus and rating agencies in India has partly addressed this problem.

However, on the trade credit side, i.e. with respect to payments and receivables, information availability remains a major challenge. Consequently, there is nothing to deter a buyer (especially a large corporation) from delaying payments to MSMEs. There is a need for developing shared information networks that serve effectively as “credit bureaus" for trade payables and receivables. Such information networks would enable MSMEs to distinguish slow- paying customers from those that pay on time.

Perhaps the best news for MSMEs in India is the rapid adoption of technology, data and analytics by various non-banking financial companies and banks. Importantly, many start-ups are focusing on developing innovative digital solutions around MSME financing needs. With the government’s focus on digitization and implementation of the goods and services tax, MSMEs will increasingly join the chain of organized commerce, and have a credible trail of operational business performance.

This digital trail can be used as the basis for favourable financing terms for MSMEs by modern data and analytics-oriented financiers.

It is estimated that if Indian MSMEs were to receive their payments from large companies in a timely manner, their profitability could go up by at least 25%. Considering the wide base of MSMEs in the country (they are estimated to number about 51 million), one can only imagine the huge positive impact this would have on the Indian economy.

Pawan Bindal is director, Dun & Bradstreet India.

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