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Greasing MSMEs' Wheels: Trade Finance And Credit

With the help of micro, small and medium enterprises (MSMEs), India is eyeing to achieve the challenging target of 1 trillion in exports by 2027

Photo Credit : Ministry of MSME

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It is that time of the year again when the majority of Indian business experts will talk about one major aspect of India— micro, small and medium enterprises (MSMEs) and how they are a necessary element for the country to become a USD 5 trillion economy and ultimately the developed nation by 2047— an ambitious goal set by PM Narendra Modi.

However, over the years, nothing has changed and the entire MSME sector is still struggling to move forward after facing major jolts from the Covid-19 pandemic, supply chain disruptions due to the Ukraine war and the decade-old problem of delayed payment.

Experts as usual pitched for better coordination between big and small corporations to solve payment-related issues and handholding from the government to augment economic growth.  

On the domestic front, Indian MSMEs are fighting hurdles to survive and grow and for India’s economic growth— their global participation is also necessary. India’s overall exports in May 2023 stood at USD 60.29 billion, a negative growth of (-) 5.99 per cent over May 2022.  Although growth is negative or positive, MSMEs contribute significantly to this number. 

With more than 63 million MSMEs spread across the geographical expanse of India, MSMEs have been contributing nearly 40 per cent of overall India’s exports, contributing to approximately 6.11 per cent of the country’s manufacturing gross domestic product (GDP) and 24.63 per cent of the GDP from the services sector. 

When seeking export finance, the foremost hurdle encountered by MSMEs is limited access to timely and sufficient credit facilities, poor credit records, high-interest rates and stringent conditions.

The ‘financing gap’ which means the ‘capital gap’ for MSMEs to pursue growth strategies, has a major impact on India’s growth since MSMEs contribute to 30 per cent of its GDP along with their contribution to employment and exports. 

“One of the foremost hurdles encountered by MSMEs when seeking export finance is limited access to timely and sufficient credit facilities. The intricate procedures followed by commercial banks often lead to delays and complexities, causing MSMEs to miss out on the opportunity to avail of credit facilities in a timely manner. Furthermore, the exorbitant costs associated with trade finance offerings from these banks make it nearly impracticable for these businesses to obtain structured funds,” said Manish Kumar, CEO and Founder, KredX.

Additionally, the demanding collateral requirements imposed by lenders restrict the capacity of MSMEs to acquire necessary funds, thereby impeding their growth trajectory. Moreover, institutional lenders often fail to grasp the distinctive financial requirements specific to SMEs.

According to the International Finance Corporation (IFC), about 65 million firms, or 40 per cent of formal MSMEs in developing countries, have an unmet financing need of USD 5.2 trillion every year, which is equivalent to 1.4 times the current level of global MSME lending. 

East Asia and Pacific account for the largest share (46 per cent) of the total global finance gap and is followed by Latin America and the Caribbean (23 per cent) and Europe and Central Asia (15 per cent). 

The gap volume varies considerably from region to region. Latin America and the Caribbean and the Middle East and North Africa regions, in particular, have the highest proportion of the finance gap compared to potential demand, measured at 87 per cent and 88 per cent, respectively, as per the IFC. 

About half of the formal SMEs don’t have access to formal credit. The financing gap is even larger when micro and informal enterprises are taken into account.

“The availability of working capital for MSMEs to meet their export order requirements has been a persistent challenge. Despite the government's efforts and incentives to encourage export financing, present financing choices have remained inadequate and securing export financing has been a complex and time-consuming procedure for MSMEs. They often struggle to secure the necessary funds to fulfill their export orders for a variety of reasons, including stringent collateral requirements imposed by financial institutions. This limitation has hindered the growth potential of many MSMEs, preventing them from capitalising on lucrative export prospects,” said Arun Poojari, Co-founder and CEO, Cashinvoice.

Creating innovative financing solutions

In the realm of supporting MSMEs, various innovative financing solutions have emerged, each with its own pros and cons. Trade finance platforms now offer integrated solutions, empowering MSMEs with working capital, bridging funding gaps, and streamlining cross-border transactions. Invoice financing converts outstanding invoices into immediate funds, while peer-to-peer lending platforms provide flexible financing options. Experts said that these advancements improve accessibility and flexibility for MSMEs in global trade.

“These solutions offer advantages such as improved accessibility, faster approval processes, and reduced reliance on traditional collateral. However, it's important to consider potential challenges like high-interest rates, cybersecurity risks, and the need to enhance digital literacy among MSMEs to fully leverage these opportunities. By embracing these solutions and actively addressing their limitations, we can foster the growth of MSMEs in the global trade arena,” said Tanmay Kumar, CFO, Shiprocket.

Notably, fintech platforms have emerged as game changers and these platforms are addressing the challenges associated with export financing by leveraging technology and innovative financial arrangements like supply chain finance, invoice financing, P2P lending, crowdfunding and trade finance technology platforms etc. 

“Unlike traditional lenders, new-age fintech platforms mitigate transaction risks without the requirement for any collateral, digitising the trade finance processes and reducing paperwork and administrative burdens. This technique allows them to assess the creditworthiness of MSMEs depending on their particular export transaction, taking into account aspects such as the buyer's credibility, the nature of the export order, and the MSME's track record and alternately enabling MSMEs to connect with global financiers,” added Poojari.

Fixing financing gap

India's monthly exports reach approximately USD 35-40 billion, yet available export credit only amounts to USD 2 billion, leaving 95 per cent of exports unfunded. This lack of financing limits working capital stifles export potential and contributes to higher CAD and fiscal deficits. 

As per Crisil MI&A Research, MSMEs account for 40 per cent of India’s exports and will face headwinds from the imminent economic slowdown in advanced countries, particularly the US and Eurozone. These two geographies account for a third of India’s overall exports.  

Notably, the global factoring services market size was valued at USD 3,566.99 billion in 2022 and is expected to grow at a compound annual growth rate (CAGR) of 9.2 per cent from 2023 to 2030, as per Grand View Research. The increasing need for alternative sources of financing for MSMEs is driving the growth of the market. 

The report added that several organisations are taking advantage of machine learning (ML), natural language processing (NLP) and artificial intelligence (AI), which are expected to generate profitable growth prospects for the factoring services during the forecast period. Experts are hoping that Indian MSMEs adopt and benefit from it.  

“By increasing export financing to cover even 50 per cent of exports, we can empower exporters, boost economic growth, and propel India towards its USD 5 trillion economy goal. Bridging this financing gap requires collaborative efforts, innovative financial products, and increased participation from domestic and international lenders,” added KredX’s Kumar.

Shiprocket’s CFO Kumar added that MSMEs can transform by diversifying, optimizing, embracing technology, forging alliances, and pursuing knowledge. These strategies enhance resilience, competitiveness, and adaptability in the dynamic business landscape. Innovative solutions like supply chain financing offer a promising avenue to reduce dependence on conventional collateral. 

“Traditional financing solutions often include high-interest rates and other costs, making it difficult for MSMEs to handle the financial strain. One significant government-led initiative in this arena is the International Trade Finance Services (ITFS), whose streamlined processes and collaborative approach have the potential to reduce the overall cost of export finance, making it more affordable and accessible to MSMEs,” added Poojari.