Trade finance: What's holding back the Indian MSMEs?

Unlocking India’s export potential in the coming years will be key, and the big push will have to come from MSMEs

Updated: Aug 20, 2019 01:42:08 PM UTC
Image: Shutterstock

Micro, Small and Medium Enterprises (MSMEs) play a key role in the industrialisation of the hinterlands as well as in generating employment in these regions. They drive the economy from below by establishing their own enterprises, enabling higher exports, and helping foster innovation. However, these enterprises also face a multitude of hurdles on their path to progress.

They have to procure regulatory and administrative approvals, attract the right customers as well as workforce and gain immediate access to affordable finance. Looking back a few years, most of the incremental credit to MSMEs was coming from NBFCs (Non-Bank Financial Companies). With the collapse of IL&FS making liquidity tighter, there is a resource crunch in NBFCs, which is being passed on to the MSMEs. The rise in compliance costs and a lack of credit inputs leads to a reduction of the enterprise’s working capital. Exim-focused enterprises’ trade suffered with RBI’s ban of Letters of Undertaking (LoU).

E-tailers such as Amazon or Flipkart pass the rinse-repeat test: you click, you buy and you receive (and sometimes you send back); and they manage to manage that entire process. Cab aggregators including Ola and Uber score slightly lower on the rinse-repeat test. Not because the system doesn’t work, but because the drivers have minds (and directions) of their own. And so we can create a rinse-repeat ranking of the economy, past phone companies, electricity companies, life insurance companies, passport offices, RTOs, and so on.

When MSMEs are left to plan out and work in their own capacities, they fall into the ‘rinse-repeat’ cycle. To put things into perspective, the process an Indian exporter has to go through before they make their commission is quite tedious. Let’s take a quick look:

  1. Identify prospective customer
  2. Agree on quality of goods, quantity, price of goods to be shipped
  3. Obtain quotation from shipping company or forwarder on cost of transportation, share this with importer
  4. Receive letter of credit from his customer
  5. Scrutinising L/C along with their advising bank
  6. Use L/C to secure pre-shipment financing from their bank
  7. Manufacturing of the goods
  8. Negotiating final access to shipping space and agree rates
  9. Securing certificate of origin
  10. Securing export license
  11. Arranging for transportation to Container Freight Station or main port
  12. Awaiting issuance of Bill of Lading (B/L) by shipping line
  13. Using the B/L to discount their invoice to customer and obtain cash
  14. 20-30 percent of submitted documents are found to contain discrepancies, requiring corrections by the exporter and/or their importer
  15. Receiving payment 10-15 days after first submission of documents

Even visually, without actually going through each of the points listed above, you’ll agree that this is an exhausting and not just an exhaustive list. MSMEs need help in a number of areas in order to become more export-ready:

  1. Finding prospective buyers
  2. Ensuring their products meet international quality requirements
  3. Arranging for pre-and-post shipment financing
  4. Arranging for their goods to be transported, often from interior locations
  5. Obtaining Certificates of Origin and Bills of Lading

Only the most determined people therefore end up exporting, as the hassle almost doesn’t seem worth it. While we all look at the monthly export figures and wish for the balance of payments gap to be closed, the process described above is not encouraging, or in VC terms, ‘not scalable’.

Need for MSMEs to move global
MSMEs contribute to 95 percent of the enterprises in the country with 40 percent of the total international exports. Easy access to finance is imperative for a healthy trading system. Currently, about 80 percent of trade worldwide has credit insurance or financing as the sole backbone to meet the task to the completion. According to the Asian Development Bank (ADB), there is a $1.5-trillion gap between the trade finance demand and supply, of which half is being attributed to developing countries in Asia; and further 70 percent of which relate to MSMEs and mid-cap enterprises.

To build on their capabilities as well as competencies, they must interact with and by extension, be a part of the international supply chain. However, due to the fact that they are engrossed and detained to back-end procedures, their focus on building up their brand takes the back seat.

Change is (finally) here
In the realm of trade finance, the part of banking responsible to provide pre and post shipment financing to exporters and importers, is changing rapidly. Fintech companies have been up-ending the world of finance by offering online platforms that help MSMEs discount their invoices. The platforms often link the issuing of credit to the financial strength of the buyers, especially when it’s traffic ex Asia to Europe or the U.S. Entrepreneurs are looking at a new way of securitising loans, for example, by taking the cargo itself as security, which makes the life of the MSME exporter or importer that much easier.

Unlocking India’s export potential in the coming years will be key, and the big push will have to come from SMEs and MSMEs. Innovative finance solutions that streamline the workload and help introduce them to new customers in far-flung corners of the world are key, and will hopefully play a large and positive role.

The author is the Commercial Head for Maersk Trade Finance.

The thoughts and opinions shared here are of the author.

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