MSMEs: About Rs 10.7m stuck in late payments to MSMEs, accounting for 6% of India’s GVA

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Imagine it’s three days after payday, not only is there no money credited to your account, but you have no idea when that will happen. How do you plan expenses and savings with such uncertainty? For a majority of Indian MSMEs, late payments and associated uncertainty are the norm rather than an exception. Buyers realize goods and services, but regularly delay payments. Our quantitative analysis estimates that around Rs 10.7 lakh crore is locked in as late payments to MSMEs in India, representing 6% of India’s GVA (gross value added) for FY 2020-21 .

Late payments are a critical issue that not only affects the growth of MSMEs but disrupts supply chains and hurts the economy, but it is not unique to India. Most of the companies around the world conduct their business by offering credit to their buyers and as a result face problems in receiving their payments on time. However, there are variations in quantum, longevity of delay variations in their available solutions, mitigation strategies, and general business environment. This article compares different countries trying to mitigate late payments, which is a useful starting point to understand whether India can adopt similar solutions and the peculiarities in India that might render some solutions unworkable although they have worked. for other countries.

Law and regulations

Most countries in Europe, the United States, Japan, and India have laws to check late payments and encourage prompt payments. In the United States, the Prompt Payments Act is limited to government contractors only, the EU Late Payment Directive covers all commercial transactions, and Japan protects contractors who supply both businesses and the government. In India, it applies to all micro and small enterprises.

These laws generally define the maximum number of days in which suppliers must be paid after the delivery of goods and services and generally penalize delays. In doing so, these laws aim to ensure sufficient liquidity for small businesses and to provide compensation and legal recourse to businesses if their payments are delayed.

Laws, however, have limited success in tackling the problem due to their weak enforceability. The legal process is long and costly in addition to straining the buyer-supplier relationship, which affects customer loyalty. Supplier companies have therefore often shown a preference for other remedies such as resorting to short-term borrowing, accepting discounted payments or having a mix of buyers with both short and longer payment terms to ensure a sufficient working capital.

Market Solutions

Market solutions such as working capital loans, credit insurance and bill discounting are used as a mitigating measure to ensure sufficient liquidity for businesses to operate. These solutions are most common in countries like Taiwan and South Korea. While Taiwan has the best compliance with payment terms of all major economies, it also has the longest payment terms offered by suppliers. The presence of these solutions allows companies to offer longer payment terms and reduce the impact of payment defaults.

For market solutions to work, formal financial institutions must respond to the constraints of small businesses. Taiwan and South Korea have the highest SME financial coverage of any major economy, with the majority of total borrowing from formal financial institutions going to SMEs. Market solutions have limited impact in countries where formal financial institutions are unwilling to serve small businesses. Some of these solutions also require the active participation of the buyer, such as in the case of invoice discounting where buyers must accept invoices before they can discount them. In countries where the prompt payment culture is weak, the effectiveness of these solutions remains low and questionable.

moral appeal

Governments, trade associations and political leaders regularly appeal to large buyers to honor their obligation to pay on time. Although not legally binding, they potentially create persuasive pressure on defaulters in the ecosystem where brand reputation affects business outcomes. An example of such a measure is the Prompt Payments Code (PPC) in the UK in 2008 to ensure a good payment culture in the country. Businesses can pledge to abide by the code, by which they commit to paying their suppliers on time, providing guidance to suppliers on the payment process and encouraging others in their supply chain to comply. Commit to adopting good payment practices.

Because these calls focus on voluntary adoption by buyers, their uptake is limited, with the UK PPC having just over 3,000 signatory companies. It could also lead to an adverse selection problem where companies with good payment practices are more likely to subscribe to them while others will not. The value of moral appeal lies in widespread awareness of the problem as well as appealing to defaulters when it comes to prompt payment.

Mitigating Late Payments in India

India is used to having legal and regulatory safeguards to protect MSMEs from late payments. The Interest on Late Payments (IDP) to Small Businesses and Auxiliary Industrial Businesses Act 1993 was the first legal measure to ensure timely payments by requiring buyers to pay interest to MSMEs if payments were overdue for more than 30 days. This was replaced by the MSME Development Act 2006, which was similar to the IDP Act 1993 except for changes in interest rates and the number of days during which payments had to be done. The payment threshold has been increased to 45 days. These laws suffer from the same limitations of applicability that were discussed above. Samadhaan is a platform set up by the government for MSMEs to raise disputes regarding non-payment of dues. The platform currently has complaints raised by 1.08 lakh MSE filed claims with delayed amounts totaling Rs 28,085 crore since its launch in October 2017. Against late payment estimates of Rs. 8.55 lakh crore, this indicates the limits of legal remedies.

India has a long history of market-based solutions to alleviate the burden of late payments, such as the Trade Receivables Discounting System (TReDS) and the SIDBI-NSE Trade Receivables Electronic Discounting Engine (NTREES), that MSMEs could use to securitize their receivables, making the job easier. shortage of capital due to late payments. This has led to trading platforms such as M1xchange, Invoicemart and RXIL where MSMEs can obtain finance based on their unpaid invoices. Adoption of TReDS has been limited due to buyers’ reluctance to integrate with the platform. The three TreDS platforms together have around 3,000 buyers and 30,000 sellers, which pales in comparison to the 60,000 businesses with revenues above Rs. 50 Crore and 78.16 lakh MSMEs registered on Udyam. Solutions such as working capital loans and credit insurance have been poorly adopted due to the low penetration of formal finance in the MSME sector.

India does not yet have an equivalent to the Prompt Payments Code in the UK. The Global Alliance for Mass Entrepreneurship (GAME), in collaboration with Omidyar Network India and D&B, is trying to set up the first of its kind initiative aimed at creating a culture of prompt payment through the engagement of prompt payment as part of the ongoing campaign against deferred payments.

To conclude, based on the experiences of other countries, no single solution has been successful in dealing with late payments, but a combination of these solutions can solve late payments and create an environment for people to thrive and the growth of MSMEs. Although complex, late payment is a solvable problem.

(The author is a consultant at GAME – Global Alliance for Mass Entrepreneurship. He holds a master’s degree in sociology from the Delhi School of Economics)

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