Working Capital for small businesses in India

For Small and Medium Enterprises (SME), a big issue is the availability of working capital and the cost of financing it. See the earlier blog post on the productivity of working capital.

SMEs that supply to big corporations are usually at their mercy for payment of invoices. If the buyer is monopsony, then the supplier’s bargaining position is even weaker. Nor can they afford to pursue legal remedies against recalcitrant corporate customers. Such remedies will be costly, protracted and may ruin the business too. ‘Factoring’ is the answer. SME suppliers discount their receivables and bills of exchange with banks who buy them (with or without recourse to the SME, in the event of non-payment) at a discount and then collect the proceeds from the corporate buyer.

The idea was included in the report of the Raghuram Rajan Committee on Financial Sector Reforms in 2008. Then, RBI appointed a working group which submitted its report in November 2009. RBI then issued a concept paper in 2014. Then, the draft guidelines were issued followed by final guidelines. Receivables Exchange of India (RXIL), India’s first Trade Receivables Discounting System (TReDS) started operating only in January 2017.

The time taken underscores the glacial pace at which crucial reforms that would lift the economy on to a higher growth path are pursued.

The world over, on providing working capital to small suppliers, things are moving much faster (ht: Gulzar).

Six months later, hurdles to the smooth of functioning of RXIL are emerging. Companies are wary of uploading invoices lest competitors come to know about their suppliers. Second, this is important, “since TReDS is a transparent system, they (companies) necessarily would have to settle the suppliers’ invoices within 45 days of acceptance of goods/services rendered.”

From a policymakers’ point of view, starting from the Panel Discussion on Agriculture and the posts on India’s informal, small and large factories, three interventions are becoming clearer:

(1) Risk mitigation in the form of a functioning crop insurance market with the Government bearing the premiums payable to cover not only yield, output but also realisation risks.

(2) Irrigation coverage – canals, inter-linking of rivers (long-term and huge capital commitment), rainwater harvesting (ongoing and needs top-level ownership like in the case of ‘Swachh Bharat’)

(3) For informal enterprises, financing via Mudra Loans but with performance caveats

(4) For small enterprises, working capital access – discounting, factoring, etc.

(5) For small and informal enterprises: revamp, re-design and re-energise the Skilling Initiative. Make contributions to Skilling CSR Compliant (if not already done). Tie it up with big corporations. I do not know if there is further work to be done on the Apprenticeship Act.  It has been passed. Have the rules been framed under the Act, been notified and circulated?

(5) For all: stable, reasonable tax regime that is non-vindictive and non-usurious in its administration. An immediate fallout of it is GST rationalisation of rate structures and further lowering of rates. Bet on economic activity and not on economic policing.

(6) Government to expend fiscal resources on bearing more labour payroll deductions for entrepreneurs (increase the salary cut-off limit for government reimbursement)

(7) Follow through on corporate tax rates reduction with elimination of ad-hoc exemptions

Without any trace of immodesty, I would venture to state that if the Indian Government could focus on these seven for the next eighteen months, it will have done a lot to relieve the economy of the strains and stresses it is facing now.

5 thoughts on “Working Capital for small businesses in India

  1. I believe that working capital is very important for small businesses. I think that this article will definitely help a lot of business owners in India to find a solution for their business financing. Thanks for sharing this article.

    Like

  2. There is a lot of work being done on irrigation – micro irrigation specifically through the MNREGA. I read some benefits are becoming evident in Rajasthan and Maharashtra. But govt. is focussed on doubling farm incomes in 5 years.Cant say that same about crop insurance and risk management.

    Tax has become sore point. Quite a few clients have received notices for random inconsistencies in tax payments (one got notice for short-payment of Rs. 10). Similar complaints emerging from GST compliance.

    Actually, Govt. needs to realise that non-compliance with tax had two components – compliance was damn difficult (for a reason) and bribed non-compliance was super easy. In Modi’s enthusiasm to hit the second, he is hurting the first.

    That is problem in India as a whole – cost of compliance with law is too high and benefit too low and penalities on breaking the law is not material while benefits are huge.

    R

    Like

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