Credit and Finance for MSMEs: The invoice discounting, factoring, or trade financing is an overwhelmingly big market globally – over $3 trillion and is likely to be worth around $6-9 trillion in the coming four-seven years, according to multiple studies. Now, where does the Indian market stand? It is a paltry size of around $6 billion or 0.2 per cent of the country’s gross domestic product (GDP), according to a report by the Standing Committee on Finance laid in Rajya Sabha in February this year on the factoring bill. In fact, the factoring credit has only a 2.6 per cent share in the overall formal credit to India’s micro, small and medium enterprises (MSMEs).
More interestingly, of India’s total receivable market, only 10 per cent is currently covered under the formal bill discounting system while the rest 90 per cent is through the conventional cash, credit, or overdraft arrangement with banks. So, the opportunity is massive for the Modi government – to leverage trade financing for MSME exporters and importers, and others by enabling easy alternate access to working capital – to help India gain market share in the global factoring space.
Perhaps in line with this vision along with the overall objective of boosting exports of ‘Make In India’ goods, Gujarat’s Gift city-based International Financial Services Centres Authority (IFSCA) had recently issued licenses to four invoice discounting platforms in India viz., KredX, Vayana Network, M1xchange, and RXIL for offering international trade financing to exporters and importers. The latter two are TReDS platforms licensed by the Reserve Bank of India. Established by the government, IFSCA is a unified authority for the development and regulation of financial products, financial services, and financial institutions in the International Financial Services Centre (IFSC) in India. The maiden centre is currently based in Gift city.
“The import and export financing market in India is fairly limited, that is, there are very few players. There is a significant jump that India is foreseeing in exports which need to be supplemented with adequate financing, In the current scenario, exporters and importers do not have proper access to financing due to a lack of awareness of the credit options available. The aim is to help businesses with working capital issues to ensure that they are able to meet the gap between the pre-shipment and post-shipment stages. Also, if you look at factoring as a product, India definitely has a very small market share while China tops the charts in terms of factoring volumes,” Anurag Jain, Co-Founder & Managing Director, KredX told Financial Express Online.
In comparison to the 2.6 per cent share of factoring credit in total formal MSME credit in India, the share in China is 11.2 per cent. And in contrast to the 0.2 per cent share of the Indian factoring market in the country’s GDP, Brazil’s factoring market has a share of 4.1 per cent in its GDP, while China’s has a 3.2 per cent share. On the other hand, Europe continues to dominate the factoring market globally with two-third (68 per cent) of the world factoring, the standing committee report noted.
“Three big changes will happen because of this initiative. First, the liquidity is going to tremendously improve for exporters and importers in foreign currency. Second, they are going to get access to a lot more institutions (lenders), and therefore a lot more rage and competition will be there. And third, it will allow a lot more MSMEs to get into export and import without having to worry too much about spending a lot of time in securing finance,” Ram Iyer, Founder & CEO, Vayana Network told Financial Express Online.
These entities will be testing the new service under the regulatory sandbox framework at the IFSC and are expected to roll it out formally by the end of the first quarter or during the second quarter of the next calendar year. The idea is to enable businesses to go to a platform where multiple lenders are interested in financing invoices. This is expected to lead to competition among lenders and since the bidding mechanism generally works in cases of high competition, there would be a possibility of getting the overall cost of financing down and benefitting exporters and imports.
“Large exporters can go to five-six different banks to get the best quotes. Small and medium exporters don’t have that option as their capacity is limited. They just go to their own banks. Though they negotiate, it is only up to a certain limit because they do not have access to other banks at that point in time. With the new platform, they don’t have to wait for the money to come from abroad. They are assured that they’ll get the payment and they can finance as early as possible which can be without recourse,” Ketan Gaikwad, Managing Director and CEO, RXIL told Financial Express Online.
For example, around a year back, domestically large businesses were getting financing at 7 per cent which is now down to around 4 per cent as more and more banks came onto TReDS that led to more competition, Gaikwad added.
“This (IFSCA licenses) will certainly help exporters while it also depends on the company to company. There are a number of exporters who don’t prefer financing their invoices through any means as they simply don’t want to share details about their payments and other financials. However, I expect a large number of MSME exporters and importers, who struggle in maintaining an adequate flow of working capital and work on long term credit of six months and even a year, to benefit from this move,” Ashwani Kumar, who runs manufacturing tools making company Victor Forgings and is also the Northern Region Chairman at Federation of Indian Export Organisations (FIEO) told Financial Express Online.
While platforms may start off with banks on the lending side but over a period of time, if there are global institutional investors engaged with the platforms and are able to give borrowers originated loans or credit in a package that is rated and insured, the benefit would be massive for MSMEs.
“This essentially means that the more different kinds of investors are able to get into the game, this will make it more competitive and bring down the cost. There is a lot of liquidity available in India and even outside India, which is flowing into stocks, bonds, and other markets. Recently, some Indian bonds were included in the foreign markets. This implies that these bonds will now be eligible to be bought by global institutional investors, leading to an increase in demand. The moment the demand goes up, the interest rates tend to fall. This fall in the cost of credit will be beneficial for Indian customers, businesses, importers, and exporters,” added Jain.
Once launched, manufacturing MSME is expected to be the biggest beneficiary as a relatively lesser number of large businesses engage in trade invoicing since the challenges around working capital aren’t acute for them. Benefiting MSMEs also assume significance as they have nearly 50 per cent share in India’s annual exports. “Payments-related challenges are there in all kinds of businesses. Customers in China only make the entire payment in advance for our exports. In other countries, customers don’t pay full advance. In most cases, payments are made in 30-90 days. At least through factoring, you get majority payment,” Raj Kumar Malhotra, Managing Director, Asian Handicrafts told Financial Express Online.
The licensed entities would be setting up subsidiaries for international trade financing businesses. “By regulations, you need to establish an entity. While it would be a subsidiary, but you will require a separate legal entity for this,” added Iyer.
Importantly, in July this year, Parliament had passed the Factoring Regulation (Amendment) Bill, 2021 to help MSMEs with better avenues for credit access particularly through TReDS. The amendments made to the bill were to widen the participation of entities such as non-banking financial companies (NBFCs) in the factoring market. Finance Minister Nirmala Sitharaman in Rajya Sabha on the passing of the bill on July 29 had reportedly said that the amendment will get 9,000 NBFCs to offer factoring benefits to MSMEs from earlier only seven.