Activism Entrepreneurship

Aatmanirbhar – In Theory and Practice 2

Payment terms results in discrimination against MSME vendors. Because of this rule, and the incentives it generate, govt. departments and PSUs would love a foreign supplier or a trader of a foreign supplier. MSME cannot think of attempting bigger projects. Even if they do the cost of finance kills their competitiveness. How will atmanirbhar be achieved with this rule in place?

The second policy is payment terms. Policy makers in StartupIndia, MSME thinks that the biggest issue a startup or MSME face is getting clients. Hence they focus too much on that aspect. They think that by giving exemption on turnover criteria for startups[1] to win a project/tender the problem is solved. They are mistaken. The biggest issue is financing of the project. The skewed payment terms, especially of Central govt. departments, defence establishments and PSUs is the bigger problem.

Most of them under various ministries keep the payment terms such that supplier gets paid 100%  after delivery. This becomes an issue mainly when the product is custom built and when it take long time like six months to make. The stated objective of this payment procedure is to save the PSUs from bankruptcy of the supplier or its inability to meet the performance criteria. 

In most cases getting bank to finance the project is the issue and it prevents the startup or MSME from taking up bigger projects. Assume that they manage to get finance, let’s see how it discourages an Indian supplier when compared to foreign one. The key factor to remember is that Indian MSME get collateral-free credit at 15% compared to 5% or lower for foreign suppliers. The spread is 10%. Although there are some credit guarantee schemes like CGTMSE[2] the limit is 2 Crore with close to 10% interest rate. When combined with business loans of 16-18% the average finance cost is around 15%.

Let’s take the same case of a custom product being supplied. The typical timeline for building a product is six months. Now compare the different suppliers.

For a foreign supplier, the cost of finance is 2.5% of product cost (six months @ 5%), i.e., 2.5 units. A trader who merely acts as a representative of foreign firm is like a foreign supplier. An Indian MSME with ownership of the product and taking the supply risk will have higher finance cost. For such a firm the cost of finance is 7.5% of product cost (six months @ 15%), i.e., 7.5 units.

Now if we add the finance cost for each supplier we get the real cost:

Foreign supplierTraderMSME 10% indigenisationMSME with 50% indigenisationMSME with 80% indigenisation
102.5107.5121.0115.0107.5
Real costs after adding finance cost

Clearly the MSME who thinks of atmanirbhar is having its competitiveness against foreign suppler further lowered by this higher finance cost.

In comparison most state governments and its departments follow stage payments against milestone achievement and there are multiple milestones in a project. At every stage the payment is slightly lower than the value of the product in that stage to lower risk and also a clause that the part product is property of the client. This simple measure ensure that both the need for working capital as well as finance cost of the project is lower. 

We have seen how payment terms results in discrimination against MSME vendors. Because of this rule, and the incentives it generate, govt. departments and PSUs would love a foreign supplier or a trader of a foreign supplier. MSME cannot think of attempting bigger projects. Even if they do the cost of finance kills their competitiveness. How will atmanirbhar be achieved with this rule in place?

Read the first part highlighting the import duty exemption and the issues it generate for MSME.

Read the third part of this article where discrimination due to payment timing is discussed.

Read the fourth part of this article where discrimination due to currency difference is discussed.


[1] – Startup India scheme providing exemption to startups on turnover – https://bit.ly/2ZXChpe

[2] – https://www.cgtmse.in

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