How inclusive and practical is our monetary policy framework? Many research papers find the degree of pass-through of monetary policy to bank interest regime partial, staggered and low. Policy transmission is more effective in respect of money market. A forgotten aspect of ineffective monetary policy transmission is role of trade credit (TC).

TC is as old as B2B (business-to-business) trade. Historically, and much before the emergence of banks, TC financing powered the development of trade and industry, growth of commercial centres and rise of business communities such as Marwaris. Even after the growth of mass banking, TC continues to be the single largest source of working capital across businesses.

TC enables millions of day-to-day B2B transactions. India’s MSME Financing Report, 2018 by IFC finds that banks and NBFCs accounted for 16 per cent of MSMEs’ overall credit need. Credit gaps are generally met by TC.

TC serves as a medium of exchange, an essential function of money. B2B transaction financing role of TC is similar to that of currency and bank demand deposit. Firms use a mix of bank credit and TC to finance their working capital. Thus, every firm that sells on credit functions like a bank or financial intermediary. Collectively, firms constitute the largest credit intermediary network — far bigger and more inclusive than the banking network. Our bank-centric approach to monetary policy misses macroeconomic perspectives of TC.

The centrality of TC in working capital financing is a fact. TC channel functions as an important conduit for monetray policy transmission. Through credit intermediation, TC network positively impacts the pace of saving-investment-growth. It provides last mile links in credit multiplication and distribution along the input-output chain. It translates macro liquidity into micro liquidity. TC works both as a source (a/c payables) and use (a/c receivables) of funds for a firm. It touches every aspect of a business — production, sales, management of inventory, receivables, payables, liquidity, capex and operational efficiency.

In fact, the World Bank too advocates TC as an important tool for channelising credit by large firms to SMEs. Fragile TC network results in misallocation of credit and stagnation of liquidity with banks and high-end corporates.

Cross exposure and interconnectivity between banks and TC networks span across supply chain financing. Bank credit is transformed into TC when it enables a firm to extend TC to its clients. Transactional velocity of TC is critical for business growth. Adverse effects of TC ecosystem contaminated by trust deficit, low credit confidence, and repayment defaults impact bank credit portfolio.

Disruption in payment

In such a setting, demonetisation triggered sudden disruptions in the TC payment system.

A pre-Covid survey of payment practices by Atrdius finds a three-fold increase in write-offs of uncollectable debt and doubling in average value of long-overdue invoices. Before these disruptions could stabilise, Covid-19 waves badly struck business operations. Notably, the Covid pandemic witnessed amplification of trust deficit, significant deterioration in B2B payment culture and growing fear of opportunistic behaviour by trade debtors.

The result was a spike in receivables backlog, delayed payments and bad debts. Anecdotally, micro units’ receivables stood at 195 days in FY2021. The RBI’s annual study of select public limited companies’ receivables to sales ratio in respect of companies with turnover between ₹1 crore and ₹25 crore surged from 36 per cent in FY 2019 to 40 per cent in FY 2020 and further to 60 per cent in FY 2021. Now, these trends continue without any self-correcting mechanism.

They contribute to subdued investment and growth vulnerabilities. Failure of credit intermediation was a critical feature of the Great Depression.The World Bank warns that TC paralysis can be a potential source of liquidity shock. Dysfunctional TC can hold back investment and growth, despite supportive monetary policy and macro fundamentals.

Indeed, private investment has not grown much despite twin advantages of healthy balance sheets of corporates and banks, global buyers’ China+1 policy, slowdown in China and above all various credible pro-manufacturing growth and investment policies, large public investment and a buoyant capital market. This can be explained by a dysfunctional TC ecosystem.

Strengthening of the TC ecosystem is necessary for effective monetary policy transmission, finance-led recovery and higher investment.

The writer is former DGM, SIDBI

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