Opinion

Trade credit paralysis, a time bomb

Bhawarlal Chandak | Updated on November 18, 2020 Published on November 18, 2020

Credit worries The payments system is in a precarious situation   -  /iStockphoto

Collapse of confidence has led to a freeze in informal credit flows. This could trigger a financial contagion

Trade credit-based payment network is an integral part of payment and settlement system. Firms use a mix of currency, demand deposits and trade credit (TC) as means of payment. A majority of B2B transactions are on credit. Any disruption in payment and settlements (PS) can destabilise the financial system.

The global financial crisis of 2008 was triggered by repayment defaults on subprime mortgages. PS was first to show signs of crisis when the Lehman Brothers failed. Similarly, demonetisation followed by GST seriously impinged the payment system, especially in the unorganised sector as circulation of informal/unaccounted business funds in financing TC was disrupted.

This disruption has reached a point of breakdown in the wake of the Corona crisis. Repayment completes the recycle of loanable funds and makes the lending sustainable. Velocity and volume of credit flows are directly correlated with the speed of the repayment cycle. Recent measures to step up credit flows have not taken into account the link between banking sector credit and informal sector, or trade credit. A collapse of the latter will reflect in a rise in bank loan defaults, triggering a financial contagion.

Critical role of TC

The importance of TC as working capital channel and credit multiplier cannot be underestimated. Millions of day-to-day inter-firm credit and its repayment chains constitute the functional prime base of working capital for businesses. MSMEs are predominantly TC-dependent for working capital. RBI’s corporate financial studies clearly show the important role of TC in working capital financing, even in the organised sector. Atradius (Payment Practices Barometer, 2015) finds that in India 48 per cent of respondents granted TC to their domestic clients. In China, private firms rely more on TC as banks give credit preference to state-controlled enterprises. TC accounts for almost 50 per cent of B2B transactions in many European countries. According to World Bank blogger Andres Liberman, “Walmart uses four times more supplier financing than short-term external financing.”

Payment system logjam

Moderate delays in payments are common and tolerable. However, firms are constrained to absorb long delays. D&B (2017) finds that in India 78 per cent of the companies have delayed their payments and in 14 per cent of cases delay was over 120 days. With jamming of TC and TC repayment chains, the situation is precarious now. When payment delays and defaults reach a critical threshold, it can have a contagion effect. With the onset of the Corona crisis, the payment crisis in the unorganised sector has worsened. Disruptions in credit, production and input supply chains, demand recession, liquidity-bind and payment backlog and above all deterioration in credit culture, have impacted repayments in the post-lockdown period. A sharp deterioration in informal institutional credit discipline has magnified the payment crisis.

Heightened uncertainty about cash flows, excessive risk in the realisation of ovedue payments and growing fear of opportunistic behaviour by debtors drive firms to hold more precautionary cash balances and exercise a strong preference for cash-based transactions.

This is reflected in the extraordinary surge in currency circulation during April-September 2020, despite widespread deep contraction and excessive system liquidity. During these six months, y-o-y increase has more than doubled. Liquidity holdback across firms, credit-bind and large payment backlog are proving fatal for many firms.

TC-intensive sectors like MSMEs, wholesale and retail trades, textiles, construction are facing a severe payment, credit and insolvency crisis. A good number of firms are shut since the start of lockdown. The payment contagion experienced by a large number of firms gets transmitted to other firms both in the unorganised and organised sectors as firms have cross-exposure through TC and bank credit networks. The effects of this contagion on macro credit aggregates, output and productivity are considerable. Official data don’t fully reflect this phenomenon. The risk of chain insolvency and closure of firms is real.

The way forward

Bank-centric remedial measures like moratorium on debt repayment, loan restructuring, bank capitalisation, monetary easing and credit guarantee offer partial, temporary solutions. They overlook the need for fixing the dysfunctional TC channel — the biggest credit intermediary network. Fund flows from both banks and TC channels are fungible and interlinked.

The NPA problem remains intractable as interconnected problems of delayed payment and bad debt in private credit persist. During this unprecedented TC crisis, triggered by trust and confidence contagions, trade/industry associations need to assume a leadership role.

Besides these, measures such as increase in bank credit, pushing prompt payment by the government entities/corporates, refunding of GST on unrealised payments, extending GST credit and promoting receivable financing, are required.

Coordination failure among firms and lack of collective action against TC renegades encourage indiscipline and mistrust in inter-firm dealings. Payment logjam is like a highway jam caused by slow movement (late payment)/breakdown (defaults) of some vehicles (units) leading to abandoning of traffic discipline by one and all.

The role of the government should be like a policeman here. It may facilitate establishment of a credit directory for TC transactions and encourage an interactive networking among IAs, business chambers, firms to evolve and build-up an eco-system conducive for orderly working of credit channels.

The government may accredit select IAs which can work for self-discipline/self-regulation and prompt payment.

Their trade knowledge, reputational weight and moral authority can work more efficiently than legal remedies in solving payment problems.

The writer is former DGM, SIDBI

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Published on November 18, 2020
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