Sometimes, a problem that is staring at us is often overlooked. The case in point here is that the systemic disruption in trade credit (TC) network is the root cause of a financially frail and disrupted ecosystem. The nationwide Covid-19 lockdowns simultaneously hit the operations of both suppliers and buyers. TC and its repayment flows (see chart for how it works) have been systemically disrupted with a sudden stop to millions of day-to-day B2B commercial transactions and repayments.
This has led to a liquidity freeze in the TC network with knock-on effects on the banking sector.
Banking and TC networks are interlinked across supply chain financing, liquidity funding and credit-based payment systems. The chain effects of a liquidity shock on macro credit aggregates, output, supply chain financing, volume of delayed/defaulted payments and micro liquidity can be significant.
Other outcomes include excessive durable liquidity with banks, poor lending appetite, high demand for cash and low velocity of circulation of money, a weakening of the savings-investment-growth nexus and risk of NPAs. This is a silent contagion possibly in the making.
Legacy effect
Disruptive events like pandemics, financial disruptions and socio-political upheavals can dramatically change repayment behaviour, credit risk perception, B2B transactional trust/confidence and liquidity conditions. Despite near-normalisation of conditions, trust and confidence channels in TC continue to be weak — although this is not acknowledged or even talked about in mainstream policymaking circles.
There is fear or uncertainty over realisation of receivables, and on time. A backlog of doubtful trade receivables accumulated following the lockdowns, along with severe funding constraints, has had debilitating effects on a majority of MSMEs, retail businesses, young and financially weak firms. These firms, a bulk of which are in informal sector, have large negative net trade credit (receivables less payables vis-a-vis other actors in the supply chain) balances, bad debt, low equity capital and severe credit constraints.
These have pushed some of them towards financial disarray and insolvency — despite the RBI’s efforts to release liquidity in the wake of the pandemic. The RBI’s liquidity infusions have not significantly translated into bank credit growth.
Meanwhile, there has been a large increase in gold loans to businessmen, as well as in their auctioning by lenders. This has co-existed with a sluggish demand for mass market products — pointing to informal sector distress.
On the other hand, top corporates and financially strong firms are less affected. Both, bank and TC flows continue unabated to them. They have quickly recovered. Strong corporate results seem to bear that out.
While the GDP is barely above pre-Covid level, the contrast between TC flows in the top end of the corporate sector and such flows at the lower end amidst financially weak firms is only too evident.
These has led to a build-up in stress at the bottom of business, and population, pyramids. The CMIE’s Index of Consumer Sentiments was at 60 in October 2021 (Base 100 in September-December 2015). It was higher than in October 2020 but much lower than in the pre-pandemic month of October 2019. A situation of growing insolvency in SMEs and unemployment can further impact private consumption, even as the economy seeks to recover. The consumption-income-investment cycle will not be robust.
Serious systemic fallouts
The Covid crisis has amplified the TC vulnerabilities that had set in during demonetisation-cum-GST. The vulnerabilities include:
Drop in trust and confidence. Most significantly, a deterioration in repayment culture, and of business conventions; a kind of sociological breakdown
Large increase in late payments, debt and liquidity squeeze
Intentional delay /default in suppliers’ payments. These funds are used to finance working capital needs. The outcome is lower volume and velocity of TC which impede business growth. This affects repayments to banks.
This breakdown of the TC chain has led to a strong preference for cash sales, selective credit relations and underutilisation of bank working capital limits to feed this chain; the SBI Chairman has pointed to about 50 per cent utilisation of working capital limits by large corporates.
High TC risk makes firms focus on safety and security of their capital which prompts diversion of business funds to investment in real estate, gold and capital market.
Besides, there’s the invisible cost of the growing trust gap in TC, in terms of trade deals not effected, goods not produced and investment not undertaken, as businesses anticipate that they cannot entirely rely on counterparty commitments.
Why fragmented recovery?
Meanwhile, a bank-led recovery is not really working the way it should, owing to the dominant role of the TC system, now disrupted, in keeping the informal and small businesses running. A more functional TC system in corporate India, integrated into the bank credit network, is giving rise to dualism in the economy.
The collapse in TC flows is borne out by the high currency supply, out of sync with expectations; muted investment and industrial growth despite record low interest rates; and excessive bank liquidity. Bank-centric solutions are of limited help in this situation.
The way out
The indiscipline in TC network appears to be acquiring the nature of crowd behaviour, not dissimilar to the indiscipline that breaks out in the event of a major traffic jam where everyone decides to break the rules. The jam is cleared through police intervention.
The Government needs to intervene. It may accredit selected industry associations (IAs) and direct them to assume a leadership role in restoring institutional discipline in TC ecosystem.
Self-discipline, self-regulation, collective action against TC renegades, naming and shaming them, sharing of credit information among members and dispute settlement mechanism by IAs can offer a practical, effective solution to the TC contagion.
Their domain knowledge, peer pressure and moral authority can work more effectively and efficiently than legal remedies in trade debt recovery. Other measures may include accelerated repayments by the government/PSUs/corporates, disclosure of their payment policies, adoption of payment codes by businesses and mandated reporting of late payments.
The writer is former DGM, SIDBI