Micro, small and medium enterprises (MSMEs) contribute to the reduction of income inequalities. As on July 2024, there were around 2.74 crore registered MSME units in India , employing around 18 crore individuals, contributing to around one-third of the country’s GDP and around 45 per cent of its exports.

The transitional uncertainties of the world economy, created by Covid 19 and wars, are leading to fluctuations in prices of significant primary commodities like fuel, agriculture produce, minerals and basic metals.

MSMEs are facing heightened volatility in commodity prices. During the last five years, studies have shown that while the prices of primary commodities (used as inputs) have fluctuated between -15 per cent and 15 per cent of their long-term average, the prices of output goods fluctuated narrowly, between -2 per cent and 2 per cent.

This shows that firms are unable to pass on the fluctuations in input costs to customers.

Fluctuating commodity prices do not allow business entities to plan their activities, set their prices, forecast their sales volumes, and budget their costs.

A number of MSMEs undertake jobs that are outsourced by the major players, deliver project-related contracts, or offer generic products and services catering to the local or regional markets in India. A minority of them have their own branded or non-branded unique products offered directly in the B2B segment, enjoying an original equipment manufacturer (OEM) status.

The following significant commodity price-related vulnerabilities were identified by the authors based on a pan-India research project; the field research covered 17 States.

Vulnerabilities of MSMEs

MSMEs can neither fully pass on the commodity price fluctuations to their customers, nor negotiate fixed price contracts with their suppliers, nor negotiate price variation clauses with their customers, due to insignificant value addition to their final product.

They neither have liquid cash, nor generous lines of bank lending to stock more commodities when the prices are low. Their dependence on short-term financing coupled with sudden change in the commodity prices is creating inability to meet repayment schedules and an eternal vicious circle of borrowing and repaying, ultimately leading to distress.

They operate with very thin margins and their profits get hurt when commodity prices go up by around 5 per cent, unexpectedly. Often, they undertake orders of large corporate customers, based on average historical prices; and they procure raw materials at upwardly trending current prices.

They lack the expertise, time and interest to monitor and forecast the prices of commodities beyond the next one month. Therefore, they cannot undertake long-term fixed price contracts, losing their market share to companies which professionally manage commodity price risk.

MSMEs often prefer cash-based transactions and informal arrangements to buy primary commodities in the recycled markets to remain discreet. When the prices of commodities move against them, the suppliers either do not deliver or demand higher prices.

The following are some best practices recommended for MSMEs:

Monitor spot and future commodity prices by referring to price quotes of commodity exchanges regularly.

Focus on productivity, quality and innovation, to develop new value-added products and develop the pricing power with higher margins.

Ask large customers to provide raw materials and agree to just execute the value addition part of the order.

Consciously visualise the next one-year sales orders, to time the purchase of inventory and also to maintain inventory.

Practice complete hedging using exchange traded futures contracts to begin with.

Consider adoption of digital transactions to build a record of financial transactions that facilitates lending by channels other than banks.

MSMEs should believe that professional risk management not only protects them but also creates sustainable long-term value.

The writers are Associate Professor and Professor, respectively, at ICFAI Business School, Hyderabad