How deep-tier financing can help India’s manufacturing sector

The pandemic has disrupted India’s growing auto sector. The industry, which was flourishing in the early 2010s, recording a growth of over 10 per cent, is now struggling. In FY21, sales of all segments (two wheelers, three wheelers, commercial vehicles and passenger vehicles) were at a multi-year low. In FY11, 6,76,000 commercial vehicles were sold and in FY21 only 5,69,000. This sharp downturn is a huge setback to the millions of SMEs, who have been a crucial part of the auto value chain and are now grappling to stay afloat.

Take for instance, Ford’s recent exit from India. The company had more than $272 million in dealership investments. Its decision has put at risk over 4,000 vendors, some of whom claim that business with Ford made up 20 to 40% of their business. Simply put, this means losses worth crores, in terms of finances, raw materials and human capital.

Auto-sector MSMEs at an increased risk

Ford is just one example. In the last two years, the auto component industry declined over 30% and capacity utilization remained at roughly 60%. If we look at exports in FY21, India’s share in the global trade in auto components is a dismal 1.3% of the $1.3 trillion. Undoubtedly, several vendors of large Original Equipment Manufacturers (OEMs) have suffered setbacks due to COVID-19. Now, with everything slowly returning to normal, the auto industry will continue to face two challenges:

  • Slow recovery for demand
  • Increased supply side constraints, particularly with financing

According to Automotive Component Manufacturers Association of India (ACMA), MSMEs constitute 80% of India’s component industry, and a majority of these are tier 2 and tier 3 players. For long they have been challenged with access to timely capital, manpower and technology. Now, these issues become all the more pertinent because vehicle production is still at an all-time low, and MSMEs continue to struggle with liquidity.

Adding to their woes are challenges faced by NBFCs and banks. NBFCs who have traditionally been major lenders to the auto industry are embroiled in the ongoing liquidity crisis post the bankruptcy of Infrastructure Leasing and Financial Services impacting lending outcomes. Banks prefer to focus on financing large tier 1 vendors, due to NPA fears. This leaves out a massive chunk of MSMEs, almost 80% in the country. Not only does this lead to increased risks in supply chain distribution, but also poses risks of MSMEs shutting down.

While the situation is perhaps most stark in the auto industry, most manufacturing sectors have a similar tale to tell. Between the pandemic, existing and exacerbated systemic liquidity issues, cyclical lows and the global supply chain crisis, manufacturing SMEs countrywide are struggling. While some sectors such as pharma may have come through a little better, they too are facing challenges with the global supply chain crisis.

Understanding deep-tier financing

There’s an urgent need for capital to reach tier 2 and tier 3 vendors at timely and affordable rates. A way to achieve this is through deep tier discounting, that will ensure acceleration of capital from OEMs to tier 1 and tier 2 as well, all through a seamless automated model.

Deep-tier discounting is an effective concept. It goes beyond traditional vendor financing that focuses on large OEMs and tier 1 vendors in isolation, but instead, unlocks access to working capital for the entire supply chain of a company, allowing the buyer to deploy working capital to SMEs all the way down the value chain. This transparency also encourages financial institutions to provide working capital solutions at competitive and affordable pricing, making it easier to offer financing to the entire supply chain, even the smallest vendors/SMEs.

Enabling deep-tier financing requires all stakeholders – corporates, tier 1, 2 and 3 vendors to be on a unified platform where there’s complete transparency across levels, and information and capital flow can take place in a seamless manner. Technology plays a key role here. Once established, there will be several benefits. Buyers have clear visibility of where the liquidity gaps are and in due course, be able to pre-emptively plug those gaps to avoid any unnecessary disruption.

Finally, deep tier financing doesn’t just benefit the vendors i.e. MSMEs but large corporates as well. It allows them to optimize working capital in a similar fashion to that of vendor finance. Hence, the impact is deeper, considering all suppliers across the chain are enrolled in the program. This, in turn, allows corporates to build more resilient and sustainable supply chains, which becomes important in today’s scenario.

In a nutshell, considering all suppliers have access to finance, corporates are in a better position to mitigate risks, enabling greater profits and growth that benefit all.

(The writer is Founder and CEO, CashFlo)

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