As Msmes Face Cost Led Stress Lenders Must Assess Risk Dynamically

Across India’s industrial clusters, stress is becoming increasingly visible because of the ongoing geopolitical tensions in West Asia that have contributed to heightened volatility in energy and logistics markets. For India, which imports over 85% of its crude oil, this is a direct operating shock. The impact is most visible in the MSME sector, which contributes around 30% of GDP and employs over 110 million people, making it the backbone of the economy.In textile hubs, exporters are renegotiating contracts as freight costs rise and delivery timelines stretch. Engineering clusters are navigating input shortages. Elsewhere, small manufacturers are scaling back amid rising raw material prices. These are connected signals of a broader shift, most visible in clusters operating on thin margins and high input intensity. For exporters locked into earlier contracts, production has become economically unviable, forcing output cuts despite steady demand. These developments point to the early stages of a cost-led stress cycle within India’s MSME ecosystem.Unlike traditional credit cycles driven by over-leverage, the current phase is shaped by external disruptions feeding directly into operating costs. Logistics costs have risen materially, and raw material inflation in several input-intensive sectors has been estimated at 15–20% in some cases. For MSMEs operating on net margins of 5-8%, such increases are difficult to absorb.The impact is immediate. Cash conversion cycles are stretching from 60 days to upwards of 90 days. Working capital utilisation levels, which typically hovered around 65%, are now breaching 80-85% across parts of the MSME lending ecosystem. Requests for restructuring and tenor extensions have also begun to rise. This creates a familiar sequence: margins compress, cash flows tighten, and dependence on short-term credit increases. Credit stress here does not emerge overnight; it builds quietly in delayed payments, elongated receivables, and eventually repayment slippages.Encouragingly, policy signals suggest the current stress is being recognised early. Targeted measures to support exporters affected by logistics disruptions have been introduced. Reports suggest discussions are underway around a new credit guarantee framework, potentially in the range of ₹2-2.5 lakh crore, to support MSMEs facing liquidity pressure.India has faced a similar dynamic before. During the Covid-19 pandemic, MSMEs encountered an abrupt liquidity shock. The government’s response through the Emergency Credit Line Guarantee Scheme (ECLGS) ensured credit continued to flow. With over ₹3.6 lakh crore in guarantees extended to nearly 1.2 crore borrowers, the scheme prevented a large-scale credit dislocation. It stabilised the broader financial ecosystem. The lesson was clear: in systemic stress, liquidity is stabilisation. That lesson is relevant once again.This reflects a proactive approach, but effectiveness depends on design. The ECLGS experience offers validation and caution. While broad-based guarantees ensured speed, they also supported businesses that were structurally weak prior to the crisis. In the current environment, greater calibration is critical. The next phase of policy response must balance urgency with precision, ensuring liquidity reaches viable businesses facing temporary stress without creating long-term credit dependency.Equally important is reach. Micro and small enterprises, operating with limited buffers, remain the most exposed to cost shocks. Any framework failing to reach this segment risks diluting its impact.From a lender’s standpoint, the current cycle presents a different challenge. Stress is not yet fully visible in asset quality metrics; it is emerging in borrower behaviour. Conversations with lenders suggest that borrowers’ working capital utilisation is rising beyond seasonal norms, payment cycles are extending, and restructuring requests are increasing among stable borrowers.Simultaneously, a divergence is apparent. Formalisation has improved significantly, and MSME credit growth remains resilient despite signs of moderation. Yet formalisation does not equate to resilience. A business may be compliant and well-integrated into the formal system while operating under severe cash flow stress due to rising input costs. Traditional credit metrics, being inherently backward-looking, fail to capture this real-time shift.For NBFCs, this necessitates a dynamic approach to risk assessment. Sectoral exposure must be monitored, underwriting frameworks must incorporate external variables like commodity prices, and borrower-level cash flows require closer scrutiny. Resilience will depend less on growth and more on precision.As the RBI Governor Sanjay Malhotra recently indicated, even with near-term relief, the risk of second-round inflationary pressures remains significant. The impact of the current crisis may persist, keeping financial conditions tighter for longer.India enters this phase with structural strengths. Formalisation has accelerated, and policy responsiveness has improved. But resilience cannot be assumed. If global uncertainties persist, cost pressures will test MSME viability. Stress in this segment transmits through the credit system with meaningful impact.The difference this time may lie in preparedness. The policy framework is evolving, and financial institutions are attuned to early warnings. The task now is to act before stress becomes visible in its most obvious form. In MSME credit cycles, the real risk begins in compressed margins and shrinking cash flow buffers. By the time it reflects in asset quality, the warning signals have already emerged.(The views expressed are personal)This article is authored by Navin Kanjwani, executive director, Areion Fincap Pvt Ltd.