Introduction
For many MSMEs in India, credit is more than just financing—it’s the fuel that keeps daily operations running. A common way they manage this is through open-market credit, or “udhaar,” where they rely on suppliers, dealers, or financiers who allow them to pay later. While this seems flexible, fast, and relationship-based, it hides significant risks that can gradually undermine a business’s health. With rising commodity volatility, prolonged customer payment cycles, tight margins, and growing working capital needs in 2025, dependence on unstructured credit can derail profitability and stability.
What Is Open-Market Credit — and Why MSMEs Use It
Definition: Open-market credit refers to informal or semi-formal financing extended by suppliers, brokers, dealers, or local financiers without formal contracts, fixed terms, or documented interest.
How It Works in Practice: Examples include:
A supplier giving 15–45 days of payment flexibility
A dealer letting you take materials and pay “whenever”
A broker providing rolling credit based purely on relationship
A local financier offering cash on informal trust
Why MSMEs Rely on It:
Formal loans take too long, need lots of documentation, and often require collateral
Many MSMEs lack assets to pledge, so they can’t access traditional bank credit
Lack of awareness about alternative formal credit (digital credit lines, invoice discounting, etc.)
Supplier pressure: “buy from me, you take my credit terms”
It feels easy — no KYC, no bank visits, few documents
1. Hidden Interest Costs Are Much Higher Than They Appear
On the surface, udhaar can seem “interest-free,” but costs are baked into pricing.
Suppliers may raise the base price per kg or ton, especially during high demand.
They might restrict discounts, bundle slow-moving or low-quality stock, or cut the credit period.
When you calculate the effective interest rate, it can amount to 24–48% p.a. or even more.
The impact: MSMEs lose negotiating power, pay more, and their profit margin quietly erodes.
2. Unpredictable Payment Terms Create Cash-Flow Risk
There is usually no written agreement, so payment terms are fluid.
A promised 30-day credit can suddenly become “pay tomorrow,” depending on the supplier’s liquidity.
Suppliers can change their payment demands at any time due to cash pressure or market swings.
For an MSME, this unpredictability can force:
Pulling money from payroll or other obligations
Pausing raw-material procurement
Delaying dispatches, hurting customer commitments
In 2025’s tougher business environment, this uncertainty can severely strain working capital.
3. Supplier Dependency Builds Over Time
Open-market credit is deeply rooted in relationships rather than formal contracts.
Over time, the supplier may demand loyalty: “only buy from me if you take my credit.”
This constrains the MSME’s freedom:
Harder to negotiate better prices
Difficult to switch to lower-cost or higher-quality vendors
Less flexibility when market conditions change
Ultimately, the business gets locked into a less competitive and more vulnerable sourcing chain.
4. Lack of Legal Protection
Because everything is informal, there is no legal safety net:
No written repayment schedule
No documented interest or penalty clauses
No dispute-resolution mechanism
If conflict arises:
Suppliers may cut off credit
They may pressure for immediate payments
They may impose informal penalties
Since there’s no paper trail, MSMEs have limited recourse to enforce their rights.
5. Informal Penalties Are Real and Costly
Penalties for delayed payments are rarely written down—but often enforced.
Suppliers might:
Increase the price for the next order
Shorten the credit period arbitrarily
Delay dispatches until dues are cleared
Refuse to supply in urgent orders
These informal “charges” escalate especially when payment delays grow.
Because it’s not documented, MSMEs can’t challenge such penalties easily, and these costs can exceed formal loan interest.
6. Credit Terms Can Change During Market Volatility
In open-market credit, nothing is fixed: the credit amount, duration, or terms can change.
During market swings (especially in commodities like steel, copper, etc.), suppliers may:
Shorten the credit period or demand payment upfront
Tighten or stop credit entirely for smaller buyers
Increase the minimum order quantity
Impose hidden premiums to offset risk
For MSMEs, this means the supply may dry up when they need it most, or they may be forced to pay peak prices.
7. It Hinders Long-Term Growth and Building a Credit Profile
Informal credit doesn’t leave a documented repayment history.
Since there is no formal record of repayments:
Banks and fintechs can’t assess creditworthiness properly
Credit bureaus can’t record a history of reliable repayments
As a result, MSMEs may struggle to access:
Working capital loans
Overdraft/Cash Credit facilities
Invoice discounting or supply-chain finance
Government-backed schemes or higher-limit digital credit
Over time, this lack of formal credit history keeps the business small, limits tender participation, and makes future financing costlier or harder.
Bonus Reason: Hidden Commercial Costs Erode Margins
Beyond interest and penalties, udhaar can lead to other subtle losses:
Higher Product Pricing: Suppliers raise base prices to offset credit risk.
Forced Bundling: MSMEs may be compelled to take slow-moving or mixed-quality stock to maintain the credit relationship.
Advance Blocking: Suppliers may ask for advance funds to secure priority or locked pricing — this ties up working capital.
Cost of Disputes: Without contracts, any disagreement over quality or quantity can lead to rework, delays, or transport inefficiencies.
Relationship Fallout: If credit terms change or worsen, supply may be cut off, or the MSME may lose its vendor — damaging operations and reputation.
What MSMEs Should Do Instead: Safer & Clearer Credit Options
Structured supplier credit with documentation
Negotiate credit terms in writing
Define timelines, interest (if any), and penalties clearly
Trade credit platforms / Digital credit lines
Pre-approved credit for raw materials or inventory
Quick digital KYC, transparent repayment
Often lower cost than informally lending from suppliers
Bank Working Capital (OD/CC) Limits
Helps manage fluctuating cash needs
Interest on only the amount drawn
Builds credit history
Invoice / Bill Discounting
Convert pending customer invoices into cash
Reduces dependency on supplier credit
Secured or Unsecured Digital MSME Loans
Fast disbursal, minimal paperwork
Flexible repayment, clear interest structure
Helps build credit score over time
How to Transition Away from Open-Market Credit Smoothly
Audit your current credit costs: Identify hidden premiums, penalties, and cost leakages you’re paying.
Negotiate cash discounts: Offer to pay in cash in exchange for a 2–5% discount — suppliers often accept this.
Move a portion to documented credit: Start small (say, 20–30% of purchases) using formal supplier credit.
Apply early for structured credit: Engage banks, NBFCs, or digital lenders before your cash flow tightens.
Build a repayment track record: Pay reliably to create a documented credit history — this will help future credit access.
Use a simple cash-flow tracker: Monitor receivables, payables, inventory, and repayment cycles. Even a spreadsheet helps.
Diversify your supplier base: Don’t rely on just one credit-providing supplier; this reduces risk and increases negotiation power.
Impact: Why Avoiding Open-Market Credit Strengthens Your Business
Better Negotiating Power: Without credit dependence, you can compare vendors and negotiate on value, not favors.
Lower Procurement Cost: Transparent credit and cash payments let you access discounts, better rates, and bulk negotiation.
Predictable Cash Flow: Fixed repayment dates and structured credit reduce sudden cash shocks.
Financial Discipline: Formal financing encourages clean bookkeeping, documented obligations, & better control.
Creditworthiness: A formal credit record opens doors to bank loans, credit lines, and supply-chain finance.
Stronger Business Relationships: Stability and reliability make you a more credible partner to large buyers, tenders, and corporates.
Conclusion
What feels like convenient, relationship-based credit today (udhaar) can quietly cost your MSME much more in the long run. In 2025’s volatile business climate, the hidden costs, shifting terms, and lack of legal protection are no longer minor inconveniences — they can be existential risks. Choosing structured, transparent credit is not just about risk management; it’s a strategic move to build resilience, profitability, and growth.