Government Loan Design for Cash-Constrained Supply Chains

Abstract

MSMEs (Micro, Small and Medium Enterprises) play a crucial role in the economic development of many developing countries, albeit facing a number of challenges that limit their growth and success. One crucial challenge is the lack of access to affordable financing programs. A typical policy intervention is offering affordable government loans to poor or small-scale players, covering either limited or multiple supply chain tiers. Motivated by the Indian example, this paper investigates two types of government loan policies: the traditional loan policy offering the government loan only to the upstream manufacturer and the new loan policy extending the government loan to the manufacturer and the downstream retailer. We develop a game-theoretic model to characterize market equilibria under the two government loan policies and examine the impact of the loan policy change on operations and profits of such cash-constrained supply chains. Our research yields the following main insights. First, the loan policy change never hurts the upstream manufacturer. When the government loan budget is relatively large, the manufacturer is strictly better off under the new loan policy, as she no longer loses the wholesale profit due to the retailer’s credit default. Second, counterintuitively, the downstream retailer is hurt by the government loan inclusion when the loan budget is moderate due to the manufacturer’s strategic cancellation of trade credit and rise in the wholesale price. Third, the loan policy change could escalate the government deficit and hurt the supply chain profit (and even social welfare). Finally, our paper lays out several important guidelines for government loan design to enhance social welfare, including loan eligibility criteria, loan budget adjustment, forgiveness rate selection, and credit risk preference. Overall, our results underscore that government loan policy design must carefully account for the strategic responses (both operational and financial actions) of supply chain players to the policy change, in order to achieve positive societal outcomes.

Keywords: Cash-constrained supply chain, government loan, trade credit, bank financing, policy design