Small and medium enterprises (SMEs) constitute more than 90 percent of all businesses and significantly contribute towards economic growth in any country. SMEs contribute to development in multiple ways: create employment for an expanding labour force, provide much needed flexibility and innovation in the economy, and contribute to value-addition in GDP. In Pakistan also, more than 90 percent of business establishments are SMEs that collectively contribute more than 40 percent to GDP.
The government has identified the SME sector to focus for growth and constituted National Coordination Committee (NCC) on SME Development with the objective to facilitate development and promotion of SMEs in the country. It also approved National SME Policy Action Plan 2020 to provide much-needed support to SMEs and focuses on key areas including access to finance, business development services, skills and human resource, technology, market access, infrastructure and entrepreneurship. Key recommendations proposed under the Action Plan include simplification of rules, regulations and taxation regime, programmes for SME access to credit, SME quota in public procurement, simplification of SECP procedures, facilitation to participate in international fairs and exhibitions on subsidised rates and developing SME data bank to bridge information gap.
Indeed, SMEs can spur a country’s growth for two reasons. First, integrating proven practices and technologies is faster and safer than testing new ones, and SMEs have a large adoption gap to close. In the same way that emerging markets can grow faster than high income markets by adopting tested technologies, SMEs can grow faster than large companies by adopting the proven technologies and practices of larger enterprises.
Second, start-ups, which are a critical subsegment of SMEs, have become important sources of innovation. Because they are unhindered by legacy systems and outdated strategies, new market entrants are often able to rethink established practices and cut through traditional industry boundaries.
There is however a need to create a thriving ecosystem of small and medium-size enterprises. When enabled by a business friendly environment and open markets, large companies can thrive; however, it is not as simple for SMEs as they face a broad range of unmet needs. The limited size of many SMEs means they have difficulty accessing capabilities and resources that would make them more productive, including talented individuals with the latest knowledge of technology, finance, and managerial practices. Furthermore, many SMEs are recent businesses, which, when combined with their small scale, makes them a weaker counterpart for many standard market players, not only in terms of funding access but also for customers who might perceive small suppliers as too risky.
There is a need for understanding and improving the SME ecosystem through pursuing a targeted approach to serving various SME subsegments. Specifically, they should focus on promoting three characteristics of a healthy and well-performing SME ecosystem: boosting the business confidence of SMEs, enabling the growth of SMEs, in general and for high performers, and increasing the competitiveness of SMEs
SMEs typically fall into broad but specific categories: these include start-ups, growing medium-size companies, locally focused small businesses, and informal microbusinesses. While it is important to consider each of these categories and design various resource support initiatives accordingly, it is most critical to prioritise limited resources on those categories with the highest potential for economic impact, with programmes tailored to their specific situations.
In case of most banks and funding institutions, medium-size companies are often priority categories as even though medium-size enterprises make up only 2 to 3 percent of all companies, they account for about 30 percent of GDP and employment in most countries. This can vary by country, of course. A country like Pakistan will have millions of people employed in the informal sector or in small businesses in rural areas as well.
However, when it comes to priority, more focus would be required on innovative start-ups and medium-size companies to drive the biggest economic impact. The country’s economic-development strategy should guide the prioritisation. For example, as in case of Pakistan, where export growth is a priority, medium-size companies operating in tradable goods and services must take precedence. Providing the right levels of support to small and medium-size enterprises, government institutions and banks need to reflect a good understanding of SME subsegments so as to better tailor their programmes to meet SMEs’ unmet needs. As such this is critical to focus towards bridging the productivity gap that these SMEs face today which in itself can significantly spur economic and export related growth.
In case of SME growth and development, entrepreneurial culture and education are also important in increasing the development and survival rates of start-ups. Many ideas are never prototyped or converted into a business plan. Risk aversion, fear of failure, and lack of capabilities can be just as significant barriers as lacking the regulatory and institutional support. Entrepreneurs around the world choose major start-up hubs to launch their businesses, seeking an innovative environment, access to financing, and business support. Many governments have prioritised turning one or more of their cities into a start-up hub, by either branding the city as a start-up hub or supporting start-up campuses. As governments attempt to enable or develop start-up hubs, they can focus on some of the toughest challenges entrepreneurs typically face—navigating the administrative requirements to start and run a company, accessing the competencies needed to run a business, and being able to afford the launch of a start-up as well as the costs of operating in a start-up hub.
The most critical problem however, with SMEs being underserved is, when it comes to banking credit. Some subsegments are deemed too risky for banks’ appetites while other subsegments have access to loans that have higher interest rates than their true risk profile. In reality, SME loans can actually be more profitable than large firms for lenders provided there is an effective risk management strategy in place. A widely used programme to resolve this is a credit guarantee scheme (CGS), which aims to reduce the cost of potential defaults by guaranteeing part of the repayment of SME loans. CGSs have significantly increased SME credit access, with existing and running public and private credit guarantee schemes in nearly 100 countries. Pakistan has more recently focused on outlining effective policy measures to support SME funding. Recently, a circular has been issued on SME Asaan Finance (SAAF) scheme where SBP has sought expression of interests (EoIs) from banks/ FIs.
Under SAAF, SBP will offer both refinance and credit guarantees for three years. This will be a somewhat unique and hopefully, if managed effectively, successful initiative. Banks have traditionally approached SMEs through a conventional relationship-based lending model whereas typically such funding is better implemented through a sector driven programme lending approach similar to retail lending programmes. As per estimates, till date only Rs141 billion loans are extended to SEs within SMEs with an estimated 115,000 unique borrowers. These also include loans from government schemes which reflects the dismally low banking sector credit penetration within this sector.
The SAAF initiative would allow refinancing window to banks at a very low 1 percent cost of funds and credit guarantee model of 40 to 60 percent of the portfolio and would therefore be an attractive proposition for banks who have traditionally shied away from this segment citing lack of documentation and collateral concerns. Ideally SBP can expect a large number of borrowers to benefit and create an SME lending portfolio through this scheme in excess of Rs60 billion in three years.
The government through various initiatives can help SMEs capitalise not only on growth but also target productivity improvement opportunities. The potential of SMEs’ growth and increased productivity can be significant to spur the economic growth agenda for the coming years.
The writer is a staff member