THE assessment of the role of Small and Medium Enterprises in Pakistan is of vital importance. SME sector is the backbone of any economy, as SMEs account for 99 per cent of over 3.2 million business enterprises in Pakistan and have 35 per cent share in value addition. SMEs produce the income stream for masses located in the countryside and the capitalists associated with this activity that is generally medium or small as the name suggests. The sector has the advantage of inclusive growth that permeates deeper into the population and is more resistant to economic recessionary cycles. We talk a lot about large businesses but often ignore the engine that actually drives the economy i.e. our SME sector.
Pakistan has a huge population with a workforce estimated at 65 million, one of the largest in the world. However its economic output places it among the lower end of the middle income countries. With its population advantage and benchmarked against higher income countries, Pakistan’s SMEs certainly have the potential to contribute significantly more than their current share of about $86 billion towards GDP. The vital question shouldn’t be “what SMEs have produced?” But, what are they capable of producing both in terms of product and output? The simple answer is if they produce at their full potential and capacity Pakistan would be way ahead on economic racetrack of the world.
The SME sector is marred by issues hindering its growth which include (i) access to finance; (ii) access to inputs; (iii) access to markets for the products. Lack of sufficient number of large lead enterprises which could sustain an ecosystem of smaller SME clusters means that, most SMEs have to look towards foreign markets or compete with foreign goods in the local market for growth. Smaller businesses don’t know how to manage and scale their business beyond a very basic operational model. They have limited exposure to global best practices in design, production and quality. Pakistan’s vocational training programmes are antediluvian and do not produce the skilled force required to be globally competitive.
Globally, the major growth constraint for SMEs is information symmetries and financial inclusion. Interestingly, in a recent World Bank survey on enterprise growth constraints, Pakistani SME owners ranked electricity, corruption, court systems, crime, transportation and inadequately trained workforce ahead of access to capital. Pakistan ranking has steadily declined over the past decade and is a lowly 138th out of 189 countries in the ease of doing business Index. None the less, once a business is established, access to capital is a prerequisite for rapid growth. Pakistan lags behind all other south Asian countries in taking advantage of the formal banking sector. There are both demand side and supply side reasons for this.
On the demand side, SME owners are suspicious of the banking system and feel more comfortable borrowing from friends and family rather than banks. The majority of the smaller SMEs are not really focused on growth as for them their enterprise is a vehicle for livelihood generation only. In light of the draconian laws relating to secured lending and the high lending rates, they are averse to taking risks associated with growth and do not seek long term financing. Debt is also very expensive at 5.7percent on average; Pakistan has the highest net interest margins (added to KIBOR by banks to determine lending rate) compared to Bangladesh at 4.3percent and India at 3percent.
The problem is further compounded by the supply side constraints. Over the last five years, in spite of SBP efforts, commercial banks have reduced their investment in the SME sector. Part of the problem was the flawed handling of the government owned, specialised SME Bank which has now undergone major restructuring to improve its functioning. In the absence of a functional model they could emulate, most banks tried to create SME departments from the lens of their corporate sector legacy while experience has shown that SME lending more closely resemble consumer lending or micro lending. They did not invest much effort in developing this sector and consequently made bad investment decisions which lead to very high NPLs (30pc) in the recent past. This negative experience caused banks’ lending policies to be increasingly concentrated around minimal risk, government and lower risk, corporate lending. •
Although the banks’ financing to small and medium enterprises has risen in FY14 after being in limbo for six years but the number of borrowers declined, indicating that additional lending didn’t contribute to financial inclusion. Worse still, the share of SMEs in banks’ total financing also slipped from 5.99pc in FY13 to 5.61pc in FY14. This again shows that incremental bank financing to SMEs was slower than that for other borrowers. Banks’ exposure to the SME sector grew 13.4pc to Rs264.8bn in FY14, from Rs233.5bn in FY13. But the number of SME borrowers fell 7pc to about 134,000, according to a SBP report. The authors of the report suspect that the volumetric rise in financing, without any increase in the number of borrowers, could be due to a rise in the lending limit for medium-sized enterprises.
Most of the SME lending remains concentrated in units engaged in trading because their businesses are more documented than those in manufacturing and services. Manufacturing SMEs need to be promoted to obtain higher production in value-added agriculture and upstream and downstream industrial sub-sectors. Besides, unlike trading SMEs — a majority of whom operate from large urban centers — manufacturing SMEs are located in rural and semi-urban centers or in suburbs of large cities. Their cash flow cycle is also longer than that of trading SMEs. Thus, raising funds from informal sources is more difficult for them. Most of the banks who are working towards penetrating the SME segment should start working more efficiently on customer segmentation, risk management, products and services, organisation and human resource, delivery channels and the use of information technology to improve their lending to SMEs.
A vast majority of manufacturing SMEs either rely on costlier informal financing or defer their expansion and modernization plans for want of funds. Thus, their optimal growth potential remains unexplored.
In conclusion, the entire SME segment needs to be looked through a microscope and revamped accordingly. SMEs need to document its operations, as it will reduce if not eliminate the risk for a bank to invest in them. The banks need to provide specialized rates for SMEs which can ease in SMEs that are looking for capital to grow their business. The contribution of SMEs to Pakistan’s economy, employment and poverty reduction can be seen from the fact that the SMEs employ some 78 per cent of non-agricultural labour force and therefore a solid support network has to establish.
Manos Schizas, senior economic analyst at ACCA, conducted research to try to discern the capabilities of the finance function in SME development and his findings were that the majority of small and medium-sized enterprises in the UK are really under resourced when it comes to financial capability. Very few SMEs do any consistent business planning and relatively few of them produce regular management accounts. Surprisingly few of them have trained professionals in charge of their finances. Schizas concluded that SMEs that produce regular reports, employ financially trained staff are more likely to grow rapidly and safely. These growing SMEs are critically important because of their contributions to economy majorly because their operations are labour intensive and therefore help in sustaining employment.
It is an established fact that SMEs play a vital role in generating wealth and due to their contribution to GDP, the government of Pakistan has over time developed substantial policies to support them. The critical area of intervention remains the provision of credit to these businesses to support cash flow through the restructuring of key institutions such as the SME Bank. In addition to this the other sources of funding include micro finance banks and other medium size banks that have special schemes in place for this purpose. Nonetheless, SMEs are generally found to be short of institutional credit because of a lack of clear articulation of value proposition and business plans on their part. Despite these obstacles the future for SMEs looks bright because there are more innovative forms of funding available apart from government assistance.
—The Author is a Fellow Chartered Certified Accountant (FCCA) with more than 16 years of progressive experience in operations, financial management and expertise in telecom and IT.