The measures the government is executing to compress demand as part of the $6 billion bailout package from the International Monetary Fund (IMF) are shrinking the space for the 4.5 million small and medium enterprises (SME) to operate.

The cost of doing business has spiked steeply because of the exchange rate depreciation, the hike in domestic energy prices, and the increase in the tax and regulatory burden resulting from the measures announced in the budget. Consequently, many are struggling to survive in the tough new business environment.

“The adjustments being made to stabilise the economy and control growing budget and current account deficits under the IMF programme are hampering business environment for the small and medium enterprises,” argued an SME analyst, who has worked closely with the government for the development of policies for this sector in the past.

“The ongoing fiscal and monetary measures, increase in regulatory burden on these enterprises as part of the government’s efforts to document the economy, and overall compression in aggregate demand due to economic slowdown and reduction in the purchasing power of consumers is contracting the space for SMEs. I see a significantly large number of small and medium businesses close down for good over the next several months,” he concluded.

‘The ongoing fiscal and monetary measures will result in a significantly large number of enterprises closing down for good over the next several months’

The Small and Medium Enterprise Development Authority (Smeda) categorises nine out of every 10 business enterprises as micro, small and medium enterprises (MSMEs), which contribute about 40 per cent to the nation’s GDP and account for 80pc of the total non-agriculture jobs.

A vast majority of these businesses operate in the informal sector to avoid regulatory burden and taxes and are facing challenges in securing bank loans owing to the lack of collateral, poor documentation and reluctance of bankers to extend credit to them.

“These are indeed very tough times for the SME sector,” asserted Mudassar Aqil, the chief executive officer of the Finca Microfinance Bank. “These enterprises will face significant challenges in the short to medium run (owing to ongoing policy adjustments).”

The analysts agree that the 30pc exchange rate depreciation in less than one year, substantial hike in energy prices, enhanced taxation and regulatory burden has sharply spiked the working capital requirements of the SMEs operating in the manufacturing, services and trading sectors.

The steep hike in the State Bank of Pakistan’s policy rate from 7.5pc to 13.25pc in the last 11 months will dampen the demand (from the SMEs) because of enhanced collateral requirements and supply (from the commercial banks because of change in their risk appetite and increased borrowing by the government to finance its deficit), resulting in a further contraction of space for the small and medium businesses.

“The cost of credit has increased exponentially which has affected the demand for credit. The change in the risk appetite of commercial banks means the SMEs now have to comply with more stringent

collateral requirements to secure loans,” pointed out Mr Aqil, who strongly advocates that the microfinance banks should be provided greater regulatory space to finance the cash requirements of the SMEs.

The share of SME financing as a ratio of total private sector credit plunged to 7.7pc in the first quarter of 2019 from 8.5pc in the last quarter of 2018 as its outstanding volume fell 8.4pc to Rs470.1bn from Rs513.5bn in the same period. The number of borrowers nevertheless rose slightly to 181,749 from 180,704 over the period.

Mostly, small and medium enterprises borrow money for meeting their short term working capital requirements, which usually accounts for almost two-thirds of their total exposure. Their borrowings for longer term fixed investments account for 25.8pc and for trade finance just above 9pc of total SME financing.

The new tougher business environment means the SBP will face a significant challenge in achieving the objective of significantly boosting SME financing in its National Financial Inclusion (NFI) strategy. The strategy aims to enhance lending to the SMEs to 17pc of the total private sector credit in 2023 — close to the regional average of around 19pc — from the present 7.7pc.

It also seeks to increase the number of SME borrowers to 0.7m out of the estimated 4.5m MSMEs operating in the manufacturing, services and agriculture sectors.

The analysts warn that the non-performing loans of the SME sector, which increased by 1.9pc to 16.6pc of the sector’s total outstanding credit portfolio during the first quarter of 2019, may see a further rise in the following months due to the massive hike in interest rates.

“The increase in the cost of doing business for the SMEs, and a general slowdown in business owing to falling aggregate demand, will adversely impact cash flows and profits as we cannot pass on the costs to our buyers. This situation could result in large scale bankruptcies and defaults,” cautioned an auto parts vendor.

In a similar situation that prevailed in the country in the aftermath of the economic and financial crisis in 2008, the NPLs of the SME sector almost doubled to Rs77bn in 2009. The NPL ratio stood at 32-35pc during 2011-14 compared with 8-13pc during 2004-08, according to a study by Karandaaz.

In order to support the small and medium enterprises in these tough times, the government should give certain incentives. These could include a new refinance scheme to provide cheaper credit to the SMEs and offer risk guarantees to commercial banks to encourage them to fund the working capital and other financial requirements of the small and medium businesses.

It will also need to reduce the regulatory burden on this sector and slash taxation to encourage the SMEs operating in the informal economy to agree to documentation of their business operations. Incentives for technology up-gradation to improve their efficiencies and productivity will also help them survive in the new environment.

The small and medium enterprises are considered the backbone of an economy because of their contribution towards exports, domestic supply chains and ability to create jobs. The downturn in the SME sector is going to deepen the economic woes of the country and result in massive job losses unless the government takes measures to help them.

Published in Dawn, The Business and Finance Weekly, August 5th, 2019