ANOTHER effort is underway to support the country’s small and medium enterprise (SME) sector through the creation of an enabling business environment for them by knocking down longstanding regulatory and fiscal impediments hampering their growth. The objective of this effort is to enhance the role of this sector as a major player in mainstream economic development.

The effort is being led by the Small and Medium Enterprise Development Authority (Smeda) that has proposed a raft of measures in the draft SME policy to fix the regulatory framework and tax regime to create space for SMEs in the national economic development strategy.

The SME policy proposes a medium- to long-term framework spanning over 8-10 years for the development of separate regulatory and tax policies/regimes for SMEs as well as suggests the establishment of dedicated banks or financial institutions to increase their access to finance.

The draft was sent to the government for approval earlier this year and Smeda officials are expecting the cabinet to approve it in the next couple of months. The cabinet was due to consider and approve the policy in March, according to a Smeda executive who did not want to be quoted. But the Covid-19 breakout in the country has delayed its approval as the government’s focus shifted to the danger posed by the coronavirus,” he added.

Smeda authorities have requested the government to not privatise the SME Bank or even if it is sold the buyer should not be allowed to change its mandate

Smeda officials claim that they have already taken the State Bank of Pakistan (SBP), Federal Board of Revenue, Security and Exchange Commission of Pakistan, provinces and other stakeholders on board regarding its policy proposals to seek their input and support for their successful implementation once the policy is approved.

SME definition

The policy addresses the issue of multiple definitions of SMEs used by different stakeholders and stresses adoption of a single definition by all for the development and application of SME-specific regulatory regime, tax laws and prudential regulations. It categorises SMEs into three distinct groups based on the number of people employed and annual turnover – start-up, small and medium businesses.

A start-up has been defined as less than five years old, employing up to nine people with an annual turnover of Rs5 million or less. The small enterprises are the ones with 10-30 employees and turnover ranging between Rs5-20m. Businesses employing 31-150 people with a turnover in the range of Rs20-200m are categorised as medium-sized enterprises.

The acceptance of a single definition will help the government introduce separate regulatory frameworks and tax regimes for each segment as defined by the draft policy. Similarly, it will help banks develop financial products suited to the requirements of each SME segment.

“Unless we agree on a single definition, it will be difficult to frame a new regulatory and fiscal regime for the SMEs,” the Smeda official insists. Currently, different government agencies and banks define SMEs differently to suit their own purpose, instead of supporting their development.

“SMEs the world over are treated differently from large businesses and governments implement SME-specific regulatory and fiscal regimes for their development and growth to ensure their meaningful participation in mainstream economic activities. However, it is not possible to create a conducive environment for them without agreement on a single definition.”

There are almost 3.3m SMEs in Pakistan in the manufacturing, service and agriculture sectors, employing nearly 80 per cent of the non-farm labour force, making up about 25pc of the nation’s manufactured exports and contributing around 30pc of GDP. Mostly, the SMEs operate in the informal sector because of a hostile regulatory environment and unfriendly tax regime. That makes it impossible for a vast majority to access finance and acquire new technologies to grow big.

The policy seeks to address these and other issues holistically unlike isolated efforts made in the past, which have failed to bring about significant, tangible improvements in the way these businesses operate and survive.

Specialised financing vehicle

The Smeda authorities strongly believe that SME financing can not be increased without dedicated banks and financial institutions. For this purpose, they have asked the government to not privatise the SME Bank or even if it is sold the buyer should not be allowed to change its mandate.

“We have seen many efforts made in the last couple of decade to increase SME financing. The SBP has been pushing commercial banks to increase their SME portfolios by setting annual lending targets for this sector. Yet total SME financing remains 7-8pc of their total private sector credit. That shows the SBP cannot increase SME financing by ‘pushing’ the banks or changing prudential regulations; for this, you have to have dedicated institutions and banks like the SME Bank to cater to the needs of this important sector of the economy.”

In addition, the policy suggests the establishment of a hybrid fund under Smeda for the development of SMEs through equity investments on the pattern of venture capitalists, provision of grants and capital injections in the form of subsidies on bank loans. Smeda estimates it will require Rs120 billion for five years to support the SMEs in selected sectors with potential for fast growth. Officials insist the government has the option of raising funds through bilateral and multilateral lenders/donors besides making allocations in its annual public sector development programme.

Besides working to improve the overall business environment for the entire SME segment, Smeda is also in the process of selecting a limited number of new and existing sectors with potential for fast-paced growth in which it can make focused interventions. “Our experience shows that we cannot hold everyone’s hands; we have to be selective and choose sectors with the most potential for faster growth as far as our focused interventions are concerned. If our efforts are spread thinly, we will be comprising the impact of our interventions,” the official argues.

Published in Dawn, The Business and Finance Weekly, August 4th, 2020