ISLAMABAD: A report of the Asian Development Bank (ADB) has said the potential annual market for supply chain finance (SCF) in the Central Asia and Caucasus region is relatively large, up to $18 billion in the medium term, and to harness this potential, the State Bank of Pakistan (SBP) is developing a framework to cover SCF.

Pakistan is the market with the highest potential in the region.

Its GDP in 2022 was $376.5 billion. If factoring volume reached a penetration rate of 2.4pc, the average in similar markets, the potential factoring volume could be as high as $9 billion, the report said.

There is no specific law covering SCF in Pakistan, and current regulations have few limitations on the adoption of factoring or reverse factoring – lack of legal structures around non-recourse factoring and inability to use e-invoicing and others.

ADB says Pakistan has highest potential in region

Several factors restrict the full development of SCF in this market. The legal framework needs to adapt to accelerate the use of e-invoicing and facilitate various products of SCF. Moreover, the current tax law requires payment to be made directly to the seller to obtain tax credits, which renders SCF product operations untenable.

The ADB cautioned that the growing demand for Islamic banking products is also creating hurdles for the development of SCF. Despite encouragement by the government and the State Bank, the country’s banks are still cautious about offering SCF because of a lack of clarity in the regulations and low awareness of the nuances of SCF, the report said.

The market for SCF in Pakistan is relatively new, but has been growing gradually, largely because of strong government initiatives since 2017. Banks and regulators have benefited from knowledge sessions and webinars on SCF done by multilateral development banks such as ADB.

A few banks have started offering factoring and reverse factoring products, which were developed with the support of the International Finance Corporation (IFC).

The main SCF products currently offered in Pakistan are domestic factoring, known locally as “invoice discounting”; and reverse factoring, often referred to as “supply chain finance.”

Market volumes, especially for reverse factoring, are small but growing.

There is high suppliers’ interest in these products mitigating challenges of supplier education.

Notwithstanding that, significant challenges to accessing technology and enablingplatforms, as well as fulfilling various compliance andknow-your-customer requirements, persist in themarket.

As per the estimates of the Small and Medium Enterprise Development Authority, there are more than 5 million SMEs in Pakistan. SMEs contribute 40 per cent of the country’s GDP and 25 per cent to its overall exports. Therefore, the National Financial Inclusion Strategy in 2017 set out a plan for SME finance, which included SCF.

Supply chain finance (SCF), with various techniques under that umbrella term, has grown rapidly in recent years, providing access to working capital finance to small and medium-sized enterprises (SMEs) involved in global supply chains. Although various forms of SCF are now commonly used in developed markets, with a notable contribution in certain emerging markets, adoption and acceptability of SCF tools took years, and even decades, to develop. SMEs are the main economic drivers in many countries in developing Asia, but they often struggle to obtain adequate financing, including trade-related financing.

As per trade finance gap study of ADB in 2021, the global trade finance gap is estimated at $1.7 trillion. This estimate for the gap likely increased to at least $2 trillion in the following years because of heightened economic and financial uncertainties. The study also highlights that 40pc of the trade applications rejected by banks are from SMEs.

The SCF could help bridge this gap, but it is still nascent in many economies in the region.

Published in Dawn, July 6th, 2023