KARACHI, Aug 17: “The SMEs (small and medium size enterprises) constitute over 90 per cent of the businesses in Pakistan, and a majority of them operate in the undocumented informal sector,” says Economic Survey 2001-02 published by the Ministry of Finance.

As in many other developing countries, the high cost of doing business in formal sector drives the SMEs into the informal sector. This is quite often not recognized by the policy-makers.

To quote Latin American social scientist Hernando De Soto, the cost of observing formal law outweighs the benefits held together by a social contract supported by the community as a whole. The disadvantage is that small enterprises in the informal sector are not connected into the formal financial and investment circuit. Yet, the small business operates efficiently.

And Hernando says: “The only organized way to integrate these social contracts into a formal property system is by building a legal and political structure, a bridge, if you will, so well anchored into peoples’ own extra-legal arrangements that they would gladly walk across it to enter this new encompassing formal social contract.”

The key issue is what can be the best articulated by quoting an old German saying, “The law must come from the mouth of the people.”

Harassed and penalized on questions regarding sources of income, the new investors/assesses want that the exemption limit for declaring the sources of investment be increased from Rs0.5 million to Rs5 million and rampant harassment be stopped. Upfront taxation of investment capital also impedes investment, say SME representatives.

The SMEs have been strongly supported by the Ministry of Industries and Production which wants that investments should be exempted from declaration of sources as well as retrospective taxation.

But the CBR holds a different view. It says section 13 requires all taxpayers to explain their sources. It ensures that investment/expenditures are made out of taxed incomes. It is this rigid view that deters investments to flow from informal to formal sector that could, in the long run, raise tax revenues by pushing up investment, production and economic growth in the formal sector.

The current prudential regulations do not support small and medium enterprises. Collateral requirement (130-140 per cent) is too high. And clean lending limit of Rs0.1 million is too low.

SME Bank has proposed separate prudential regulations for SMEs, which the State Bank, is reviewing. The State Bank is actively considering separating prudential regulations for SME Bank/DFIs and also the issue of the clean lending limit. There is no credit guarantee scheme for long-term investment by SMEs. The SME Bank has taken up the issue with the State Bank which feels that it is not advisable to have such credit guarantees as it could lead to imprudent lending by banks. SBP is asking the SME Bank to give them appropriate formulation for the issue.

To help improve the management, technical and marketing skills and access to capital, the government has set Small and Medium Enterprises Development Authority (SMEDA) and the SME Bank.

Yet the irritants/problems faced by SMEs in dealing with almost all federal ministries, utility agencies and autonomous organizations like Wapda/KESC, are a drag in the rapid growth of SMEs. According to a Board of Investment (BoI) report, these include SMEDA, SME Bank and NAB.

The nature of the problems facing the SMEs has been identified by the BoI in a working paper for a proposed meeting of President Pervez Musharraf with small and medium businessmen.

As big business has access to the corridors of power and has opportunities to rub shoulders with the government leaders, it is easier for it to get its problems resolved on one-to-one basis. The owners of SMEs are rarely provided with such an opportunity. And to quote Hernando “the extra-legal systems constitute the most important rebellion against the status quo.”

When the policy-makers challenge “extra-legal rights”, Hernando says, “the resistance will be most impressive” because the defenders “have a constituency to protect.”

In an effort to facilitate development of SMEs, the BoI approached no less than 184 trade bodies to identify irritants of SMEs and help them resolve their problems. These included 37 chambers, 125 trade associations, four organisations (SMEDA, ABC, Pak-UK and Pak-Japan) and 17 consultants and law firms. In all 94 organizations responded.

The highest number of problems/irritants faced by SMEs was with the CBR, followed by provincial governments, the finance ministry and the State Bank.

Based on the inputs and responses, the problems/irritants have been classified in the BoI working paper as: tax related matters, problems of access to capital, labour-related issues, irritants in the availability and pricing of gas and problems falling in the provincial domain. These issues were taken by the BoI with the departments concerned, and a report on their responses have been sent to the Chief Executive.