Economically, Pakistan is experiencing a very tumultuous time, and at this crucial juncture we need to realise the significant role that small and medium enterprises (SMEs) play in buttressing the foundations of the economy. SMEs represent a very important market segment in any country since they engage or involve those segments of society that are living on relatively lower income thresholds within the economy. Public policy accords a high priority to the development of the SME sector because of its potential for generating employment, increasing incomes and reducing poverty.
Developed economies such as the US, or emerging economies like South Korea and Taiwan, are cases in point that have greatly benefitted from the development and evolution of the SME sector. Growth in these enterprises mainly resulted owing to an enabling environment for the development and growth of small and medium entrepreneurs. In order to create an enabling environment it is imperative to design exclusive policies and create regulatory space, remove fiscal and non-fiscal barriers, re-invent the basic definition of SMEs that could qualify for possible support, introduce measures to eliminate disadvantages of size, remove unnecessary regulatory burden and institute SME support mechanisms while simultaneously working to improve support delivery mechanisms.
Policy evaluation and review mechanisms have a far reaching impact in terms of generating employment and improving incomes of low-income households. However, it is essential for us to understand that the promotion of the SME sector cannot be carried out without enhancing the competitiveness of the economy and generating additional employment. Until recently Pakistan’s population has been growing at a rate of three percent annually, however, these figures have now decreased to around two percent per annum. Based on estimates, our labour force is expected to grow at a rate of over three percent annually and in order to absorb the increase in the quantity of labour that enters the market every year, it is imperative for the GDP to grow by more than seven percent. Further, we need to understand that there is a significant chunk of unused capacity in the manufacturing sector of the country. The SME sector provides the perfect platform to ensure that the unused capacity in the manufacturing sector is exploited to create greater employment and hence economic growth for the country.
Reportedly, SMEs constitute nearly 90 percent of all enterprises in Pakistan, employ 80 percent of the non-agricultural labour force and their share in the annual GDP is approximately 40 percent. Unfortunately, unlike large enterprises in the formal sector, a small and medium enterprise is constrained by financial and other resources. Therefore, in order to sustain growth of this vital sector, there should be a mechanism through which it may get support in different functions of business including technical upgradation, marketing, financial and human resource training and development.
Therefore, to facilitate this sector, it is essential that we create a favourable business environment and eliminate fiscal and non-fiscal barriers to SME growth and corporatisation by ensuring access to finance, resources and services.
While the potential for SMEs is largely underutilised due to constraints mentioned earlier, one of the principal constraints remains lack of access to financial services.
Estimates reveal that the portfolio of banks that finance SMEs has reportedly dropped from 16.2 percent in 2007 to 7.7 percent in 2011. Having worked in the microfinance market of Pakistan for well over a decade, the boundaries between microfinance and SME finance are gradually becoming blurred and the new terminology that we now increasingly refer to is MSMEs — micro, small and medium enterprises.
This represents a large potential for financial services within the emerging economies of the world and according to one estimate the total potential market for investment by financial institutions today is estimated at $150 billion and is likely to grow to $300-350 billion over the next five years. One reason why we should strongly promote the SME and microfinance sector is because an estimated 60 percent of the global banking revenue growth over the next decade lies in the emerging markets. Increasingly, banks in developing economies are finding ways to overcome the inherent difficulties to serve the MSME segment. These efforts are being facilitated through innovation in technology, risk assessment and development of business models.
Therefore, there lies a great potential, not just for local banks but international players to explore cross-border opportunities to invest in this sector. While the market potential is large it requires specialised institutions to be able to work successfully and sustain ably serve clients.
Based on global experience, some of the key elements identified for a financial institution to succeed in these markets are: developing a good understanding of the dynamics of these markets; business models need to operate efficiently offering innovation in products and services as well as ensuring efficient distribution channels; risk assessment methodologies to underwrite large volumes of relatively small ticket items efficiently and cost effectively; ensuring financial literacy for clients and ensuring appropriate government policies/financial infrastructure.
Pakistan can be placed in the emerging markets category but it has yet to actualise its potential. The microfinance bank’s framework in Pakistan provides the foundation to the country to leverage the opportunity represented by the MSME market.
The Economist Intelligence Unit Report 2011 ranks Pakistan among the top three countries in terms of business environment for microfinance and the policies and regulatory frameworks are ranked as the best. Today there are nine private sector microfinance banks operational in Pakistan under the framework. They have a presence on ground across the rural and urban areas of the country with strong ownership structures and a good insight into sector dynamics to serve these markets.
The growing confidence of the central bank in these institutions has enabled them to raise the maximum loan ceiling from Rs150,000 to 500,000 to be able to serve the low end micro enterprise market besides investing in financial literacy programmes to educate the clients. The branchless banking regulations allow financial institutions to reach scale and outreach through technology based distribution channels, thereby reducing the cost of delivery.
Khushhali Bank, being the largest microfinance institution, demonstrates the strength of the framework in terms of a large presence across the rural and urban areas of the country. It is well poised to leverage this opportunity to expand its products and services to the micro-enterprise segment of the market.
While the issues highlighted above have just one important element of ensuring financial access that will generate growth in the sector, institutions such as the Business Support Fund can play an important role in bringing together the remaining elements of the MSME ecosystem in the country. This can serve as an agent for Pakistan’s economic revival.
The writer is the president of Khushhali Bank.