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The Big Role of Small Businesses

What is preventing SMEs from becoming Pakistan's economic backbone?
Updated 16 Apr, 2020 02:08pm

To say that the small and medium enterprise (SME) sector is the backbone of all economies worldwide is not an understatement. No country, developed or developing, has achieved sustainable and inclusive economic growth without a dynamic and thriving SME sector. While initially this was more of an intellectual policy discussion among economists as to whether large businesses or SMEs would take the lead in powering economic growth, current statistics make a definitive case in favour of the latter.

The World Trade Organisation estimates that SMEs constitute almost 90% of all business enterprises, generate between 60 and 70% of total employment and contribute an average of 55% to the GDP of developed economies across the world (source: World Trade Report 2016 Levelling the Trading Field for SMEs). As for developing economies, SMEs account for almost 99% of all businesses, are responsible for over 70% of overall employment and their share of the GDP hovers around the 60% mark. These figures demonstrate that SMEs are fundamental to the economic fabric of emerging economies and are vital in creating employment, wealth and shared prosperity. It is hardly surprising that in countries such as Brazil, China, India, Japan, Malaysia and Sri Lanka, among others, SME development has enabled them to flourish and be competitive on the world stage against far more developed and sophisticated economies.

In Pakistan, the story has been no different. The Federal Board of Revenue (FBR) estimates that SMEs are responsible for 60% of total job creation (this equates to providing 80% employment to the non-agriculture labour force), while contributing 30 to 40% to the national GDP. Perhaps even more importantly, SME output contributes around 25% to export revenues. Given these numbers, logic dictates that the SME sector would command government attention. However, the on-ground reality presents a very different picture. Until recently, the sector has been one of the most neglected in terms of policy making, resource allocation and capacity building.

Although various governments did take certain initiatives – for example, establishing the Small and Medium Enterprises Development Authority (SMEDA) in 1998 or the State Bank of Pakistan’s (SBP) attempts to create a favourable monetary framework – none of these initiatives have yielded the desired results, primarily because of the lack of a sustained, focused and strategic approach. However, the situation is not entirely bleak and, in fact, for the first time in more than two decades, there are plenty of reasons to be optimistic about the SME sector finally receiving the attention and credit (pun intended) it deserves.

Creating an Ecosystem

For SMEs to realise their potential and be competitive in national and international markets, government support is crucial. No matter how well-funded and sophisticated the private sector is, it lacks the authority to create a business environment that is supportive of SMEs. A major step in the right direction has been the current government’s announcement of several initiatives aimed at developing an SME friendly ecosystem, not least the announcement of the National SME Policy 2019. The last time such a policy was developed was 13 years ago in 2007, but was never properly implemented.

Although naysayers may argue that the National SME Policy 2019 (which is still awaiting the Prime Minister’s approval) will in all likelihood face the fate as the 2007 Policy, some programmes have already been implemented in an effort to kick-start the SME sector, not least the fact that the role of SMEDA has been re-focused in three main areas.


Firstly, SMEDA has been tasked with creating a conducive environment for SMEs. According to Mukesh Kumar, Provincial Chief-Sindh, SMEDA, this will involve lobbying the FBR and the Ministry of Finance to revise and restructure import duties on specific raw materials that may be hampering the growth of a particular local industry; for example, the ongoing negotiations between the Pakistan Soap Manufacturers Association (PSMA) and the government. Most small soap manufacturing factories have shut down or are on the brink of closure because of the imposition of a seven percent additional custom duty (ACD) on Palm Stearin (an essential raw material used in soap), as well as the ban on the import of tallow from India (a policy relaxation that has already been made for the pharmaceutical industry).

Secondly, SMEDA will focus on product, market and human development. This is important because small businesses lack the resources and expertise to identify gaps in international markets where their products or services may have a niche. This also holds true for SMEs looking to upgrade their resource capabilities in terms of installing new technology and machinery in their factories. Kumar explains that information about the associated costs of importing and installing and efficiently operating the latest technology is often difficult to obtain. SMEDA works with various industry experts to ensure that SMEs looking to move to the next level have access to the information they need. Perhaps most important of all is the role SMEDA is playing in terms of HR development. Small business owners can now benefit from subsidised one-on-one training programmes in areas such as branding, taxation, marketing, quality assurance, health and safety, and product compliance, each of which is essential in manufacturing export quality products that are viable in international markets. Perhaps more importantly, given that a substantial proportion of the estimated 4.8 million SMEs (source: SMEDA) in Pakistan are located in second- and third-tier cities, semi-rural and rural areas, SMEDA has initiated online training clinics so that small businesses and cottage industries’ remote locations can take advantage of specialised training programmes.

Thirdly, SMEDA will focus on supporting SMEs on a collective level by providing the technological infrastructure needed to improve the quality and volume of output. In the words of Kumar, “Even when small business owners have the capital to invest in automation, their risk averse mindset and fear of failure are huge obstacles. This is where SMEDA provides a crucial service by installing machinery and technological capabilities that clusters of SMEs can then benefit from.” He cites several success stories that have helped many SMEs produce export quality output, including installing a mango pulping unit in Multan, establishing a composite sports material project in Sialkot, and foundry service centres in Lahore.

Much-Needed Credit

Although both the government and SMEDA deserve appreciation for the above initiatives, there is one area that remains a major cause for concern – availability of bank credit and there are myriad reasons why SMEs continue to face a massive financial gap. Among these reasons is the fact that due to religious reasons, combined with an inherent mistrust of all financial institutions, the percentage of Pakistan’s banked population is a meagre 23% (source: SBP’s Access to Finance Survey 2015). Extrapolating from this figure, financial experts are of the view that most business owners (barring large players who constitute a mere 10% of total business ownership in Pakistan) do not use formal banking channels.


While the SBP has been active in incentivising commercial banks to increase their customer base and the size of their SME loan portfolio, the results have been disappointing. Over the last decade, the share of SMEs in the total private sector credit has declined to 7.5% (compared to 20% in Bangladesh and 29% in Turkey) from a peak of 17% in 2006. Aamir Kureshi, General Manager Head – Consumer, SME & Rural Banking, HBL, attributes this reversal to the global recession in 2008 when bank lending stalled worldwide; unfortunately for Pakistan, even after the recessionary pressures had eased off, lending to SMEs did not bounce back.

It is pertinent to point out here that SME lending is a risky proposition and the credit policies of the banks are structured to minimise risk and therefore giving loans to SMEs goes against the nature of a bank’s lending operations. Equally important, as Kureshi points out, is recognising that access to capital is not a challenge that only SMEs in Pakistan face. According to estimates by the International Finance Corporation (IFC), almost 40% of micro and SMEs in emerging economies have an annual unmet financing need of $5.2 trillion. As of 2019, in Pakistan, of an estimated 4.8 million SMEs, only about 180,000 (3.75%) have access to formal financing through the banking sector.

The three key stakeholders in this debate, the Federal Government, SBP and SMEDA, all agree that this massive gap is the dominant factor constraining both growth and scale of the SME sector. This is a major reason why the current government has set a target of increasing the number of SME borrowers from the present 170,000 to 700,000 by 2023. However, as well-intentioned as this goal may be, it is fraught with challenges.

As mentioned earlier, SME loan schemes are not the most profitable products for banks and there is no monetary incentive for them to develop products and services specifically structured to suit the needs of small businesses. Even when large banks, such as HBL, are willing to take the risk and launch SME lending initiatives, (currently, SME loans constitute seven to eight percent of HBL’s overall portfolio), they have to battle strongly held beliefs among the business community that banks give out loans at very high interest rates.

Kureshi states this not to be true. In his opinion, thanks to the regulatory incentives of SBP, the cost of capital for SMEs averages between six and seven percent and that it is not high interest rates that deter SMEs, rather it is their reluctance to deal with FBR documentation and disclose their sales and revenue figures. “Many business owners are willing to borrow capital from the informal economy at much higher rates than we do because they do not have to provide documentation or financial statements.”

Another challenge for the banking industry is that until now, SMEs have been lumped into one category, despite the fact that their financing needs are different. Since medium enterprises are viewed as more stable and can offer some collateral, most SME lending goes to them. Both Kureshi and Kumar agree that it is important to make a distinction between small and medium enterprises and devise a separate definition for each one to make it easier to set and track bank financing. To this end, SBP has proposed categorising all businesses with up to 20 employees and annual sales of Rs 100 million as small businesses and enterprises with up to 250 employees and annual sales of Rs 100-800 million as medium enterprises.


Although government approval of these new definitions is pending, Kureshi says that from this year onwards, HBL will specifically focus on the small business sector (small scale traders and mom and pop stores) through two core products. The first is Small Business Finance which caters to people who have some form of collateral and can obtain financing between Rs 10 and 15 million. The second is a product that will be launched in the next two to three months and will factor in credit and debit card usage information as well as POS data of traders and provide short-term loans of between four and five million rupees without collateral requirements. The advantage to such customers will be a quick turnaround from the time of application to receiving the loan, minimal documentation and no pressure to provide high value collateral.

The Road Ahead

Industry experts are cautiously optimistic about the potential growth of SMEs (and hopeful that the National SME Policy 2019 will be approved and implemented in the next few months), least because although previously it was the services sector that attracted the most interest and capital, now given the rupee depreciation and increase in import duties, the manufacturing sector is seen as a promising area of investment for SMEs. Furthermore, the recently negotiated free trade agreement (FTA) with China has created an opportunity for SMEs, particularly in the agro processing and food sector, to gain access to the trillion dollar Chinese market of consumption products. Another factor for optimism is that despite the absence of a dedicated Ministry of SMEs, the government has simplified a lot of regulations and compliance requirements specific to SMEs to make it easier to set up a new enterprise and reduce their cost of doing business.

However, an important area to keep an eye on is the cost of energy. Although the problem of availability of LNG has been resolved to some extent and power production capacities have been enhanced through coal and hydel projects in Tharparkar, the government has not announced any specific plan to subsidise energy costs for textile, leather, furniture, sports and surgical goods factories operating within the SME sector. This is crucial because energy costs tend to be the most expensive input for SMEs and prevent them from being cost competitive at the regional and global level. Even more important for the SMEs to thrive is the need for subsequent governments and stakeholder institutions to continue the momentum.

Ayesha Shaikh is a freelance writer. ayeshasamadshaikh@gmail com