SMEs not the Cinderella of our economy******
Wednesday, 11 May 2011
Muhammad Ali
Small and Medium Enterprises (SMEs) are the backbone of the Bangladesh economy. They require special treatment. But with their graduation, Bangladesh can have sound industrial base. I have visited many a times rural areas and micro enterprises on different occasions. The success stories are amazing. They are striving for graduation. Development of SMEs should also be based on graduation of micro enterprises. The Bangladesh Bank for the first time released a 'small and medium enterprise (SME) Credit Policies and Programmes' with a disbursement target of around Tk 240 billion for the calendar year 2010. The new policy has focused on encouraging more women entrepreneurs in business and investment across the country. The central bank announced to set up a three-tier monitoring system to ensure growth of the SME sector in the country. The loans to be given to more than 60 SME sectors include light engineering, handicraft, flower, fish processing, handloom, rice-mills, jamdani, Rajshahi silk, khadi, bio-gas and compost fertiliser. Now I like to define SME in global perspective. The term SME bundles micro, small and medium enterprises and their definition and scope vary in terms of number of employees, annual turnover, capital investment, paid-up capital, etc. from country to country. The European Union defines SMEs as independent enterprises (not owned as to 25 per cent or more of the capital or voting rights by one or jointly by several enterprises) which have one to 250 employees and have an annual turnover not exceeding 40 million euros, or an annual balance-sheet total-not exceeding 271 million euros. Small enterprises have fewer than 50 employees and annual turnover not exceeding 10 million euros. It is said internationally that SMEs account for about 50 per cent of GDP and 60 per cent of employment. They are estimated to contribute between 25 and 35 per cent of world manufactured exports. According to 2003 survey, the SMEs accounts for 20 to 25 per cent of GDP and about 40 per cent (about 31 million workers aged 15 years or older) of employment in Bangladesh. About 98 per cent of industrial enterprises are SMEs accounting for 80 per cent of total employment and around 40 to 45 per cent of industrial value-addition. If we also look at the corresponding scenario in other countries, we can safely conclude that expansion of national GDP, employment, and industrial value-addition and output cannot be achieved without promoting healthy SMEs and fast and selective industrialisation. Large Industry in Bangladesh, as per Industrial Policy -2009: In manufacturing, large industry will be deemed to comprise enterprises with either the value (replacement cost) of fixed assets excluding land and building in excess of Tk 300 million or with more than 250 workers. For services, 'large industry' will correspond to enterprises with either the value (replacement cost) of fixed assets excluding land and building in excess of Tk 150 million or with more than 100 workers. Medium Industry: In manufacturing, medium industry will be deemed to comprise enterprises with either the value (replacement cost) of fixed assets excluding land and building between Tk 100 million and Tk 300 million, or with between 100 and 250 workers. For services, 'medium industry' will correspond to enterprises with either the value (replacement cost) of fixed assets excluding land and building between Tk 10 million and Tk 150 million, or with between 50 and 100 workers. If on one criterion, a firm fall into the 'medium' category, while it falls into 'large' category based on the other criterion, the firm will be deemed as in the 'large' category. Small Industry: In manufacturing, small industry will be deemed to comprise enterprises with either the value (replacement cost) of fixed assets excluding land and building between Tk 5 million and Tk 100 million, or with between 25 and 99 workers. For services, 'small industry' will correspond to enterprises with either the value (replacement cost) of fixed assets excluding land and building between Tk 0.5 million and Tk 10 million, or with between 10 and 25 workers. If on one criterion, a firm fall into the 'small' category, while it falls into 'medium' category based on the other criterion. The firm will be deemed as in the 'medium' category. Micro Industry: In manufacturing, micro industry will be deemed to comprise enterprises with either the value (replacement cost) of fixed assets excluding land and building between Tk 0.5 million and Tk 5 million, or with between 10 and 24, or smaller number of workers. If on one criterion, a firm fall into the 'micro' category, while it falls into 'small' category based on the other criterion, the firm will be deemed as in the 'small' category. Cottage Industry: In manufacturing, cottage industry will be deemed to comprise enterprises with either the value (replacement cost) of fixed assets excluding land and building of less than Tk 0.5 million, or with up to nine workers, including household members. If on one criterion, a firm fall into the 'cottage' category, while it falls into 'micro' category based on the other criterion, the firm will be deemed as in the 'micro' category. Japan defines SMEs as establishments capitalised at less than 300 million yen, employing less than 300 persons and Large Enterprises as those capitalised at more than 300 million yen, employing more than 300 persons. The industrialised countries had their own pattern of evolution of their SMEs under their own geo-political, social, traditional, environmental and natural endowment history along with the development of science and technology. The situation of individual countries may be different, but there are many things in common in their approach to strengthening their SMEs, particularly those involved in innovative technology and engineering backed by supporting legal frame, institutions and liberal fund at state initiative to maximise the inherent and acquired creativity of their citizens. The states that failed to do that in time are the economically backward countries of today. Without losing further time, we can also review others' strategies, adapt them to our need and take bold steps forward to promote SMEs to launch selective industrialisation for rapid economic development for the sustained welfare of our people. There is no doubt that SMEs need to be promoted. An aggressive campaign for SMEs with revolutionary spirit is required. The government better go all out for it. SMEs may be promoted through ensuring access of credit, tax-exemption for at least ten years (this will also mean transfer of subsidy from government to SMEs), and business development service. These aspects have been clearly spelt out by the taskforce. But one part is still missing in argument is the relationship between large industries and SMEs. If large industries are allowed to operate as complete units then SMEs will not be meaningfu1ly developed. Large industries will have backward linkage with SMEs. The industrial policy, in possible cases, clearly restrict emergence of such large industries that will not have backward linkages. This kind of forceful provision will only broaden the industrial development base. It will also create huge demand for SMEs both in rural and urban areas. This is kind of promotion of SMEs that the government can do. It has been quite evident that both private and public commercial banks are reluctant to finance SMEs. To some extent, however, the medium enterprises have access to credit. The problem virtually exists for small-scale enterprises. They have least access to credit. There is a need for specialised institution for small business or small-scale enterprises. Such institution can be established with some seed capital from the government and other commercial banks and donor agencies. The institution will also mobilise deposits and also finance small business. Their portfolio will only be small business and small-scale enterprises. Once the portfolio comprises small, medium and large enterprise loans, then the institution will gradually tilt toward medium and large enterprises at the cost of small-scale enterprises and small business. There is a positive correlation between risk and return. This is true in all markets including capital market. In order to minimise risk, lenders, based on their knowledge of risk management approaches, adopt the traditional approach of collateral and high interest rate. Lenders' concern with high risk can be easily tackled through some institutional measure credit guarantee fund or scheme. This is what the Taskforce Report (2006) had recommended. Such credit guarantee fund can solve the problem of seeking collateral from the potential borrowers. This is going to influence positively supply of finance for SMEs. But the issue of high transaction cost for the lenders can be resolved through being cost efficient and appropriate interest margin. Should lenders' be given subsidy to partially cover high transaction cost of lending? This needs to be examined. In brief, the government may (i) establish Credit Guarantee Fund or corporation, as in Japan, (ii) establish a separate bank for SMEs (the name can as well be SME Bank), (iii) encourage MFIs to become Micro Finance Banks to promote rural SMEs, (iv) link SMEs with large industries or enterprises in the industrial policy with emphatic statement of no large enterprises without backward linkages, and (v) reinsurance of credit risk of lenders in the case of SME financing. Let SMEs be the movement for widening industrial base. Let SMEs be a revolution for growth and development. This exactly what SMEs can do in Bangladesh. Recently, some banks are giving more emphasis on cluster financing. Under a recent agreement, the SME Foundation will provide a fund for Tk 20 million to a private commercial bank under their Wholesale Credit Programme. The agreement would facilitate the bank to get the fund from SME Foundation and provide it to the cluster borrowers only at 0.9 per cent interest without any security. Examples of India, China, Korea: The operating environment of SMEs in India has never been an object of envy. Despite accounting for 40 per cent of manufactured goods exports and over 70 per cent of sectoral employment, SMEs have consistently been the Cinderella of the Indian economy. The inability to revitalise the SME sector has arguably been the primary reason for India being reduced to simply admiring China's manufacturing prowess from afar. Concerns about inclusive growth will continue to ring hollow as long as this very important sector of the economy is allowed to languish. SMEs have traditionally been perceived as a lending risk by financial institutions, which have made it extremely difficult for them to borrow in both domestic and international markets. While the Reserve Bank of India moved to relax lending rules in 2008, it left the actual decision to lend to individual banks, which have yet to shed their earlier misgivings. The result is: SMEs tend to be highly undercapitalized and characterised by pervasive technological obsolescence. Following the economic recovery of the past two years, SMEs increasingly have to contend with another problem: rising wage inflation. Nominal wages in the industrial sector are estimated to have gone up by 23 to 28 per cent in recent months, which is squeezing the already precarious situation of the SMEs. As expected, sharply rising wages have resulted in a high employee turnover, which sharply reduces the incentive for employers to invest in augmenting skill levels through on-the-job training. Studies across the board indicate that the employers are able to capture a significant proportion of the returns from training only if it is firm-specific in nature. In the case of more general training, the returns accrue to the employee. Given that not many SMEs are engaged in niche activities, it is not surprising that few SMEs invest in developing human capital, if at all. The exception to the generally bleak scenario in which SMEs are concerned is the new generation of upcoming "boutique" SMEs in design, systems integration and testing and even manufacturing. These firms, though small, are classified as "high tech" and do not suffer from the same funding constraints as the traditional SMEs. This is due to greater access to private equity and venture capital funding. Several of these SMEs have been set up by returning expatriates and are well embedded in global knowledge networks. The SME sector in India is characterised by increasing duality, though the new SMEs are currently outnumbered by the traditional SMEs. Clearly, SMEs need more policy support and hand-holding by larger firms and the financial sector. The measures announced in the recent budget to this end were disappointing. So SMEs would have to contend with wage inflation in the foreseeable future. However, given the prevailing macroeconomic situation, dedicated government support by way of greater credit availability, facilitating technology transfers and harnessing the benefits of agglomeration economies could make a noticeable difference to SME performance. The problem of integrating SMEs with the broader economy is by no means unique to India. Countries that faced comparable problems - such as Korea and China - are aggressively addressing the issue. India simply cannot afford not to. In line with the above scenario, we can assert that there is need to double the contribution of SME sector to gross domestic product (GDP) for helping Bangladesh achieve mid-income country status. Presently, the country's SME sector contributes about 25 per cent to the country's total GDP. The rate has to be enhanced to at least 50 per cent. There is no alternative to develop our SME sector if we like to upgrade our economic strength through increasing the purchasing capacity of our teeming millions and we have to move to that direction under the discerning policy framework of Bangladesh Bank. The writer is the Managing Director of Social Islami Bank Ltd
Small and Medium Enterprises (SMEs) are the backbone of the Bangladesh economy. They require special treatment. But with their graduation, Bangladesh can have sound industrial base. I have visited many a times rural areas and micro enterprises on different occasions. The success stories are amazing. They are striving for graduation. Development of SMEs should also be based on graduation of micro enterprises. The Bangladesh Bank for the first time released a 'small and medium enterprise (SME) Credit Policies and Programmes' with a disbursement target of around Tk 240 billion for the calendar year 2010. The new policy has focused on encouraging more women entrepreneurs in business and investment across the country. The central bank announced to set up a three-tier monitoring system to ensure growth of the SME sector in the country. The loans to be given to more than 60 SME sectors include light engineering, handicraft, flower, fish processing, handloom, rice-mills, jamdani, Rajshahi silk, khadi, bio-gas and compost fertiliser. Now I like to define SME in global perspective. The term SME bundles micro, small and medium enterprises and their definition and scope vary in terms of number of employees, annual turnover, capital investment, paid-up capital, etc. from country to country. The European Union defines SMEs as independent enterprises (not owned as to 25 per cent or more of the capital or voting rights by one or jointly by several enterprises) which have one to 250 employees and have an annual turnover not exceeding 40 million euros, or an annual balance-sheet total-not exceeding 271 million euros. Small enterprises have fewer than 50 employees and annual turnover not exceeding 10 million euros. It is said internationally that SMEs account for about 50 per cent of GDP and 60 per cent of employment. They are estimated to contribute between 25 and 35 per cent of world manufactured exports. According to 2003 survey, the SMEs accounts for 20 to 25 per cent of GDP and about 40 per cent (about 31 million workers aged 15 years or older) of employment in Bangladesh. About 98 per cent of industrial enterprises are SMEs accounting for 80 per cent of total employment and around 40 to 45 per cent of industrial value-addition. If we also look at the corresponding scenario in other countries, we can safely conclude that expansion of national GDP, employment, and industrial value-addition and output cannot be achieved without promoting healthy SMEs and fast and selective industrialisation. Large Industry in Bangladesh, as per Industrial Policy -2009: In manufacturing, large industry will be deemed to comprise enterprises with either the value (replacement cost) of fixed assets excluding land and building in excess of Tk 300 million or with more than 250 workers. For services, 'large industry' will correspond to enterprises with either the value (replacement cost) of fixed assets excluding land and building in excess of Tk 150 million or with more than 100 workers. Medium Industry: In manufacturing, medium industry will be deemed to comprise enterprises with either the value (replacement cost) of fixed assets excluding land and building between Tk 100 million and Tk 300 million, or with between 100 and 250 workers. For services, 'medium industry' will correspond to enterprises with either the value (replacement cost) of fixed assets excluding land and building between Tk 10 million and Tk 150 million, or with between 50 and 100 workers. If on one criterion, a firm fall into the 'medium' category, while it falls into 'large' category based on the other criterion, the firm will be deemed as in the 'large' category. Small Industry: In manufacturing, small industry will be deemed to comprise enterprises with either the value (replacement cost) of fixed assets excluding land and building between Tk 5 million and Tk 100 million, or with between 25 and 99 workers. For services, 'small industry' will correspond to enterprises with either the value (replacement cost) of fixed assets excluding land and building between Tk 0.5 million and Tk 10 million, or with between 10 and 25 workers. If on one criterion, a firm fall into the 'small' category, while it falls into 'medium' category based on the other criterion. The firm will be deemed as in the 'medium' category. Micro Industry: In manufacturing, micro industry will be deemed to comprise enterprises with either the value (replacement cost) of fixed assets excluding land and building between Tk 0.5 million and Tk 5 million, or with between 10 and 24, or smaller number of workers. If on one criterion, a firm fall into the 'micro' category, while it falls into 'small' category based on the other criterion, the firm will be deemed as in the 'small' category. Cottage Industry: In manufacturing, cottage industry will be deemed to comprise enterprises with either the value (replacement cost) of fixed assets excluding land and building of less than Tk 0.5 million, or with up to nine workers, including household members. If on one criterion, a firm fall into the 'cottage' category, while it falls into 'micro' category based on the other criterion, the firm will be deemed as in the 'micro' category. Japan defines SMEs as establishments capitalised at less than 300 million yen, employing less than 300 persons and Large Enterprises as those capitalised at more than 300 million yen, employing more than 300 persons. The industrialised countries had their own pattern of evolution of their SMEs under their own geo-political, social, traditional, environmental and natural endowment history along with the development of science and technology. The situation of individual countries may be different, but there are many things in common in their approach to strengthening their SMEs, particularly those involved in innovative technology and engineering backed by supporting legal frame, institutions and liberal fund at state initiative to maximise the inherent and acquired creativity of their citizens. The states that failed to do that in time are the economically backward countries of today. Without losing further time, we can also review others' strategies, adapt them to our need and take bold steps forward to promote SMEs to launch selective industrialisation for rapid economic development for the sustained welfare of our people. There is no doubt that SMEs need to be promoted. An aggressive campaign for SMEs with revolutionary spirit is required. The government better go all out for it. SMEs may be promoted through ensuring access of credit, tax-exemption for at least ten years (this will also mean transfer of subsidy from government to SMEs), and business development service. These aspects have been clearly spelt out by the taskforce. But one part is still missing in argument is the relationship between large industries and SMEs. If large industries are allowed to operate as complete units then SMEs will not be meaningfu1ly developed. Large industries will have backward linkage with SMEs. The industrial policy, in possible cases, clearly restrict emergence of such large industries that will not have backward linkages. This kind of forceful provision will only broaden the industrial development base. It will also create huge demand for SMEs both in rural and urban areas. This is kind of promotion of SMEs that the government can do. It has been quite evident that both private and public commercial banks are reluctant to finance SMEs. To some extent, however, the medium enterprises have access to credit. The problem virtually exists for small-scale enterprises. They have least access to credit. There is a need for specialised institution for small business or small-scale enterprises. Such institution can be established with some seed capital from the government and other commercial banks and donor agencies. The institution will also mobilise deposits and also finance small business. Their portfolio will only be small business and small-scale enterprises. Once the portfolio comprises small, medium and large enterprise loans, then the institution will gradually tilt toward medium and large enterprises at the cost of small-scale enterprises and small business. There is a positive correlation between risk and return. This is true in all markets including capital market. In order to minimise risk, lenders, based on their knowledge of risk management approaches, adopt the traditional approach of collateral and high interest rate. Lenders' concern with high risk can be easily tackled through some institutional measure credit guarantee fund or scheme. This is what the Taskforce Report (2006) had recommended. Such credit guarantee fund can solve the problem of seeking collateral from the potential borrowers. This is going to influence positively supply of finance for SMEs. But the issue of high transaction cost for the lenders can be resolved through being cost efficient and appropriate interest margin. Should lenders' be given subsidy to partially cover high transaction cost of lending? This needs to be examined. In brief, the government may (i) establish Credit Guarantee Fund or corporation, as in Japan, (ii) establish a separate bank for SMEs (the name can as well be SME Bank), (iii) encourage MFIs to become Micro Finance Banks to promote rural SMEs, (iv) link SMEs with large industries or enterprises in the industrial policy with emphatic statement of no large enterprises without backward linkages, and (v) reinsurance of credit risk of lenders in the case of SME financing. Let SMEs be the movement for widening industrial base. Let SMEs be a revolution for growth and development. This exactly what SMEs can do in Bangladesh. Recently, some banks are giving more emphasis on cluster financing. Under a recent agreement, the SME Foundation will provide a fund for Tk 20 million to a private commercial bank under their Wholesale Credit Programme. The agreement would facilitate the bank to get the fund from SME Foundation and provide it to the cluster borrowers only at 0.9 per cent interest without any security. Examples of India, China, Korea: The operating environment of SMEs in India has never been an object of envy. Despite accounting for 40 per cent of manufactured goods exports and over 70 per cent of sectoral employment, SMEs have consistently been the Cinderella of the Indian economy. The inability to revitalise the SME sector has arguably been the primary reason for India being reduced to simply admiring China's manufacturing prowess from afar. Concerns about inclusive growth will continue to ring hollow as long as this very important sector of the economy is allowed to languish. SMEs have traditionally been perceived as a lending risk by financial institutions, which have made it extremely difficult for them to borrow in both domestic and international markets. While the Reserve Bank of India moved to relax lending rules in 2008, it left the actual decision to lend to individual banks, which have yet to shed their earlier misgivings. The result is: SMEs tend to be highly undercapitalized and characterised by pervasive technological obsolescence. Following the economic recovery of the past two years, SMEs increasingly have to contend with another problem: rising wage inflation. Nominal wages in the industrial sector are estimated to have gone up by 23 to 28 per cent in recent months, which is squeezing the already precarious situation of the SMEs. As expected, sharply rising wages have resulted in a high employee turnover, which sharply reduces the incentive for employers to invest in augmenting skill levels through on-the-job training. Studies across the board indicate that the employers are able to capture a significant proportion of the returns from training only if it is firm-specific in nature. In the case of more general training, the returns accrue to the employee. Given that not many SMEs are engaged in niche activities, it is not surprising that few SMEs invest in developing human capital, if at all. The exception to the generally bleak scenario in which SMEs are concerned is the new generation of upcoming "boutique" SMEs in design, systems integration and testing and even manufacturing. These firms, though small, are classified as "high tech" and do not suffer from the same funding constraints as the traditional SMEs. This is due to greater access to private equity and venture capital funding. Several of these SMEs have been set up by returning expatriates and are well embedded in global knowledge networks. The SME sector in India is characterised by increasing duality, though the new SMEs are currently outnumbered by the traditional SMEs. Clearly, SMEs need more policy support and hand-holding by larger firms and the financial sector. The measures announced in the recent budget to this end were disappointing. So SMEs would have to contend with wage inflation in the foreseeable future. However, given the prevailing macroeconomic situation, dedicated government support by way of greater credit availability, facilitating technology transfers and harnessing the benefits of agglomeration economies could make a noticeable difference to SME performance. The problem of integrating SMEs with the broader economy is by no means unique to India. Countries that faced comparable problems - such as Korea and China - are aggressively addressing the issue. India simply cannot afford not to. In line with the above scenario, we can assert that there is need to double the contribution of SME sector to gross domestic product (GDP) for helping Bangladesh achieve mid-income country status. Presently, the country's SME sector contributes about 25 per cent to the country's total GDP. The rate has to be enhanced to at least 50 per cent. There is no alternative to develop our SME sector if we like to upgrade our economic strength through increasing the purchasing capacity of our teeming millions and we have to move to that direction under the discerning policy framework of Bangladesh Bank. The writer is the Managing Director of Social Islami Bank Ltd