SMEs – A tale of two sectors

If you commit the time to take stroll in your local city, what would you glimpse on? Multimillion firms? Top notch co-operates every corner? Obviously not. Reality is you see; compact one storied busy corners with catchy phrases ranging from “Rathna Stores” “New Lanka Groceries” “Hotel de 616” etc to small IT services outlets. These little busy corners are more formally known as small and medium enterprises of our country. SMEs in Sri Lankan terms can be stretched out upon different industries; apparel, agricultural (tea / rubber / cinnamon / cashew / coconut etc) products, export / import, services (Finance / Hotel / Other varied services ex: Salons, Motor service station etc).

SMEs play a pivotal role in improving a country’s socio economic conditions since all production activity done on domestic terms makes an important contribution to the Gross Domestic Production (GDP) of the country.

Considering the statistics, SMEs mark up to 89% of the Private Sector in Sri Lanka, which means that almost over 2/3 of the private sector comprises of firms that makes a turnover less than Rs. 600000 as per monetary criterion. On employment, 30% of the workforce is claimed by SMEs, 90% of it is on sole ownership with 25% controlled by women. Many of these firms are registered enterprises with 11% operating in the Informal sector.

In any case, the numbers as a whole look confident and it is certainly a good turn of events as it shows the potential clogged up and ready to be exploited with new SMEs added on with time. But there’s no point in increasing the number of enterprises if – from one side new SMEs are piling up onto the mountain and from the other end matured SMEs are estopped or dispersed as failures – such situations are often referred to as “economic traps” by analyst thus the crucial factor in any case is maintaining sustainability of SMEs. So how could we ensure sustainability and develop SMEs to progress beyond “small and medium” enterprises to “larger and complex entities”? How should a gradual expansion from that 10% of larger firms in the private sector to a sustainable 20 – 25% be achieved? As reflected on the quote below, this is where government intervention comes into play– but it must be noted that putting down on theory would be simple but not so simple in the works of reality.
The SME cycle in brief can be as follows:

sme
The cycle as one may comprehend would impact the entire economy because when a SME grows into a larger entity it would adversely affect domestic employment, production, tax income which would in turn benefit the economy. Many SMEs are feasible in its initiation and could be provided within the private sector itself with the assistance of financial institutions – currently a role performed by the Banking sector. But what the private sector could do is limited: hence the step of “developing” the enterprise is where government intervention is called for to play the role of “facilitator”.

On principle, many successive governments, during past budget allocations have appreciated the importance even emphasized the role played by SMEs in the economy. However, despite the countless claims of developing SMEs in budgetary ramparts, there has been continuous less interest to pursue the matter on policy implementation level. The most primary and effective incentive that a government could procure to any unit is taxes, but unfortunately, although SMEs has been reflected on fiscal policy of successive governments, when it comes to practice there has not been any tax incentive provided “specifically” to SMEs.

Of course one may dispute such by claiming upon many remedies provided in budgets; i.e incentives on custom duties (for a limited range of products) based on investment portfolios. But the problem is most of these incentives are beneficial towards that 10% of larger firms in the private sector as opposed to the 90% of SMEs. Essentially, incentives provided in past were aimed at promoting foreign direct investments via the board of investments (refer budget proposals: March 2002 / November 2004 / November 2008) this maybe partly because of the timely economic issues that governments had to tackle. Nonetheless there has been continued trend of less attention to specific issues (other than taxes) faced by the small/medium businessman such as on finance, technology, business development services, resource management etc. It is rather unfortunate that the regulator has been playing a hypocrite role of ‘politician’ on showering praises on SMEs during parliamentary speeches whilst providing incentives to another section all together.

Essentially, the state must not blindly pass the burden of developing SMEs to the private sector as it has done on previous occasions; on the contrary a pragmatic approach is required. Engaging the Banking sector can be considered as one of the countless other steps that can be taken to meet ends. It has been surveyed that 44% of small/medium firms obtained credit over the past five years, with commercial banks accounting for a bulk of such loans. Out of that 56% that did not access credit most of them didn’t apply since they had sufficient liquid cash but the rest either;

1. Found the loan application process to be too complicated, and/or
2. The interest rates and collateral requirements too high.

These are clear indications where there is a need of immediate remedy, and regulator is the entity best positioned to intervene and facilitate solutions. Essentially, in addition to taxes and finance related matters, other specific areas such as management of resources, insurance, technology updates etc must be facilitated lest organized the means of acquiring such assistance – this could be done by utilizing state resources ; (state run finance institution, special board of committee for SMEs)along with the private sector under appropriate guidance and direction.

The modern trend in economic policies is different, thus as much as foreign investments are important to a country so is the effect of SMEs, and it is high time for administration to focus on these matters. The incumbent interim government’s effort on consolidating tax revenue by restructuring the tax system and improve tax income in GDP is praise worthy and one could be tempted to conclude that we are finally on the right track – but this is too early to predict on.

In essence, the Sri Lankan SME sector has a long way to go, but with a clear path ahead to create its legacy. With a clever tax policy in place striking a balance between tax compliance improvement and growth promotion, along with the conjunct utilization of private sector and state sector resources to facilitate incentives, the Sri Lankan SME sector should be enabled to play a key role in socio economic development of the country in the years to come. But it is of paramount importance that both State and Private sectors appreciate and welcome the scope of the role they have to play in their efforts to meet ends.

“The State should be the facilitator, and the Private sector the developer of the economy”
– Hon. K. N. Choksy
(Minister of Finance: – 2001 – 2004)
(Budget Speech – March 2002)

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Yohan Cooray

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