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SME development: Critical role of information and finance

Dr.Zaid Bakht
THE case for SME dev elopment is usually based on the following expectations about these enterprises:
More labor intensive: that is, they employ more labor relative to capital than large enterprises producing similar products. This is particularly important in capital scarce and labor abundant low-income countries like Bangladesh where workers from poor households have few employment and income opportunities.
More efficient, at least in some cases; that is they use fewer resources per unit of output, as they face factor prices closer to their social opportunity costs and consequently use more of the abundant factor.
More equitable in distributing the income that they generate. This has to do with both the more jabot-intensive produ^tbM"AfAho3$ ■ and the likelihodtfiftaf o\vners
of small firms are less wealthy than owners of large firms.
More widely dispersed geographically; that is, they are more likely to operate in towns and villages, as well as in less developed regions. This would contribute to a wider spread of the benefits of development and partly alleviate the pressure of rapid urbanization.
More scope for female employment; Given the relatively low skill and technology' content and the geographically dispersed nature of SMEs, the incidence of female employment is expected to be higher in these enterprises compared to their large-scale counterparts. This attribute would render SMEs more supportive of poverty reducing development strategies.
Although the evidence from the real world on the above mentioned expected advantages of SMEs has been a mixed one, support for SME development has remained an enduring theme in the e o n\MFH5 ri ff ^ wi d o m ro f developnienf Tins*was largely
due to the threat of rising unemployment and poverty and the failure of the agricultural and large-scale enterprise sector to absorb much of the rapidly growing labor force in the capital-poor low-income economies. However, the perspective on SME development has changed over time. Development of SME is now seen as an important element of restructuring the economy away from agriculture towards industry and service and it is acknowledged that SMEs are likely to play different roles at different stages of the economic development. The experiences of SME development in different countries provide two other qualifications. The thrust of SME development should be on modern" SMEs that have higher growth potentials compared to the "traditional" SMEs and the policies towards SME should be based on a positive, developmental attitude, seeking to aid by pionlotrnig of Ki ci o oka . -a-d a pyt aa-i o iMt'O n*e*w
circumstances and growth, rather than simply protecting the sector from larger or modern enterprises through a distorted incentive structure. If policies are anti-large rather than pro-SMEand if protective measures provide scope for reaping rental benefits, it is likely that large industrialists will create tiny units concentrated in few areas and co-opt the benefits intended for genuine small-scale entrepreneurs.
What holds back SME development?
Constraints faced by SMEs can be grouped under three broad heads: (a) policy-induced, (b) structural and (c) those relating to poor governance. The policy-induced constraints emanate mainly from controls and regulatory measures on private investment that raise transaction costs. These are more easily borne by large enterprises than by SMEs because they always contain a fixed cost dlemont. SinceTt may cost as much to arrange a license for a small transaction as for a large one, the smaller enterprises pay more as a percentage of sales, exports, or the amount borrowed. The structural constraints, on the other hand, relate to a wide range of bottlenecks experienced by the SMEs
involving access to information, finance, infrastructure, skill, technology and markets. The combined effect of these two sets of constraints is compounded by poor governance and weak public service delivery constraining the ability of business to function efficiently and
thereby reducing their competitiveness. The resulting weak enabling environment imposes a disproportionately greater impediment to small business growth.
Bangladesh has carried out wide ranging policy reforms under the rubric of structural adjustment program that included deregulation of sanctioning procedure and relaxation of other regulatory barriers, easing of import procedure, reducing trade barriers, following a market oriented exchange rate policy, and implementation of fiscal, monetary and public enterprise reforms. These reforms helped remove a large part of the policy bias against small and medium enterprises that prevailed earlier and facilitated growth ofSMEs.
The successes achieved have renewed the confidence of the policy planners in the potential contribution that the sector can make to accelerate growth and poverty reduction in Bangladesh. There is increasing realization that efforts towards development of small and medium enterprises need to be integrated with the mainstream poverty reduction strategy; and for the efforts to succeed there is need for a focused and comprehensive approach towards addressing simultaneously the policy induced constraints, the MnimifJ ( .mMrj.ni> Mid IM 0rbblFrh W remaned Tino business support services that are holding back the sector from achieving its full potentials.
This changed approach to SME development has been reflected in the pivotal role attached to the sector in the Poverty Reduction Strategy Paper (PRSP), and the steps that have already been taken by the government for implementing the SME development measures identified in the PRSP. These include (i) setting up of the SME cell within the Ministry of Industries, (ii) formulating a separate SME development policy consistent with the
measures delineated in the PRSP, (iii) formation of a high powered National Task f orce on SME development, and (iv) constitution of an Advisory Panel to guide and support the activities of the SME cell. These measures culminated in the setting up of SME foundation in July 2007 as a public-private joint undertaking. The f oundation is to deliver all promotional and administrative facilities including planning, finance, development, awareness raising, evaluation and advocacy services for the development of SME in the country.
Absence of pre-investment counseling services Guiding investment into the SME sector has to be one of the critical initial measures of SME promotion. This will require institutional provision for preinvestment counseling. This is particularly important as the SMEs, unlike their large-scale counterparts, are ill equipped to collect on their own, relevant information relating to market, demand, technology etc. Existing arrangements for collection and compilation of data that are needed to facilitate private investment are grossly deficient and the provision of investment advisory service u Airmailv iSWxistent. rrnirft m
One of the designated functions of Bangladesh Small and Cottage Industries Corporation (BSCIC) is to provide pre-investment counseling to small and cottage enterprises. For this purpose, BSCIC used to prepare project profiles of potential activities. But these profiles were not found helpful by potential entrepreneurs as they provided information of very general nature and were not based on market surveys.
The newly formed SME Foundation should provide support to upgrade the preinvestment counseling facility' of BSCIC. Project profiles
should be prepared on the basis of detailed market surveys and collection and compilation of relevant statistics. Project profiles should be sufficiently informative to be useful to the potential entrepreneur. For example, there should be information on possible sources of machinery, raw materials, marketing channels etc. The Foundation should also arrange training for BSCIC officials for providing useful pre-investment counseling.
Access to finance
In the past, government has attempted to provide small and medium enterprises with access to finance through targeted lending. But actual delivery' of institutional credit to this sector has been grossly inadequate. One of the main factors that have hampered flow of institutional finance into small and medium enterprises is banks' preoccupation with collateral based lending. Traditionally banks have used fixed asset ownership particularly land ownership as the basis for judging credit-worthiness. This puts small and medium enterprises at relative disadvantage as they often cannot put up such collateral for loan. Moreover, whatever collateral they can manage gets used up in taking the term loan leaving them with no means to ^eek working capital Joan trqm ihthdthmhl sources. Unlike‘ their large-scale counterparts they cannot use influence and contacts and solve the problem by putting up collateral of dubious valuation. Banks, on their part, also tend to be less flexible about the collateral requirement in the case of the SMEs as they perceive SME loan to be more risky and the cost of monitoring and supervision of small loans to be higher.
Various alternatives to real estate based lending have been suggested for the SMEs. Group guarantee and peer pressure, successfully used in the case of micro-finance, do not appear appropriate for SMEs as these
are mostly sole proprietorship units with capital size significantly larger than the amount typically disbursed under micro-finance. Use of assets other than land and building, such as fixture, equipment, vehicles etc as collateral is also a fairly standard practice in institutional finance but is of less use in the case of SMEs as these enterprises usually possess few such non-land assets. Sales proceeds, accounts receivable, inventory etc can be the basis of working capital loan, but this requires proper documentation of the transactions of the SMEs and close monitoring and supervision on the part of the lending institutions. Because of the informal nature of many SME transactions and high cost of small loan administration, use of such movable asset for working capital lending will involve certain difficulties.
The other major problem SME entrepreneurs face in seeking institutional finance is with regard to the preparation of the project proposal. In spite of directives from the central bank to follow standardized procedure, the loan application process has still remained lengthy and cumbersome. The entrepreneur often lacks the ability to formulate a proper project proposal. Even when he
MUeaares the proposal drawing no ourM.h- expert service* there is no guarantee that the proposal will be evaluated properly as the financial institutions themselves lack adequate capability for proper project evaluation.
Loan processing, particularly in the case of public sector banks, involves high transaction costs for borrowers in terms of time and visits needed and unofficial payments made. Because of lack of proper autonomy and accountability, the public sector financial institutions are beset with inflexibility, inefficiency, political interventions and corruption. Since the performance of the
bank officials is not properly evaluated they lack the incentive to bring larger number of suitable borrowers, particularly those in the small and medium enterprise sector, within the fold of institutional financing. They adopt a passive and inflexible attitude towards the borrowers either to avoid the risk of making an inappropriate lending or to force the borrower to make side payments for more favorable handling of the loan application.
Financial institutions can significantly reduce the risk when they are lending to SMEs without real estate based collateral if they (a) pre-screen SMEs on the basis of cash flow statements and information from business service providers and receivers to assess track records of firms and their ability to repay in future, and (b) implement close monitoring and supervision in the postdisbursement stage.
The SME Foundation as a joint venture of the public and the private sector will be well-placed to collect information on the financial transactions of the potential SME borrower for pre-screening and also support lending institutions with postlendingmonitoring.
Concluding Remarks
The current policy of mainstreaming SME ;d$velupotent wi^OC?^ poverty reduction strategy and seeking comprehensive solutions by simultaneously addressing the structural, policy induced and business support related problems has placed SME development efforts in the right track. Coopting the private sector in the process and assigning it an institutional role in policy formulation and promotional measures through the SME Foundation mark the point of departure to this renewed attempt towards the development of the SME sector in Bangladesh.
The author is Director Resarch, BIDS.