Small and Medium Enterprises (SMEs) play a major role in driving the economy of a country. These entities are crucial in meeting the demand of niche markets in particular. Their role in terms of contribution to exports, production, and employment is quite substantial too. How extensive their part in economic development is can vary from one country to another. Pakistan, being a developing country, owes a significant chunk of its GDP to SMEs.
There are almost 3.3 million Small and Medium Enterprises in Pakistan. These include manufacturing units, service providers, and startups operating on various levels. SMEs employ 78% of the non-agricultural labor force, make up about 25% of manufacturing exports and over 30% of the GDP in Pakistan. The part that they play in the economy is elaborate but the attention paid to them is negligible in comparison.
The challenges that Pakistan’s SME sector is faced with and their potential remedies were also recently underscored at the Pakistan Innovative Finance Forum co-organized by Karandaaz Pakistan and The ADB Institute (ADBI). The sector’s low access to credit due to unavailability of tailored financing solutions from banks, requirement for adequate collateral, and lack of documentation and poor cash flow management on the SME part, was also discussed at length during the conference.
There are a number of limitations that SMEs face from time to time. Pakistan is a country where changing governments bring substantial economic variations. The result of these differing policies translates into inadequate progress in a field or industry. The SME sector in the country has remained largely unregulated with low financial inclusion ratios in the industry. This has given rise to a variety of problems especially when it comes to accessing financial services.
For the 3.3 million SMEs, there are 175 financial institutions in the country. In the financial market, there is significant information asymmetry in this specific sector which is a major hindrance when applying for credit and other financial services with conventional banks and other organizations. Without relevant information, credit risk assessment can’t be performed effectively which leads to banks ultimately refusing to finance them.
Around the world and even in Pakistan, SMEs face a number of challenges when determining how much risk an entity has. Since the majority of the SMEs remain outside the governmental regulation framework, financial institutions find in hard to study and evaluate them. This leads to a number of barriers being placed which include high lending rates, collateral guarantees, and complicated procedures for acquiring loans and other services from leading banks.
The potential of the SME sector in Pakistan is tremendous considering the fact that it can be brought into the regulatory framework of the country. With the availability of complete and accessible information, these organizations will be able to benefit from banking services to help grow their own entities while contributing to the growth and development of the country’s economy at the same time.
The first step on the path to improvement remains the need for constructive steps to encourage SMEs in embracing standard procedures and set principles for regulation of their operations.
The government of Pakistan has recently launched the ‘Digital Pakistan’ initiative which aims to implement digital systems in all departments across the board. This is a welcome step because it will eliminate the information asymmetry that exists in the market. Information Technology and the internet in general can be put to use in creating avenues for SMEs to reap the benefits of modern networking, enhanced processes, and access to advanced tools as well as techniques.
Power is one of the biggest challenges that a local SME is faced with. Power shortage and unscheduled load shedding continue to adversely affect productivity and profitability of small businesses. Pakistan has huge untapped potential for development of energy through renewable sources. Wind, water and solar power generation remains largely unexplored with low investment percentages. The use of green energy is beneficial in lowering cost inefficiencies and improving productivity. Switching to green energy requires initial investments which can come through banking channels. The whole issue therefore comes full circle.
The SME sector has the ability to grow beyond expectations and work wonders for the country. However, positive steps are required from both institutional and government levels to encourage this growth.