An International Monetary Fund (IMD) report issued this year has underscored the role played by small and medium-sized enterprises (SMEs) as catalysts for economic growth and employment in the Middle East and Central Asia.
The study, entitled “Financial Inclusion of Small and Medium Enterprises in the Middle East and North Africa, Afghanistan and Pakistan (MENAP) and Central Asia (CCA)”, shows how small and medium-sized enterprises can act as catalysts for both macroeconomic growth and employment in the economies of these regions.
It also outlines the prerequisites needed to effectively include SMEs in their economies. The study holds relevance for Egypt, since the Central Bank of Egypt (CBE) launched a LE200 billion finance initiative to support SMEs with similar goals in 2016.
Under the initiative, Egypt’s commercial banks are required to allocate 20 per cent of their loan portfolios to SMEs. It came within the context of policies aimed at boosting macroeconomic growth and creating private-sector jobs. The CBE’s SME initiative aims to provide four million new jobs, according to a statement issued in 2016.
According to the IMF report, in the countries of the Middle East and Central Asia SMEs, in line with world averages, represent about 96 per cent of all registered companies and employ about half of the total labour force.
Despite this, the average share of SMEs in total bank lending in the countries of these regions totals no more than approximately seven per cent, considered to be one of the lowest in the world. In some Gulf Cooperation Council (GCC) countries in the Arab Gulf the percentage of bank lending for SMEs falls as low as two per cent.
According to a World Bank Enterprise Survey, about 32 per cent of firms in the MENAP region and 18 per cent in the CCA region report access to credit as a major constraint. This compares with a world average of 26 per cent.
The financial inclusion index for SMEs, a measure of their role in the wider economy, shows that the MENAP countries lag behind the rest of the world, with the CCA region performing slightly better. They also lag behind other countries with similar levels of economic development.
The importance of boosting the low rates of SME inclusion in these economies is underscored by the fact that small and medium-sized enterprise growth holds significant macro-financial benefits for the economy, and in some cases it can boost a country’s economic growth by one per cent, according to the report.
SME growth could also potentially create about 16 million jobs by 2025 in the Middle Eastern and Central Asian economies.
A Financial Inclusion Plan for SMEs was endorsed at the 2010 G10 Summit in Seoul as a result, that made recommendations based on the experience of countries that have been successful in boosting SME funding through bank credit.
Where this has taken place, it has been due to the existence of several prerequisites, including macro-economic stability, a limited public-sector size that does not divert the funding available for SMEs, financial sector soundness, a competitive banking sector, and, “more broadly, a competitive and open economy that can boost SME investment and demand for credit”, the summit said.
An institutional environment featuring strong governance, financial regulations, and supervisory capacity and credit information availability are also needed for SME growth, the report says.
Another important prerequisite for SME growth is a supportive business environment providing modern collateral and insolvency frameworks and legal systems that enable the adequate enforcement of property rights and contracts.
In addition to bank credit, alternative channels for SME funding can also be provided by capital markets and fintech (financial technology tools). Although these are still nascent in the MENAP and CCA regions, they could ultimately play an important role in the funding of SMEs.
A holistic approach to SME funding ranging from macro-economic to legal and regulatory practices is needed to support the sector’s growth, the IMF report says.
The potential benefits are high, since closing the SME financial inclusion gap in the emerging and developing economies could increase economic growth by an average of 0.3 per cent annually, it adds.
SMEs are the largest contributors to employment across all country income groups, and SMEs with fewer than 100 employees account for nearly half of the workforce in an average country, while small firms with fewer than 20 employees are the highest contributors to employment growth.
Employment gains are largest for small firms that are the most credit-constrained, while productivity gains are largest for medium firms that can enhance the capital intensity of their production.
SME growth is also associated with more effective fiscal policies, including better tax collection, the IMF report says, adding that MENAP and CCA countries with a high SME inclusion rate have been found to raise tax revenues more effectively.
The greater financial inclusion of SMEs is also associated with higher revenue and expenditure as a share of GDP. Monetary policy transmission and price stability appear to be enhanced when SMEs have access to formal lending and the role of interest rates in the economy increases.
Central bank aversion to inflation also increases with the financial inclusion of SMEs in the economy.
Another benefit derived from the greater inclusion of SMEs is financial stability, since the banks can better diversify portfolios and risk exposure, the IMF report says. It cautions, however, that SME credit is a relatively risky asset that can potentially lead to the unsound build-up of credit exposure.
In view of this, proper institutional safeguards must be established, including sound financial supervisory frameworks ensuring strong credit discipline and risk management standards.
Several key factors determine the extent to which SMEs can be included in the economy, the report says, including the share of public investment. In the MENAP countries, this averages 34 per cent of total investment.
The financial needs of large government and state-owned enterprises can crowd out the investment needed for SMEs, in addition to their benefiting from preferential tax treatment and easier access to credit, creating a non-level playing field for SMEs.
Macroeconomic stability is also important for SME growth, the report says, necessitating price stability and low inflation. The latter is associated with lower risk perception and stronger private-sector confidence and demand for credit.
Financial sector soundness including a competitive banking sector also positively impacts SMEs, and here the MENAP, and particularly the GCC countries, lag behind, the report notes.
Banking sector concentration, high in the MENAP region, is often associated with higher interest rates and bank profitability. This can discourage lending to smaller firms. Instead, a competitive economy is needed in which there is economic diversification and adequate infrastructure and competition within and across sectors.
This holds particular relevance for the MENAP and CCA countries, in which economic activity is often largely limited in the private sector or among a large number of firms.
Important as well are institutional aspects in which there is the strong governance and stable institutions needed to support SME access to formal financial services. Needed as well are accountability, the control of corruption and political stability.
Credit information is another key factor enabling SME access to formal financing, as are reduced collateral requirements and borrowing costs and the legal and institutional frameworks related to property rights, contract enforcement, and insolvency regimes.
Finally, policies can be adopted to develop additional alternative channels of SME financing, the report says, naming the development of capital-market instruments to mobilise savings and channel them to SMEs.
This could help to create a large and diversified investor base and promote broader capital-market development, the IMF report says.
*A version of this article appears in print in the 8 August, 2019 edition of Al-Ahram Weekly under the headline: More support for SMEs