Financial Issues for Financing SMEs in Pakistan Essay

The small and medium sector enterprises are considered an impetus to economic growth in any country since these enterprises are mostly labour intensive and they tend to boost the employment more than any other sector. The government of Pakistan has identified the SME sector as one of the leading sectors along with agriculture and construction that can generate employment and contribute to overall economic growth. This sector in Pakistan contributes over 30 percent of the gross domestic product, 25 percent in export earnings, and 35 percent in manufacturing value addition. As per industry reports there are approximately 3. 2 million economic establishments across the country of which the SME sector contributes to 90 percent of all private enterprises employing almost 78 percent of the non-agricultural labour force. The sustained growth of this sector in Pakistan is restrained by a number of factors that include shortage of skills, inadequate leadership and management qualities, scarcity of capital goods, lack of structured data on the sector, resistance to change and difficulties in marketing products. But the biggest challenge facing the SME sector in Pakistan is the lack of adequate financing facilities. The limited access to credit has impaired the growth of this sector considerably. The banks are averse to taking risks in extending finance to the small and medium enterprises. The larger corporations face no such difficulty since the financing institutions have minimized risk due to their larger scales of operation and higher credibility in the market. The SME sectors are unable to provide adequate collateral in addition to the lack of adequate technical and managerial know-how that may affect the profitability of the business venture. For the purpose of this study the researcher has identified three prominent areas that influence the credit lending policy of financing institutions to the SME sector in Pakistan. These are political, legal and economic challenges facing the financial institutions. Statement of Objectives The Pakistan economy comprises mainly of the SMEs as suggested by the recent statistics outlined in the previous section. However, the sector suffers from a number of weaknesses that have constrained its development to its full potential. The SME sector does not have adequate access to finance from the formal sectors like large private banking corporations and financial institutions. They have to rely mainly on the credit facilities from the informal sector. The research paper intends to analyse the SME sector in Pakistan with emphasis on its growth over the past few years, the impact of this sector on the overall economic development, and the policy adopted by the government of Pakistan towards the sustainable growth of this sector. It will highlight the role of major financing institutions like International Finance Corporation, Asian Development Bank, and the State Bank of Pakistan to boost the SME sector in the country. The paper will aim to provide answers to discussion objectives raised by study of the financial strategies of the funding institutions – the challenges and risk implications of financing small and medium enterprises. The objectives identified are summarised below: †¢ What are the factors that contribute to the overall financing of businesses in Pakistan? †¢ How does the political and legal environment affect the credit lending policy of the financial institutions in Pakistan? †¢ What strategies and policies are being adopted by the government of Pakistan to combat these issues? The paper proposes to analyse the economic, legal and political environment factors that simulates the lending policy of the financing institutions in Pakistan. The study identifies the lack of proper regulatory environment that restricts the banks’ operations in terms of providing finance to the borrower. The high rate of failures of business enterprises due to slumps in the market; institutional malpractices, political upheavals and damaging acts by the labour unions have presented huge risks for the credit lending institutions. In addition to insufficient and low quality production to meet demands of local and international markets, deficit in balance of payments, and increasing unemployment have increased the risk potential for the SME sector. Research Methodology The research paper will comprehensively review the SME sector in Pakistan highlighting the market statistics, trends and policies affecting the credit availability. The study will focus on the major points tabulated below: †¢ Research on the background of SMEs in Pakistan †¢ Identify the various sources of finance available for the small and medium enterprises †¢ Analyse the political, economic and legal environment factors that influence the industry segment. †¢ Research the implications of these factors on the credit lending policy of the financial institutions. †¢ Analyse the steps taken by the government in the past few years towards meeting these challenges. †¢ Analyse the roles of the financial and regulatory bodies in the growth and development of the SME sector. †¢ Provide recommendations to the SME policy within the scope of the study objectives. The paper will also discuss the SME policy that is being followed by the Government of Pakistan through its regulating body the Small and Medium Enterprise Development Authority (SMEDA). The SME policy adopted in the past laid over-emphasis on the industrial and manufacturing activities with little focus on the service sectors. The schemes designed for small enterprise development lacked focus and did not address the core issues of enterprise development and employment growth. Political manipulation and interference led to accrual of bad loans for banks and loss of public funds. Overall they contributed little to economic growth and did very little for the employment issues. These were some of the past initiatives that led to a cautious approach by the banks and financial institutions while lending credit to the small and medium enterprises in Pakistan. Recent years have seen a significant swing in the policy of the Pakistan government towards the development and growth of this sector. The Small and Medium Enterprises Development Authority was established to boost the development of SMEs and monitor their interests with an eye to encourage and facilitate the growth of such enterprises. The paper will analyse the role of SMEDA in the past few years, the initiatives taken and the policy changes that made an impact on the SME sector. The research will evaluate the steps taken by this regulatory body to counter the challenges posed by the political, economic and legal environment to the financing of the SME sector. â€Å"The most significant step taken by the Government of Pakistan for the development of SMEs was the establishment of the Small and Medium Enterprise Bank (SME bank) to arrange for speedy financial assistance. † (Kaiser H. Naseem, the president of SME bank in an interview to PAGE). In addition to the setting up of the SME bank, Pakistan witnessed impressive changes in the SME financing sector. Global institutions like International Finance Corporation (IFC) are playing a major role in aiding the SME sector in Pakistan. It is observed by these institutions that the country needs to provide a conducive and enabling environment for SMEs to operate. They require support and assistance in order to achieve their maximum potential. Organisations like SMEDA can play a critical role in business development process, advisory support, and managerial training of SMEs. The commercial banks and financing institutions need to develop dedicated segment for servicing the SMEs. The banking institutions based on Islamic principles are providing interest free financial assistance to this sector. Based on such facts the research will outline the policies and recommendations that will help in structuring the financing of the small and medium enterprises. The research will be based on various journals, Internet articles, and textbooks related to the Small and Medium Enterprise sector in Pakistan. Explanation of Research Design The research will be based on two principal source types – qualitative and quantitative research. Data collection method: Qualitative research comprising of interviews and data gathered from other sources. The research employs data gathered from the SMEs in Pakistan taken from online resources and printed materials in the form of journals, newspaper articles and textbooks. Quantitative research that constitutes of statistical data collected from financial institutions. The study will be based on the statistical data of finance to SME sector in Pakistan collected for the past five years. This data will assist in analysing the financing trends in the recent years and help in projecting growth trends in the sector. Data processing and analysis: The outcome of the research conducted on the subject matter from various sources mentioned above will be written as a descriptive conclusion of the study conducted. The processed statistical data will be presented as graphs and pie charts for better understanding. Validity, reliability and limitations: As the information collected from various journals, newspaper reports and articles reflect the current market trend; the analysis based on the findings will be accurate and reliable. Timetable of research activities: Appendices The study will make use of facts and figures available from the published reports of State Bank of Pakistan, World Bank, Asian Development Bank, International Finance Corporation, SME Bank of Pakistan, SMEDA and other journals released by the government of Pakistan on the subject matter. References: 1. SME led Economic Growth – Creating Jobs and Reducing Poverty, Ministry of Industries, Production and Special Initiatives, Government of Pakistan – http://www. smeda. org/downloads/smepolicy2007. pdf – accessed on 2nd March 2008 2. Country overview – Pakistan, International Finance Corporation – http://ifcln001. worldbank. org/ifcext/mena. nsf/Content/Pakistan – accessed on 2nd March 2008 3. SME Sector Development (Program Loan): Pakistan, Asian Development Bank – http://www. adb. org/Documents/PIDs/34327013. asp – accessed on 2nd March 2008 4. Finance and Markets – SME Bank to play pivotal role, An interview with Kaiser H. Naseem, President SME Bank – http://www. pakistaneconomist. com/issue2002/issue5/f&m. htm – accessed on 2nd March 2008 5. SME Financing: Issues and Strategies, Ishrat Hussain – http://www. sbp. org. pk/about/speech/financial_sector/2005/SME_Financing_10_May_05. pdf – accessed on 2nd March 2008 6. SME Policy Development – Small and Medium Enterprise Development Authority – http://www. smeda. org/projects/SME-policy-development. html – accessed on 2nd March 2008 7. SME Sector, SME Bank – http://www. smebank. org/SME%20Sector. htm – accessed on 2nd March 2008 8. SME Financing: State Bank of Pakistan – http://www. sbp. org. pk/sme/index. htm – accessed on 2nd March 2008 9. President’s Address to SME Financing and Strategic Conference – http://presidentofpakistan. gov. pk/FilesSpeeches%5CPolicy%5C510200583259PMSME. pdf – accessed on 2nd March 2008 10. Pakistan announced SME policy for higher growth – http://developing8. org/page/news/17/8/2007/pakistan_announced_sme_policy_for_higher_growth – accessed on 2nd March 2008