Christine Wallich and Arlene Tadle
¡¡¡¡The development of small and medium sized enterprises
(SMEs) has always been the focus of national governments and international
and regional development agencies. Unfortunately, traditional efforts
to provide credit finance for their development are now seen to have been
rather ineffective. What is needed is a more market based approach, backed
up with an appropriate policy environment, stronger financing institutions,
the availability of business advisory services and equity and other market-based
financing. The article discusses these as they apply in the Asian region.
Overview
¡¡¡¡Small and medium sized enterprises (SMSs) are
important providers of employment in most less developed countries and
can contribute to poverty alleviation. However, many now agree that traditional
approaches to SME development, focussed as they have been on providing
credit, have not worked, and that a new, more market based approach is
needed.
¡¡¡¡In this article we present a new paradigm for
promoting SME development. We conclude with a discussion of the significance
of information and communications technology (IT) and the internet in
SME development, and the role of international financial institutions
(IFIs) in exploring IT potential.
Employment, growth, and poverty reduction
¡¡¡¡SMEs have traditionally been perceived as major
generators of emloyment, especially outside urban centres. These small
firms create jobs that use labor, the main asset of the poor. Promoting
SMEs can help improve the distribution of income and can contribute to
poverty reduction. In addition, in most low income developing countries,
SMEs are the emerging private sector, and form the base for private sector
led growth. Growth depends on productive investments and on the use of
skills by poor people. And in both rural and urban areas, private sector
employment in the formal and informal sectors is a major source of economic
support for workers and their families.
Outward oriented strategy
¡¡¡¡Of course, overall economic strategies also make
a difference: inward looking, projectionist policies lead to poor resource
use and do not encourage the adoption of new technologies. In contrast,
countries that have adopted out ward looking, market oriented policies
have grown faster and have made relatively greater strides in reducing
poverty. What does this mean for SMEs? The experiences of developing countries
over time consistently show the positive relationship between outward
oriented (export) trade strategy and economic growth. And the driving
force of an outward oriented strategy, especially in highly populated
labor intensive countries is a dominant (though not exclusive) network
of small and medium private business enterprises. In Taiwan, for example,
the average return on capital in SMEs is almost three times higher than
in large, capital intensive state owned enterprises; and about twice as
high as in small, very labor intensive household enterprises.
New thinking after the crisis
¡¡¡¡The Asian crisis seriously affected the SME sector.
The reduction in aggregate demand for goods and services resulted in a
general decline in sales and lower output. Many small enterprises, weakened
by the crisis, had to fold up eventually. The remaining ones were faced
with high market interest rates. Worse, the liquidity crisis in the financial
sector resulted in banks becoming more averse to risk, which further reduced
the supply of capital to SMEs, However, it has been realized that the
continuing presence of small businesses providing low wage jobs across
the crisis affected countries has reduced the impact of the crisis on
the poor. This phenomenon has generated renewed interest in SMEs.
Traditional approaches
¡¡¡¡Throughout Asia and elsewhere, SMEs have been
the recipient of numerous support programmes from various sources, including
governments and international agencies. The Asian Development Bank's (ADB)
first loan was a line of credit to a Thai development finance institution
for on lending to SMEs in the private sector. Assistance has often been
justified on of income. Often credits were provided with subsidized interest
rates or credit guarantees through development banks, private banks credit
unions, mutual savings and finance associations.
¡¡¡¡This approach reflected the prevailing view that
a high cost of credit was the primary constraint faced by SMEs. At other
times, assistance in the form of non-financial services through public
institutions or NGOs were also provided by governmental and donors alike,
in various forms such as training to labor and management, counselling,
marketing and information, and technology development.
¡¡¡¡But the performance of SMEs varied across countries.
While Taiwan and Korea were success stories, the experience of other countries
was less than satisfactory. An assessment of SME assistance in the Philippines,
Sri Lanka, and Ecuador showed mixed results.
¡¡¡¡In Sri Lanka, the SME strategy aimed at:
Engaging the government in a dialogue about the efficacy of economic policies
for trade and the appropriate roles of the public and private sectors;
Restructuring the financial sector from one that serviced a centrally
planned industrial economy, favouring large enterprises, into one that
responded to the needs of the entrepreneus; and
Generating jobs
¡¡¡¡The attention given to the policy distortions that impeded the financial
sector helped develop a more diversified, private sector oriented economy,
a more effective financial infrastructure, and generated a significant
number of lower paying jobs. However, the overall performance of the SME
sector was less than satisfactory mainly because the enabling environment
remained weak.
In the Philippines, support for SMEs was done through lines of credit
retailed as sub loans to eligible enterprises. Such financing may have
resulted in more jobs, but these did not benefit the very poor, boost
exports, or shift the location of the industries, which were the stated
objectives of the assistance in the first place. In Ecuador, the instrument
used was provision of long term credit at fixed interest rates, as well
as the creation of an apex institution supporting SMEs. But the highly
distorted economic environment in the country during most of the program's
implementation highly negative real interest rates, along with regulated
wages and a heavily protected industrial sector meant that the loans could
not have the desired impact of greater employment. Small firms receiving
credit tended to be over capitalized and less labor intensive than of
other firms.
Why the old approach never worked
¡¡¡¡Views on how small enterprises can be best assisted
are changing and gathering momentum. Increasingly, questions are being
raised (and answered) on why the traditional approach of SME intervention
did not seem to work Governments now recognize that ensuring the availability
of credits to enterprises through development finance institutions, for
example, is simply not enough these is more to SME growth than just providing
money.
¡¡¡¡Recent reviews of the economic rationale for intervention in SMEs revealed
that directed and subsidized credit programs have done little to increase
the access of small enterprises to financial services. Sustainable financial
services. Sustainable financial institutions were not developed because
there continued to be perceived high risks and transactions costs associated
with commercial lending to the market. Instead, a 'non-re-payment culture'
among enterprises was fostered. Low rates of loan recovery pushed ex post
subsidies even higher than those intended in credit programmes, creating
more distortions in the financial markets.
¡¡¡¡Consider the experience in Korea, already a recognized leader in SME
support. In the wake of the crisis, extra efforts were made to encourage
banks to lend more actively to the enterprise sector and to stimulate
domestic demand. Korea's Central Bank adopted a more flexible monetary
stance lowering the repurchase rate that led to a decline in inter bank
call rates with the consequent gradual decline in both long and short-term
market interest rates. Credit guarantee funds were increased and special
new funds for SMEs were provided, To further support commercial banks,
the Government started purchasing non-per forming assets.
¡¡¡¡Even here, however, small enterprises complained that, despite lower
interest cuts, they still had to pay a "premium" because they
were considered "high-risk". The combination of complicated
loan procedures and excessive demand for collateral in come cases as much
as 130 per cent of the requested loan amount made it extremely difficult
to access the available funds. Moreover, the depressed real estate market
significantly lowered the value of real estate assets that SMEs could
provide as collateral for additional credit.
Another explanation forwarded for the disappointing results in SME assistance
in general is the usual formulation of multiple objective combining poverty
alleviation and minimizing gender inequalities, for example, with raising
the productivity and profitability of firms. This has in the past led
to over subsidization of services that could be provided by the market,
while at the same time failing to deliver income support to the poorest.
¡¡¡¡These is also the notion that current business development service "markets"
catering to small enterprises are prone to considerable distortions (imperfect
information, imperfect competition and externalities). Publicly provided
business development services are described as too general and supply-driven,
of poor quality, and inconsistent with the needs and willingness-to-pay
of SMEs. Finally, there is an increasing recognition of the importance
of further reforms in the areas of financial intermediation, property
rights, and legal and regulatory environment, to mention a few. Clearly,
the numerous constraints facing SMEs call for a comprehensive approach
going beyond credit availability per se.
A "4-legged stool"
¡¡¡¡There is now broad consensus that the economic
rationale for supporting enterprises should be based on a market oriented
approach. Hallberg and others have argued that the justification for SME
intervention lies in market and institutional failures that bias the size
distribution of firms, rather than on any inherent economic benefits provided
by small firms. This shifts the traditional provider to being an enabler
of good business environment opening access to markets and reducing policy
induced biases against small firms. Governments can accelerate the developments
of markets for financial and non-financial services by rationalizing public
expenditure on SME assistance programs, encouraging the development of
private markets, strengthening financial intermediaries, building institutional
capacities, and promoting innovation in products and delivery mechanisms.
¡¡¡¡On the basis of these observations, we suggest a "4-legged stool",
each leg being respectively set up by creating an enabling policy environment
that removes impediments to SME growth; supporting those financial service
institutions with specific capacity to support SMEs; supporting business
advisory services that assist SMEs in presenting bankable plans; and providing
equity and other market-based financing targeted at SMEs. We believe that
all four legs are key: one weak leg and the stool wobbles.
¡¡¡¡Leg 1: an enabling environment
It is common knowledge that a stable macroeconomy, an open trade and investment
regime, an effective legal framework, and a diversified financial sector
establish the fundamental conditions for a vibrant private sector. But
its is less commonly known that there are several aspects of the business
environmental that may inhibit the growth and competitiveness of small
firms relative to larger firms. Some of these are restrictions on access
to markets, bureaucratic regulations, improper administration of the tax
system, fees that add to the fixed costs of doing business, and an ambiguous
legal framework (Box 1). In transitional economies, for example, lack
of clear laws on land ownership and land use rights can preclude the use
of real estate as collateral for bank loans.
¡¡¡¡The other factors could be official and unofficial levies that discourage
small enterprises from growing and becoming formal; government procurement
procedures that discourage successful bidding by small businesses; zoning
regulations that restrict SME operations and entry into high income markets;
and labor market rigidities that make hiring and firing workers difficult
and expensive, and limit the flexibility and mobility of the labor force.
Last but not least, a government can increase SME access to markets through
efficient provision of infrastructure, particularly transportation, public
utilities, market facilities, and information and communications. For
example. ADB is actively assisting governments in Thailand, Viet Nam,
Laos, Cambodia, and Indonesia to improve the enabling environment by supporting
government's policy reform programs.
Leg 2: Financial institutions
¡¡¡¡It is an oft-repeated argument that the growth
and competitiveness of small enterprises are constrained by a lack of
access to financing and the high cost of credit. Experience shows that
small firms are more likely than larger firms to e denied new loans during
a financial crisis. In January 1998, the Korean Government had to respond
to the impact of the crisis by establishing a $ 1 billion fund from ADB
as a special credit guarantee for small and medium export firms. The fund
was used to recapitalize the two main credit guarantee funds. The Korea
Credit Guarantee Fund (KCGF) and the Korea Technology Credit Guarantee
Fund (KTCGF), which provide general credit guarantee for working capital
and facilities investments.
¡¡¡¡In addition to the perceived high risks and transactions costs associated
with commercial lending to SMEs, lenders are faced with a lack of reliable
information on borrowers, difficulties in enforcing contracts (the result
of inadequate legal frameworks and inefficient court systems). And the
lack of appropriate instruments for managing risk. Often, the problem
is compounded by supervisory and capital adequacy requirements that penalize
banks for lending to enterprises that lack traditional collateral.
¡¡¡¡In developing a market oriented approach, it has been realized that
there is a need to move away from a financial systems approach (e. g.
Targeted financing for SMEs). The aim is now to increase competitiveness,
strengthen institutions, and develop a more varied set of instruments
to promote SME lending. With such a strategy, it is hoped more financial
institutions will find lending to SMEs both profitable and sustainable.
¡¡¡¡The major aspects of this market oriented strategy are as follows.
¡¡¡¡£ªReducing barriers to entry, e. g., by reconsidering capital adequacy
requirements and prudential regulations that may be inappropriate for
financial institutions serving smaller clients;
¡¡¡¡£ªReducing the risks associated with lending to small businesses, focussing
on laws governing the enforcement of contract, forfeiture and collection
of collateral, and the use of movable assets as collateral;
¡¡¡¡£ªDeveloping the policy, and regulatory frameworks that are essential
to the development of innovative financial institutions and instruments,
including venture capital, small equity investments, and leasing;
¡¡¡¡£ªPromoting innovation in specialized lending technologies that reduce
the administrative costs associated with credit application, monitoring,
and payment;
¡¡¡¡£ªStrengthening the capacity of financial institutions to evaluate SME
creditworthiness in a cost-effective manner, for example, through the
use of credit scoring techniques; and
¡¡¡¡£ªImproving information on the credit-worthiness of potential borrowers,
by promoting the establishment of credit bureaus and ways to help SMEs
prepare business plans and financial projections.
Leg 3: Business development services
¡¡¡¡Business development service (BDS) or business
advisory services (BAS) cover a range of non-financial services training,
marketing assistance, technology up grading available to SMEs. Traditionally.
Governments and donors provide highly subsidized BDS/BAS interventions
to SMEs through public institutions or NGOs. However, the overall impact
of the approach was less than satisfactory, especially because the extent
of coverage is limited by the amount available, which is not much. Often
the funds come from donor agencies and the programs are rarely sustained.
Hence the need for a new approach.
¡¡¡¡Emerging BDS/BAS practice focusses on both the demand side (raising
the awareness and willingness to pay for services by SMEs) and the supply
side (increasing the availability of highquality, low-cost services by
private, for profit companies and other non-government providers). Again,
the role of governments and donors needs to shift from direct provider
to indirect supporter: BDS/BAS programs provided by the public sector
can often achieve lower cost and higher quality when they involve the
private sector in the delivery of services through industry associations,
larger firms linked to SMEs through buyer or supplier relationships, and
other SMEs them-selves. Governments and donors can put their efforts into
developing low-cost BDS/BAS products, building the institutional capacity
of BDS/BAS providers, and more importantly ensuring that services needed
by SMEs are sustainably provided. Efforts to develop private BDS/BAS markets
should be complemented with a reduction and rationalization of public
sector involvement. ADB is exploring this new approach in a number of
regions (China, Greater Mekong Region, Central Asia, and the Pacific)
and is actively supporting BDS/BAS initiatives. Many donor agencies like
USAID, IFC, EBRD, and others have also been quite active in helping SMEs
through such project development facilities
¡¡¡¡Still, there are important concerns that need to be addressed for BDS/BAS
interventions to be effective. Some of these are:
Should BDS/BAS include strategic services like providing marketing information,
and transactional services like banking and accounting?
¡¡¡¡£ªWhat vital role would commercial banks, venture capitalists, investment
funds, capital markets, and accounting firms play in providing BDS/BAS,
and for how long?
¡¡¡¡£ªShould SMEs be encouraged to go for short-term or more strategic long-term
services?
¡¡¡¡£ªIFIs are clearly aware of such concerns. In fact, a donor group is
currently working on building a set of practical guidelines using case
histories; developing a performance measurement framework to assess the
stage of development of BDS/BAS markets, and assessing the institutional
performance of BDS/BAS providers and the impact of services on SMEs.
Leg 4: Market-based financing
¡¡¡¡There continues to be a demand for establishing
and strengthening financial internmediaries that cater to the needs of
small businesses. IFIs can fill the financing gap by making available
specific in struments that have significant impact on SMEs. ADB, for example,
is supporting private equity funds. Equity funds typically buy equity
stakes in SMEs and can also provide management input. The larger and more
recent private equity funds are typically supervised by a separate management
company, established to facilitate a high standard of supervision.
¡¡¡¡One example of a private SME equity-funding agency is the Small Enter-prise
Assistance Fund (SEAF), launched in 1996 to finance the expansion of existing
SMEs relying primarily on domestic resources and producing goods for local
markets. Such enterprises can be valuable training grounds for other fledgling
enterprises. SEAF operates in 16 countries with challenging conditions
and obstacles to private sector growth. SEAF co-finances projects with
investment partners local banks, finance houses, development organization
with strong local presence and also involves itself in appraising investment
projects, assessing sponsors, and monitoring companies in which investments
are made. The ADB, in partnership with other institutions, supports such
initiatives.
¡¡¡¡Two months ago, in another example, ADB approved an equity investment
in Thailand-SME Investment and Restructuring Fund (SIRF). The initial
core investors included Japan Bank for International Cooperation (JBIC),
State Street Global Advisors (SsgA), and other private institutions. SIRF
seeks to invest in financially constrained, but fundamentally viable,
SMEs, and in turn, provide momentum for SME restructuring in the country.
Major banks in Thailand consider SIRF as a potential source for the recapitalization
of their SME clients.
E-commerce and SMEs
¡¡¡¡Against this significant change in the prevailing
view of how to assist SME development, there is no doubt that information
technology the Internet, e-Commerce, the Web-will have a key role. With
the rapid globalization that is now opening developing countries to various
market-driven changes, the required infrastructure will not only be electricity
or roads but telecommunications and the ability to understand and use
IT as well.
¡¡¡¡Here information and communication technologies can enable LDCs to find
their niches in the global economy, allowing them to access information
(to remain competitive) and also to market their goods and services. SMEs-including
even artisans, craftspeople, and family-owned enterprises-can benefit
from these technological advances.
¡¡¡¡Although much of the potential of this technological revolution is still
unrealized in developing countries, examples abound in terms of an increasing
use of e-commerce-a small business loan program in Viet Nam, the Panamian
women who posted pictures of their handicrafts on the Web. the subsistence
farmers of the Philippines who became specialists through the use of telex
and fax machines, or the villagers in Bangladesh who used the new Grameen
phone service to get current information on crop prices. Recently, a web
marketplace, called the "Virtural Souk" was launched to give
isolated craftspeople access to international markets.
¡¡¡¡IFIs are exploring the potential of IT to make them particularly interesting
and beneficial to more mainstream SMEs (Box3). Another promising area
is the establishment of "virtual clusters." Through electronic
communication among SMEs, not only within a group of firms concentrated
in one geographic location and working in the same sector, but also also
among firms that may be in a different locality or country. An example
of a successful industrial cluster is the production of surgical instruments
in Pakistan. It involves about 1500 SMEs producing precision instruments
which supply about 300 manufacturers. Certainly, connectivity will allow
these small firms not just access to technoloical advances, but also updated
business and marketing information, which can enhance their competitive
advantage.
Conclusion
¡¡¡¡Small enterprises continue to have a dominant
presence in most developing countries. While the Asian crisis reduced
the supply of capital to SMEs and weakened many others, the remaining
ones proved resilient and continued to provide low wage jobs lessening
the negative impact of the crisis on the poor.
¡¡¡¡The renewed interest in the role of the private sector in general, and
is small businesses in particular, as a key ingredient in reducing poverty,
is transforming the approaches and instruments used in assisting the SME
sector. The evolving paradigm focuses on a market oriented approach, with
the role of governments and IFIs shifting from being the traditional provider
of funds to the creator of a sound enabling environment, effective financial
service institutions, a varied set of market based financing instruments,
and business development services.
¡¡¡¡Against the continuing change in promoting SME development, there is
no doubt that information technology will provide the significant linkage.
IFIs are exploring the potentials of IT, by addressing regulatory and
policy issues, as well as infrastructure constraints in the communications
sub-sector; and by supporting, together with the private sector, the establishment
of low-cost interment and commerce access, to make information and communication
technologies particularly interesting and beneficial to small enterprises
in developing countries.
References & notes
1. In contrast to micro-enterprises which are normally
family businesses or self employed persons operating in the semi-formal
or informal sectors, SMEs consist of a wide variety of firs, ranging from
village handicraft markers. Small machine shops, etc., as well as those
operating in the formal sector of the economy and employing mainly wage-earning
workers, and participating in organized markets. The statistical definition
of SMEs varies by country and is usually based on the number of employees
or the value of the assets.
2. Hallberg, K., Small and Medium Scale Enterprises: A Framework for Intervention,
Private Sector Development Department, World Bank (May 1999), unpublished.
3. MPDF Operational Report No. 1 (August 1997), Small and Medium Sized
Private Companies and the Industrialization in Viet Nam.
4. OED Precis No. 173. Support for Smaller Enterprises. World Bank (September
1998).
5. Hallberg, K., Small and Medium Scale Enterprises: A Framework for Intervention,
Private Sector Development Department, World Bank (May 1999), unpublished.
6. World Bank (1998). Small and Medium Enterprises in Korea: A Status
Report, Small Enterprise Unit, Private Sector Development Department.
7. Gibson, A., The Development of Markets for Business Development Services:
Where We Are and How to Go Further, Paper presented at the International
Conference on Business Services for Small Enterprises in Asia: Markets
and Measuring Performance, Hanoi, Viet Nam, April 2000.
8. Hallberg, K., Small and Medium Scale Enterprises: A Framework for Intervention,
Private Sector Development Department, World Bank (May 1999), unpublished.
9. World Bank (January 2000). World Bank Group's SME Strategy.
10. Hallberg, K., Small and Medium Scale Enterprises: A FRAMEWORK FOR
Intervention, Private Sector Development Department, World Bank (May 1999),
unpublished.
11. IFC (1996)
12. Proceedings of Science and Technology for Development Symposium. Global
Knowledge' 97 Conference, Toronto, Canada (June 1997).
Investment fund to support small and medium-sized
firms in Thailand
¡¡¡¡The Asian Development Bank has approved a US$
25 million equity investment in the Thailand Small and Mediumsized Enterprises
Investment and Restructuring Fund (SIRF) which will be set up shortly.
¡¡¡¡The fund, which has a target size of US$ 100
million, will invest in small and medium sized enterprises (SMEs) with
promising businesses which are in need of expansion capital. The fund
is a part of the ADB's strategy to assist crisis-affected economies with
investment in the private sector.
¡¡¡¡The SIRF is expected to help restore investor's
confidence in Thailand. It will also aim to reduce high debt-to-equity
rations of SMEs to a lower and more prudent level, enabling the banking
system to extend credit or provide new loans.
The SIRF will have a 7-year term with an option
to extend for two years. Japan Bank for International Cooperation (JBIC)
has been playing an active role in the development of the SIRF, and is
expected to approve its equity investment of $ 25 million soon. The remaining
balance of the SIRF will be raised from the institutional investors in
the capital rich countries, which includes State Street Global Advisors
(SSgA), the investment am of State Street Bank and Trust Company.
¡¡¡¡The SIRF will identify priority sectors and industries
with strong growth prospects. It will seek a diversified portfolio which
contributes to improving governance and recovery of the SME sector in
Thailand.
¡¡¡¡In addition to the fund investment, the ADB will
make an equity investment in the Thailand Fund Management Company (TFMC)
which will manage the Fund. SSgA and ADB will be the shareholders of the
TFMC.
http://www.adb.org/News/2000/nr024-00.asp
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