Sialkot’s export hub needs no introductions. World renowned as the centre of sports goods and surgical instruments manufacturing, the cluster makes exports of nearly $300 million every year by some estimates. The entrepreneurs of Sialkot were also the first in Pakistan to establish a privately owned airport, built primarily to facilitate aerial shipments of export cargo. The region is also home to many units in sportswear accessories production such as gloves, martial arts and sportswear uniforms, a small success story in diversification of Pakistan’s largely textile heavy export basket.

However, this success story has struggled to grow its footprint due to lack of sector specific interventions particularly lack of access to finance. Most of the industry in Sialkot is small- and medium-sized, and as a result, has been excluded from formal sector financing.

To discuss these and other current issues such as challenges faced in the aftermath of Covid, BR Research sat down with a focus group of Sialkot based exporters, drawing from a variety of industries such as surgical instruments, sports goods, sportswear, and jerseys. Below are the edited excerpts of the discussion:

BR Research: How has Covid-19 affected SME-based exporting industries?

Ijaz Khokar: Covid has dramatically changed the ballgame for exporters. Before the pandemic hit, SME exporters were able to secure small contracts by visiting expos or through business networks. This is no longer possible. Consumer attitudes and lifestyles are changing, as is sourcing; traditional means of marketing can no longer be relied upon. SME led exporters must sit together with policymakers to defend their territory, and then aggressively capitalize on opportunities that have opened due to gaps in the global supply chain.

BRR: Is it true that the failure to invest in R&D is the greatest bottleneck for Pakistan’s export industry?

Ijaz Khokar: It is true that lack of investment in R&D over the years has brought matters to a head, and for that the private sector must shoulder some blame. However, the government has simply failed to play its role in trade diplomacy or in supporting export promotion. For example, TDAP’s performance has been extremely poor; the export promotion fairs it participates in are outdated. Pakistan needs a highly sophisticated and aggressive marketing plan. Instead, both the government and the exporters are hanging on by a thin thread called GSP+.

Because buyers still have an 11 percent cost-saving incentive due to GSP+, they have hung around over the last decade. The day GSP+ terminates, Pakistan may witness a large-scale migration of (export) buyers.

The government needs to target advance planning before 2023 to reach FTAs with EU as central European nations are a major destination for Sialkot based exports. Otherwise, buyers will switch to manufacturing hubs such as Vietnams – countries with whom EU has successful FTAs.

BRR: Do you believe the incumbent government has shown seriousness of intent to address the structural challenges that plague the SME segment?

Ijaz Khokar: Last month, the PM called for a discussion session with business leaders from across the country. During the meeting, he agreed that SME representation is missing at the level of policymaking consultations, that usually take place between trade bodies and the government. The PM showed his commitment to establish a new authority to lead SMEs as the existing forum of SMEDA has failed to accelerate growth and formalization of SMEs in the country. The PM hinted that he would chair the proposed authority himself.

Currently, no more than 5-10 percent of all SMEs in the country have access to formal sector financing. This is because most struggle to meet the harsh collateral requirements of commercial banks. For example, lenders demand fixed asset of land and building as collateral from SMEs, even though more than fifty percent of SMEs work out of rental properties. Thankfully, the PM has an appreciation of these bottlenecks, and has asked for a proposal to develop a structure to help access to finance of these currently “non-bankable” enterprises.

BRR: What factors do you attribute for failure of SMEDA in playing its role? What is your prescription to the incumbents to avoid similar pitfalls?

Ijaz Khokar: Despite its stated goal of facilitating ease of business for SMEs, SMEDA is plagued with bureaucratic procedures and red tape. Moreover, while the stakeholders pay lip service to the agenda of access to finance, when push comes to shove, all relevant institutions whether it’s the central bank, commercial banks or SMEDA, demand a litany of documentation that most medium sized enterprises are unable to fulfil, forget about small-sized enterprises.

Of course, it cannot be predicted whether the proposed body will turn out to be any different, because the entire process will restart from square one. However, we are hopeful as there is clarity of intent at the regulatory level. It remains to be seen whether the consultations processes will involve adequate representation of SMEs from all geographic regions as well as various industrial segments.

BRR: To what extent do export led SMEs from Sialkot blame lack of access to finance as the primary impediment to growth?

Zain ul Abideen Ahsan: The tendency to borrow from commercial banks is weak in the SME cluster because fixed mark up payments often render cottage industries uncompetitive in global markets. These industries are starved off working capital, and often fixed interest payments – especially during periods of high discount rate – can prove deadly for export-oriented firms.

Bank borrowing also makes sense when businesses have firm orders in hand, which is rarely the case with SMEs. In Sialkot, most SMEs operate on order-to-order, or on month-to-month basis. With such high levels of uncertainty, it is difficult for both the commercial bank and the business to plan for working capital requirements over a 6-12 months period. Given this scenario, most firms aim to arrange vendor or supply chain-based financing, instead of paying 10-12 percent mark up to banks.

Ijaz Khokar: Inflation in raw material prices during the past two years has been so high that most SMEs are operating at no more than a net profit margin of five percent. Between 60-70 percent of raw material is imported which has been severely impacted by currency depreciation; transportation and electricity cost have increased at a similar pace. At such mediocre levels of profitability, debt financing simply does not make sense. Of course, interest rates are cyclical, but businesses need to take into account long term sustainability of bank borrowing.

BRR: Banking credit appears to be available easily to sports goods manufacturers when needed. Out of total Rs 4 billion debt borrowed by the sector, Rs 2.5 billion consist of export refinance facilities, which is usually only available to borrowers with healthy risk rating and credit worthiness. Why then is the offtake of conventional financing schemes so low?

Ijaz Khokar: That’s because commercial banks are uninterested in lending to SMEs out of their own books. As private sector entities that exist to maximize their shareholder profitability, behaviour of commercial bank is understandable. However, when banks demand collateral worth Rs 15 million against a loan facility of Rs 10 million, prospective SME borrowers simply retract their loan applications.

SME lending can improve if SBP were to force these private banks to lend an x percentage of their loan book to SMEs and penalize those who don’t. Otherwise, access to finance for SMEs will always remain a mirage.

BRR: Do lending institutions outside of commercial banks, such as leasing companies, ever attempt to do hand holding of SME firms, in order to help grow business by improving access to finance?

Assad Malik: Yes, leasing companies often market to SME clusters, especially in the export led industries. However, because most firms fail to fulfil lender’s criteria, borrowing remains negligible. Consider that formal sector lenders insist that the electricity meter must be in the name of the borrower; in Pakistan, this is not possible if the firm is operating out of a rental property.

BRR: What has been the role of SBP in facilitating SME’s access to finance in Sialkot?

Fizan Akbar: Every year, teams from State Bank of Pakistan visit SMEs in Sialkot and conduct several seminars. Each time they commit that women and young entrepreneurs will be provided collateral free loans. To date, no exporter in Sialkot has received any collateral free loan. Either this policy of “collateral free loan” is misplaced, and needs to be amended/revised, or the central bank needs to ensure that its commitments are implemented by commercial banks both in letter and spirit.

The red-tapism is also endemic. For example, if a newly established entrepreneur approaches a bank to seek these concessionary schemes, banks often simply decline receiving any intimation of a concessionary scheme from SBP.

Access to finance for SMEs will remain a pipedream unless SBP and commercial bank address three crucial issues: expensive loan pricing for SMEs, unrealistic collateral requirements, and documentation that discourages young entrepreneurs from seeking formal sector financing altogether.

Similarly, TDAP and SMEDA have done nothing in Sialkot beyond constructing fancy buildings and trade centres.

BRR: In the aftermath of Covid, what is the level of readiness among Sialkot’s exporters to adopt E-commerce?

Fizan Akbar: The rest of the world – especially our buyers – have shifted to completely online facilities. We have been caught unprepared. Neither does Pakistan have policies to facilitate e-commerce, nor do we have payment gateways.

Let me note here that it is possible that the actual export out of Sialkot cluster may be much higher than what is claimed. This is because many young entrepreneurs simply do not register their companies. Instead, they receive small-sized orders from online websites such as Amazon and E-bay that use direct shipping or drop shipping modes to courier their products through DHL and FedEx. Of course, the revenue from such business does not reflect as export earnings from formal sector, as most of these payments are remitted to a foreign bank account of a relative NRP.

BRR: But eventually, those earnings must make their way back to Pakistan one way or the other?

Fizan Akbar: Export goods worth many metric tons is couriered through DHL/FedEx offices based in Sialkot on daily basis. In some instances, these reflect as foreign remittances, but more often these funds are sent back through hawala/hundi. At the end of the day, it is loss of foreign exchange earnings.