EDITORIAL: In yet another bid to encourage the growth of small and medium-sized enterprises (SMEs), the government has drawn up a plan to provide affordable credit facilities to such businesses. The matter was discussed in some detail during a meeting of the federal cabinet recently, where it was agreed that an alternative SME-focused financing structure was the need of the hour if Pakistan wants to fully exploit the opportunities this sector could provide with respect to job creation and contributing to the country’s economic growth. The Finance Division has coordinated with several banks and a scheme has been drawn up by the State Bank of Pakistan to make it easier for SMEs to access bank loans.
The stable, consistent provision of credit is the lifeblood for any business, as appropriate funding provides the necessary financial resources for growth, diversification and day-to-day operations. However, the development of the country’s SME sector has been perennially hampered by the deficiency of this very vital resource owing to the lack of access to banking services.
Over the years, numerous attempts have been made to promote SME financing, but these have failed to leave the desired impact as a significant portion of such businesses too often remains undocumented and operates in the informal economy, and are thus unable to fulfill basic banking requirements related to assessing credit worthiness and risk.
Given this, it is puzzling why successive governments have expended so much effort on devising ways to encourage banks to expand SME financing without simultaneously addressing the root cause behind the inertia afflicting the SME sector: the reluctance of businesses to enter the formal economy.
Not enough attention has been paid towards the prohibitive costs and convoluted regulatory frameworks associated with becoming part of the formal sector: there are substantial expenses to incur, complicated procedures to follow, various legal codes to adhere to and multiple tax rates to keep track of in the present tax regime of withholding taxes applicable at each stage of the business transaction like value-added sales tax.
Complying with the withholding tax regime, for example, can prove to be an especially cumbersome process for a small business with limited resources as the challenge here lies in meticulous record-keeping through documenting receipts, invoices and other relevant financial information for the numerous transactions the business may be involved in throughout the year, without which it would struggle to claim refunds from tax authorities.
Moreover, there is also the need to follow a plethora of labour laws as well as adhering to union-related legislations, and keeping track of social security payments and EOBI contributions, besides the abundant other details that a business operating in the formal economy has to be mindful of.
Attributing SMEs’ resistance to enter the formal sector solely to their reluctance to become part of the tax net, therefore, is far too simplistic. What is needed is a programme that focuses on reforming and simplifying regulatory processes, and reducing bureaucratic hurdles.
The emphasis should be on reducing the cost of compliance with the relevant laws and streamlining the taxation regime. In addition, providing tax incentives or exemptions to newly-formalised businesses, offering support and guidance on compliance procedures and implementing technology solutions to streamline administrative tasks should also be considered.
The importance of the SME sector for our economy cannot be overstated. Most SMEs have a lower degree of automation compared to larger businesses, which means that they are largely labour intensive enterprises.
Given our galloping population growth rate combined with the sluggish GDP growth, providing support to such businesses can help address the problem of high unemployment and under-employment afflicting the economy.
Furthermore, facilitating their entry into the formal sector could be a key to expanding our perennially narrow tax base. Incentivising the entry of SMEs into the formal economy, therefore, must become an important part of the government’s economic agenda going forward.
Copyright Business Recorder, 2024
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