EDITORIAL: In yet another attempt in a long line of programmes aimed at promoting the SME sector, the Small and Medium Enterprises Development Authority (SMEDA) has announced that the “National Roadmap for Transition of Informal Businesses towards Formalisation”, launched in 2024, has now begun implementation in the textile and auto sectors.
In collaboration with the International Labour Organisation (ILO), this initiative aims to facilitate the entry of informal enterprises into the formal economy, and thus enabling SMEs to benefit from the advantages of formal operations, such as access to banking finance, eligibility for government incentives and the potential to scale up their businesses more effectively.
However, as with previous endeavours aimed at supporting SMEs, this initiative also appears to not fully recognise the core causes that have prevented SMEs operating in the informal economy to enter the formal sector.
A joint study by SMEDA and the ILO on the barriers and opportunities for reducing business informality has highlighted key challenges, including the complexity of the tax regime imposed on formal enterprises and the intrusive, often heavy-handed approach of tax authorities.
However, other fundamental obstacles preventing informal SMEs from transitioning into the formal sector have not received adequate attention. Notably, there seems to be insufficient recognition by SMEDA and ILO of the impact of Pakistan’s convoluted regulatory framework governing businesses, specifically the Industrial Relations Ordinance (IRO) and its accompanying Standing Orders Ordinance, which continue to deter SMEs from joining the documented economy.
Besides these two laws there is a plethora of intricate and costly legal requirements related to formal sector in the shape of social security, EOBI regulations and workers welfare fund.
Compounding the challenge of navigating these numerous legal intricacies is the fact that the IRO’s provisions apply to companies with more than 10 employees, creating a significant disincentive for enterprises considering formalisation.
As a result, many businesses deliberately remain informal to avoid the burdens associated with compliance.
This means that despite periodic government initiatives encouraging the banking sector to offer financing to SMEs – most of which operate informally – the reality is that undocumented businesses cannot satisfy banking requirements needed to assess their credit worthiness.
And without access to this vital resource, i.e., banking finance, SMEs struggle to scale up operations, with their growth becoming stagnant and their full potential remaining unrealised. Clearly, the priority then should be to establish effective measures that simplify and incentivise business formalisation.
Only then can the true potential of the SME sector — comprising over five million enterprises and contributing to 78 percent of non-agriculture sector employment — be unlocked and, in turn, drive broader economic growth.
In this context, the government must urgently reconsider the 10-employee threshold set by the IRO, which serves as a major barrier to SME formalisation.
Revising this threshold to 100, for instance, could encourage more businesses to transition into the formal economy without the immediate burden of excessive regulatory requirements.
Additionally, simplifying tax procedures must also be considered as the current income tax framework presents a significant challenge for SMEs, as they must navigate a complex withholding tax regime with multiple tax rates applied at various stages of business transactions.
For small enterprises, this is costly and cumbersome. Since this tax framework is designed more for the ease of tax authorities than for the businesses it governs, its fundamental restructuring is essential.
It is clear then that unless the tax system is reformed to reduce the burden on SMEs, and key legislations defining SMEs — particularly the applicability of the IRO — are amended, a significant portion of SMEs will continue to operate in the informal sector, stunting their growth and preventing the economy from reaping the benefits of a thriving, documented small business sector.
Copyright Business Recorder, 2025
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