TEXT: The Micro, Small and Medium Enterprises (MSMEs), the back bone of inclusive growth and development, have the potential to contribute to half a dozen of Sustainable Development Goals (SDGs) in particular poverty reduction, jobs creation, competitiveness enhancement and productivity of industry and trade etc.
Globally, MSMEs stand out for their dynamism, entrepreneurship and competitiveness and constitute 96% of the total registered enterprises and over 40% of the employment. In Pakistan, of the 5 million total businesses, 4.5 million are estimated to be SMEs that contribute 40% to the country's GDP and 80% of the employment to non-farm labour.
SMEs face intense challenges in Pakistan: sector policy distortions, difficulties in access to finance, high cost of doing business and onerous taxation regime.
SMEs, which try to be formal and documented, find themselves at huge disadvantage when competing with nonfilers operating in the informal sector. Further, over 70% of direct taxes are being collected through withholding means with businesses acting as collecting agents. Businesses incur significant costs of compliance and, in some cases, penalties when in violation of the stringent tax code. Access to finance has been major constraint. As a proportion of private sector lending, bank lending for SME steadily declined to 7.3% in 2023 from 15% in 2008. As of May 2023, commercial banks SME lending at PKR 519billion, much lower than the demand estimated to be around PKR 3.20-4.05 trillion — barely about 13-16% of the potential demand.
Recent reforms and enhancements in the financial ecosystem of Pakistan supported by the Government and regulators and backed by Karandaaz are path breaking and are likely to offer major opportunities for MSMEs. Public policy has evolved over the years. These include
Introduction of a SME policy and actionable targets in the National Financial Inclusion Strategy (NFIS) championed by the State Bank of Pakistan since 2008. Under the latest NFIS, ambition is to increase the number of borrowers from under 200,000 to over 700,000 and increase credit penetration from under 10% to 18%.
Karandaaz - an innovative public: partnership platform—has emerged as a special purpose investment vehicle and is unravelling the access to finance problem of SMEs. Its investment strategy is to enhance 'market efficiency' by addressing gaps in the financial architecture in Pakistan, invest with 'additionality' to crowd in private and development sector investment in support of new and scalable solutions including technology-supported ones, and create 'development impact' in order to contribute to equitable economic growth with special focus on environmental conservation, and generation of employment and additional revenues for MSMEs.
The establishment of Pakistan's fully interoperable micro-payment gateway, RAAST, is a crucial step towards a cash- lite future and for creating linkages between various segments and players in the financial sector, and pushing a shift from siloed operations to an interconnected industry. The launch of the RAAST's Person-to-Merchant use- case is anticipated to massively disrupt retail businesses, allowing for substantial cost-efficiencies through frictionless payment settlement while also augmenting volume of transactions.
Karandaaz has supported strategic initiatives of national significance such as setup of a moveable asset collateral registry, partnership with the Pakistan Stock Exchange (PSX) for enhancing the flow of listing of SMEs on the Growth and Enterprise Board (GEM) and Munsalik, an initiative of the Pakistan Microfinance Network, for helping the digitalization of the microfinance industry.
Karandaaz is anchor sponsor of such specialized non-bank finance entities which did not exist but were required for richer product offering to MSMEs. Pakistan Microfinance Investment Company, a joint partnership of Pakistan Poverty Alleviation Fund, German KfW and Karandaaz, is an apex market-based fund for wholesale financing of the microfinance sector. PMIC integrates the microfinance sector with the commercial banks and the debt capital markets. It is also delivering tailored support to investees for enhancing their capacity to access commercial credit markets.
Credit guarantee is another important enabler for financial access as these make SMEs and projects bankable by providing risk coverage on loans. Guarantees lower the cost of borrowing and collateral requirements for clients. InfraZamin Pakistan (IZP) was established in March 2020 with joint ownership of Singapore based InfraCo Asia and Karandaaz. In addition, London based GuarantCo is an anchor sponsor as it is providing contingent capital for IZP. IZP's specializes in issuing PKR-denominated credit guarantees for enhancing the creditworthiness of infrastructure ventures. Further, Karandaaz is in advance stage of setting up a national credit guarantee facility (i.e. National Credit Guarantee Company) which will underwrite risk of banks and non-bank commercial capital providers to SMEs.
Karandaaz also launched Parwaaz Financial Services Limited (PFSL), a wholly- owned subsidiary, in 2021. PFSL will distinguish itself from its competitor conventional banks on service standards, agility and product innovation. It will leverage capital for on-lending to SMEs from impact finance as well as commercial capital providers.
MSMEs are to benefit from the new wave to broaden and deepen the Islamic finance industry - already Islamic Finance share (net)as of June 2022 has increased YoY from 24% to 27%. SBP has pitched to raise this share further to 35%. Islamic finance may be the life line that businesses need. Islamic financial products such as Murabaha, which replaces interest with a profit on the purchase of an asset, is one of the most popular Islamic finance products. Very large number of Pakistanis prefer Islamic finance over conventional, this provides opportunities for product innovation and higher financial inclusion.
Non-banking finance companies (NBFCs) have the potential of becoming key players in addressing the financing needs of underserved SMEs. The credit extended to SME sector in FY21 was miniscule at PKR 30 billion as per the last available data, however, it represented a portfolio growth of 30%. We need to take note of the digital movement in credit to SMEs. The technology-oriented NBFCs can embed themselves more effectively in the SME value chains, assess risks involved and create products which were difficult to introduce by conventional banks. Market is witnessing rapid growth of innovative digitally enabled solutions in supply and distributor chain financing. In Budget FY24, banks were given a relaxation on the taxation on markup income on SME lending. However, this incentive was not given to the NBFC sector, and is something that can be considered if the playing field is to be levelled.
The large magnitude of the SME sector presents numerous opportunities. As demonstrated by myriad interventions of Karandaaz, there is a strong business case for fintechs, traditional lenders and now digital banks. However, ultimately the success of SME financing will not only depend on how financial institutions respond to and prioritize the SME sector but the way the eco-system is strengthened through the addition of credit bureaus, third party data provision, moveable asset registry and credit guarantees. Lending institutions will get comfort through this strengthened ecosystem and will be better placed to appraise and quantify the risk and reduce information asymmetries. However, reduction in the financing gap will need interventions on both supply and demand sides. The handholding and incentivizing of SMEs to formalize through standardized book keeping, better product development and improved governance practices will be just as important if SMEs are to be made bankable and the large financing gap is to be plugged. To conclude, besides dealing with generic policy, institutional and structural shortcomings, Pakistan would benefit from reflections on 2023 MSME day agenda, which among others, underscores the need for nurturing resilient supply chains, a critical component of global trade and commerce, to build capacities and partnership and safeguard vulnerable, women- and youth- owned enterprises at risk of external shocks.
Co-Auditors: Dr Shamshad Akhtar, Chairperson Karandaaz and Mr Waqas ul Hasan, CEO Karandaaz
Copyright Business Recorder, 2023