EDITORIAL: In an attempt to highlight the importance the government accords to small and medium-sized enterprises (SMEs), the deputy governor of the State Bank of Pakistan (SBP), while speaking at a summit held recently to discuss digital-based financing solutions for SMEs, stressed that enhancing ease in access to finance for such businesses remains a top priority for the central bank.
In this context, he pointed to several initiatives taken in recent years to incentivise the banking sector to come up with financing schemes for SMEs, although these have so far had only a limited impact.
There is no denying the importance of the SME sector to the country’s economy, and there is also no arguing with the contention that access to finance is essential for any enterprise’s survival and future growth. What is perplexing, however, is the perennial blind spot the government machinery appears to suffer from when it comes to recognising the root cause of the banking sector’s limited ability to enhance financing options to SMEs.
That fact of the matter is that the vast majority of SMEs operates in the informal economy, and thus cannot satisfy fundamental banking requirements pertaining to the evaluation of their credit-worthiness. As long as that remains true, they will be unable to avail any financing scheme that banks or the government might initiate.
It is obvious, then, that the government first needs to make efforts to encourage SMEs to become part of the formal sector. As has been pointed out in this space before, the reluctance of SMEs to enter the documented economy cannot solely be ascribed to their unwillingness to become part of the tax net.
There appears to be a lack of recognition of the role the country’s various laws regulating businesses have played in the continued resistance of SMEs to enter the formal sector. For example, the Industrial Relations Ordinance (IRO) that mandates businesses to follow numerous complex and expensive legal formalities related to labour laws, social security laws, as well as EOBI-related regulations is applicable on all companies employing more than 10 persons.
Common sense suggests that this 10-person employment threshold is bound to serve as a barrier to a huge number of SMEs that staff more than 10 people but just don’t have the financial strength and resources to comply with all the rules and procedures detailed in the Ordinance.
It is pertinent to note that as per the SBP’s own definitions, a small enterprise is any business employing up to 50 persons, while medium-sized trading establishments are categorised as those that employ 51-100 people, while medium-sized manufacturing concerns are classified as those that employ 51-250 persons.
This lack of harmony between the laws that govern businesses and how various government entities define SMEs is an urgent issue crying out for an early resolution. The government must look into the various delineations of the IRO and perhaps consider making its regulations applicable on those businesses that employ more than 100 persons.
Furthermore, there is the highly tortuous tax structure that enterprises are expected to comply with. As has been pointed out repeatedly, compliance with an income tax framework where businesses are required to adhere to a withholding tax regime wherein multiple tax rates are applicable at each stage of the business transaction is prohibitively expensive and cumbersome for an SME with only finite resources at its disposal.
An overhaul of this tax framework that owes its existence mainly to the fact that the tax bureaucracy finds it easy to administer has become a must. It is evident that unleashing the true potential of the SME sector will only result from businesses entering the formal economy, and the government must start taking the necessary measures that would enable this to happen.
Copyright Business Recorder, 2024