SME development

ACCORDING to the National Industrial Policy 2010, any firm employing more than 10 but less than 25 workers is called a micro-enterprise. If the number of workers employed remains between 25 to 99, the enterprise is identified as small. A medium enterprise employs 100 to 249 workers in Bangladesh. Small and medium enterprises (SMEs) are expected to play a pivotal role in achieving the goals of poverty alleviation as envisaged in the current development paradigm. 
According to the available information provided by Bangladesh Bureau of Statistics, SMEs have been the more dynamic component of the manufacturing sector during 2005/06–2010/11 and accounted for about 4.5 percent of total employment (i.e. 35.5 percent of total manufacturing employment) and 12.4 percent of GDP (i.e. 69.9 percent of total manufacturing value-addition) in FY11. However, the demonstrated dynamism conceals two important factors.  First, the heterogeneity of the sector; available research shows that there are significant inter-industry variations in productivity growth within the sector. While some are growing by taking advantage of the liberalised trade regime, some are struggling to thrive in the growing competition. Secondly, despite the demonstrated dynamism during 2005/06–2010/11 the SME sector is facing a number of constraints, which need to be taken care of. Some of these constraints are generic in the sense that they are common to the manufacturing sector while some are specific to the SME. 
The main constraints faced by SMEs include paucity of freehold land, deficient infrastructure and utility services, weak legal and regulatory framework, inadequate access to finance, lack of skilled workforce, poor business support services, etc. The government constituted a National Taskforce on SME Development in 2003 to draw up a realistic strategy for promoting rapid growth and vigorous competitiveness among SMEs in Bangladesh. The Task Force identified common constraints faced by SMEs in Bangladesh and made a number of recommendations that led to the setting up of a new institution, namely the SME Foundation in 2007. The idea was that this foundation would serve as the central authority to steer both policies and actions designed to support SMEs.
With the establishment of the SME foundation, the overall support structure for SME development in Bangladesh became a multi-institution approach. It includes the Ministry of Industries, Bangladesh Small and Cottage Industries Corporation (BSCIC), the SME Foundation and Bangladesh Bank. Each of them works in some specific areas with some overlaps, although the most prominent institutions are the SME foundation and the Bangladesh Bank. 
The SME foundation suffers from a number of stumbling blocks in carrying out this task. Total financial resource available to the foundation is inadequate and also volatile. The foundation received an endowment fund of BDT 200 crore. Interest earned on this fund is the sole source of finance. The earning on this endowment is inadequate to undertake different activities by the foundation as mandated in the government gazette. Total proceed from the endowment fund depends on the market rate of interest which varies over time. This makes the overall planning process difficult for the foundation. 
Although the SME foundation was envisioned as a 'one stop service' provider in the original plan, it is not provided with the adequate legal authority over other relevant organisations, let alone bring them under one umbrella. Although the foundation has the mandate and is better placed to undertake certain activities, these are taken up by other organisations without involving the foundation. Credit wholesaling is one example. The foundation is better informed about the SME clusters and their composition and need for credits. But it is not involved in the credit program administered by Bangladesh Bank, which lacks the sectoral knowledge.   

Bangladesh Bank has introduced several schemes and programs to ensure institutional financial services for the SMEs. These include credit wholesaling by using the grants received from different development partners, opening of 'Dedicated Desk' and 'SME Service Centre' in the banks and special services for women entrepreneurs. The sole responsibility of the newly established 'SME and Special Programs Department' of Bangladesh Bank is to formulate policy, facilitate credits and monitor the development of small and medium entrepreneurship. The credit wholeselling program of Bangladesh Bank involves refinancing of small enterprises by using their own and concessionary funds from donors through 46 banks and non-banking financial institutions, refinancing scheme for agro-based product processing industries, refinancing for women entrepreneurs, and refinancing of new entrepreneurs under the cottage, micro and small category. 
There has not been any rigorous research to evaluate the efficacy of the current support structure for SME development. However, the available evidences indicate that the current institutional system is yet to result in any notable improvements in the support for SMEs.  
A number of studies reported that small and medium entrepreneurs not only pay higher interest on loans compared to large entrepreneurs, they also face a number of non-pecuniary problems in procuring loans from banks. These include long waiting period for getting initial finance from banks due to tedious paperwork, inability to provide collateral to get loans, inexperience in preparing financial system, high interest rate, excess paperwork, and lack of proper communication skills.
The number of beneficiary enterprises has significantly increased since 2009-10, especially during 2011-12 and 2012-13.However, a close examination reveals the increase in these years is attributable to the introduction of a new window of credit targeting a new client group – the women entrepreneurs. This group of entrepreneurs is provided with credit at a single interest rate while the other entrepreneurs pay as high as 18 percent rate of interest. Since the number of women entrepreneurs is very limited, this channel has very limited scope to disburse more credit. 
In 2009, total amount of credit disbursed to the SME sector was BDT 12.45 billion, which increased to BDT 28.89 billion in 2013, registering an annual average growth of about 33 percent. To put it in perspective, this growth rate is significantly higher than the growth of overall private credit in the country. Two factors contributed to this high growth. One of them is the increase in the availability of funds that accompanied the sanction of second tranche of funds by Asian Development Bank, and the joining of JICA in the provision of funds for SMEs. Another reason is the renewed efforts of Bangladesh Bank to provide credit to women entrepreneurs of the SME sector. About BDT 3.8 billion and BDT 5.2 billion have been disbursed as credit among women entrepreneurs in 2012 and 2013 respectively.   
Despite the recent increase of overall disbursement, access to finance is still identified as a major constraint by 68.6 percent of the small and 44.7 percent of the medium entrepreneurs (INSPIRED SME Survey 2013). This indicates that there is still a dearth of credit and the small entrepreneurs suffer relatively more from it.The current institutional arrangement of Bangladesh Bank has created incentives for the banks and non-bank financial institutions to provide more credit to SMEs, but there are not enough safeguards to ensure appropriate targeting. This, by taking advantage of the missing monitoring, can lead to a moral dilemma.
Banks and financial institutions receive the funds at a rate of 5 percent interest from Bangladesh Bank. The average interest rate on loan disbursed to SMEs is 15.6 percent (INSPIRD SME Survey 2013), implying a spread of 10.6 percent, whereas in the case of normal funds, the same spread is around 5 percent. This provides incentive to the contracted banks and non-banking financial institutions to disburse credit by using funds from the refinancing schemes without paying adequate attention to targeting. Since the SME foundation has better knowledge about this sector, collaboration between Bangladesh Bank and this foundation can potentially result in better cluster and sectoral targeting for SME credit.   
Looking forward, the government needs to undertake a three-step strategy to support the development of the SME sector of the country. The first step relates to the consolidation of the naturally developed capabilities mainly serving the domestic market. The second step relates to the facilitation of their entry into the export market. The third step relates to the enhancement of capacities to thrive in the global market. The first role of the proposed strategy is protective – protecting the naturally developed capabilities. The role in the second and third strategy is promotional – promoting the capacities of SMEs to penetrate into the export market and thrive withstanding the global competition. Under this broad thematic scheme, the following specific components should be the integral part of the strategy:  
i. Selective approach to SME development
An essential element of a strategy for the development of the SME sector in Bangladesh will involve identifying niches where small and medium enterprises have comparative advantage and higher growth potential. This will mean exploring market opportunities on a sustained basis and mobilising the required support services for the promotion of these industries once such niches are identified.
Collection and analysis of the relevant industry related information will be an essential prerequisite for such strategic planning. It is with this purpose that the government has set up the SME Foundation whose mandate is to work out such development strategies for the SME sector in Bangladesh on a continuous basis in close tandem with the private sector. The capacity and activities of the SME Foundation need to be strengthened to this end.
ii. Creating an enabling environment for private investment
Constraints that contribute towards a weak enabling environment for private investment can be grouped under three broad headings: i) policy-induced constraints, ii) structural constraints, and iii) constraints rising out of poor business support services and weak governance. In facilitating development of the private sector and SMEs, the primary role of the government will have to be to establish investment-friendly law and order situation, supportive legal and regulatory framework and appropriate macroeconomic policies. These will need to be complemented by prioritised public investment designed to ease various structural bottlenecks pertaining to physical and infrastructural facilities, energy and technology. In addition, the quality of governance will have to be improved to ensure reliable supply of basic services on which honest and efficient businesses depend.
iii. A differentiated and hassle-free indirect tax system for SMEs
Given the structural difference between the SMEs and their large-scale counterparts, there is the need for a differentiated system of indirect tax for the SMEs that will enable them to pay the indirect tax free from harassment. A graduated system of turnover tax can be designed for the SMEs for this purpose. Critics argue that a differentiated system will discourage SMEs to grow larger in a bid to avoid getting under the VAT net and that a system of turnover tax makes them less attractive suppliers of inputs to other firms who need VAT certificate for inputs to adjust their own VAT liabilities. However, if the cut-off size limit is sufficiently large to include all SMEs and the turnover tax is appropriately graduated, then the problem of growth disincentive will not be a serious one. On the other hand, the problem of VAT certificate may be resolved by creating a notional VAT equivalence of the turnover tax.
iv. Easier access to imported inputs
After the initial rapid pace of liberalisation in the early 1990s, the process slowed down and during the past decade, widespread use of para-tariff reverted to some extent the benefit SMEs gained initially. A strategy for the development of the SME sector in Bangladesh, therefore, needs to be premised on further trade liberalisation measures with a view to providing SMEs easier access to imported inputs.
v. Targeting public expenditure towards augmenting demand
One important factor affecting the growth of SMEs has been the trend in domestic demand. Thus, the rapid growth of the construction sector seems to have contributed to the expansion of SMEs producing non-metallic mineral products, particularly bricks, structural clay and cement products. Public expenditure directed particularly towards the agriculture and the rural sector would raise the purchasing power of the rural people. Since the demand structure of this segment of the population is more oriented to local products, it would act as a stimulus for the growth and expansion of SMEs.
vi. Access to credit
Availability of credit is one of the most important factors for SME development. To strengthen targeting of SME credit, i) conducting a census of SMEs containing detail information on inputs, output, technology and management, ii) issuing identification cards with registration number to SMEs, iii) creating a database of SMEs and updating it periodically, and iv) creating a detailed upazila level map of SMEs to identify cluster are required. 
A lopsided feature of SME credit, particularly those under Bangladesh Bank's refinancing scheme, is the predominance of trade and other service activities as opposed to manufacturing amongst the credit recipients. Thus, Bangladesh Bank data shows that more than 60 percent of the SME credit disbursed was accrued to trade and other service activities while the share of manufacturing was less than 40 percent. Efforts need to be made, therefore, to enhance flow of credit to manufacturing SMEs.
vii. Human resource development
To address the problem of skilled manpower for SMEs, the system of technical and vocational education in the country needs to be revamped. In line with successful international experiences, the government should provide compulsory, state-funded education up to the age of 14 and partially state-funded, compulsory higher secondary education up to the age of 18 or 19. The institutional capacity to impart appropriate technical and vocational education needs to be strengthened. For this, close association of the potential employers in developing the right curriculum would be important. India's Industrial Training Institutes, which are managed by Institute Management Committees (IMCs) comprising of local industry representatives, could be an example in this regard.
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Dr. Zaid Bakht is Research Director and Dr. Abul Basher is Research Fellow at BIDS.