Small and medium enterprises (SMEs) are borrowing more from banks despite a big rise in interest rates. But they are pumping additional funds into their operations just to stay afloat, not for capacity enhancement.

In the first 11 months of 2018-19, SMEs made net fresh borrowing of Rs111 billion and the bulk of it (Rs94bn) was working capital, according to the State Bank of Pakistan (SBP). Their net borrowing was Rs25bn in 2017-18 with the share of working capital at a little less than Rs18bn. The big jump in working capital is attributable to a weaker rupee and higher inflation that increased the SMEs’ cost of operations.

The economic growth rate slowed down last year to 3.3 per cent from 5.5pc a year earlier. It is expected to grow at an even slower pace — 2.4pc — during this year. This means SMEs will have to struggle more to enhance their sales. The SBP has projected that inflation will rise at an average pace of 11-12pc this year against less than 7.5pc a year ago. The tightening of interest rates continues to check inflation. Besides, the SBP is faithfully implementing a market-determined flexible exchange rate regime under the strict supervision of the International Monetary Fund (IMF). So the rupee may depreciate further as external-sector imbalances have not gone away — they are just less pronounced now. All this indicates that SMEs’ working capital needs will outweigh their fund requirements for fixed investment.

Chinese SMEs equipped with better management skills and advanced technologies are due to set up businesses in Pakistan. Local SMEs will face tougher competition in the near future.

In such circumstances, capacity enhancement and technological advancement are key to survival. But we don’t see banks offering enough loans to SMEs for fixed investment.

Lots of Chinese SMEs are expected to compete with their Pakistani counterparts. It is high time for the government to introduce the long-awaited SME policy

However, Karandaz, a UK-funded Pakistani company, has secured $23.7m from abroad to invest in the SME sector in the current fiscal year while IFC is going to invest $2.5m to support tech-driven start-ups. These things should help in preparing SMEs for future growth.

But will growth in non-performing loans (NPLs) — amid interest rate tightening and slower economic growth — impede the generous distribution of local bank loans among SMEs? Will growing political confrontation allow SMEs — or for that matter the entire business class — to operate smoothly?

The infection ratio, or NPLs as a percentage of total bank advances, is the highest for SMEs — 16.4pc in March 2019, even higher than 16.1pc for the notorious agriculture sector. So the banking industry in general should remain cautious in lending to SMEs particularly for long-term fixed investment. The banking industry is expected to keep offering SMEs short-term working capital.

In the first 11 months of 2018-19, they lent less than Rs12bn to SMEs for fixed investment against Rs15bn in the entire 2017-18. Had interest rates not risen too fast in 2018-19, SMEs would have borrowed more under this head. Had banks not feared a build-up in NPLs, they would have pumped in extra funds.

During the first 11 months of 2018-19, banks’ net fresh lending to SMEs under trade finance also remained stagnant. This too reflects how higher interest rates made it difficult for SMEs to borrow from banks and how slower economic growth affected their revenues. During the current fiscal year, interest rates are going to remain even higher as the SBP is struggling to contain inflation and the economy is going to decelerate further. So troubles for the SME sector are far from over.

Under the present circumstances, most of our SMEs would lose ground to those of China as and when the latter enter Pakistan. And even those that would survive might remain constrained on many counts. Capacity enhancement of SMEs and innovation in business models are, therefore, necessary.

On July 11, a large delegation of Chinese companies met Prime Minister Imran Khan and assured him of investing $5bn in Pakistan in the next three to five years. The delegation represented sectors like construction, machinery, glass, electrical, power, transportation, IT and tech research. When the promised funds start pouring in, lots of Chinese SMEs are expected to compete with Pakistani SMEs after becoming a part of up- and down-stream industries for China-Pakistan Economic Corridor (CPEC) projects.

Our SME sector needs necessary adjustments. It is high time for the government to introduce the long-awaited SME policy. Business lobbies have already invited the government’s attention towards this issue.

The core purpose of that policy should be to enable our SMEs to compete with those of China, India and Bangladesh so that they can contribute more to our export growth.

Another core objective should be to help SMEs adopt futuristic approach in catering to local markets keeping in view the changing dynamics of urbanisation, quest for quality and consumer choices.

Currently, most of our SMEs operate in manufacturing and trading sectors and some of them are in IT and online business. There is a need for promoting dedicated SMEs for agricultural production and facilitating the ones that are in the services sector, particularly IT-related businesses.

The Federal Board of Revenue (FBR) has stopped all sales tax-registered business entities from making sales exceeding Rs50,000 without getting buyers’ CNIC copies. Unlike large corporate entities that can do this without fearing that grey-area operators would snatch their brand sales, registered SMEs fear a loss of business to unregistered competitors. How wisely the FBR finds a solution to this problem will be crucial for the SMEs’ growth.

Published in Dawn, The Business and Finance Weekly, August 5th, 2019