May 18, 2021 : Any discussion on the lack of corporatisation in Pakistan finds its way to the lack of avenues of capital for entrepreneurs. With banks on one hand largely unwilling to look beyond anything that involves taking risk and microfinance institutions on the other charging exorbitant interest rates, businesses find themselves between a rock and a hard place. It’s a chicken and egg problem: without the prerequisite financing, it’s difficult to grow while the funds are often channeled towards companies above a certain size. 

Considering SMEs’ importance to Pakistan’s GDP – around 40% – and the share in non-agriculture labour force at over 80%, it’s not a segment that can continue to be ignored if we want broad-based development. But all of us have heard this pitch before far too many times. Just a few days back, the new finance minister, who promises to bring back growth, said the government is focusing on the small and medium enterprises and was discussing the possibility of allowing them collateral-free loans for a tenor of up to three years. This will obviously take its own course to materialise but what about the current status? 

For that, let’s turn to SBP’s data on SME financing, which shows the outstanding amount clocked in at Rs481.78 billion during October-December 2020, surging by 24.8% or Rs95.81bn in July-September. However, given the cyclical nature of this borrowing, it’s more appropriate to look at year-on-year values when, which shows an increase of less than even 1% or Rs4.55bn compared to the same quarter of 2019. 

What’s noticeable is that the share of SME loans in the overall private sector financing continues to be range-bound around 6-9%, coming in at 7.27% in the latest quarter. Since 2016, this percentage has hit the highest of 9.2% in October-December 2016 and not reached the 8%-mark in the last two years. It’s a good indicator that little progress has been made despite usual claims from the policymakers on giving this segment special attention. 

In terms of number of borrowers, there was actually a decline as they fell from 185,010 in October-December 2019 to 179,934 in the quarter under review. From the financial institutions’ perspective, there is obviously a much higher risk associated with SMEs as reflected by their infection ratio of 15.62% during the period. 

The overall corporate sector’s infection ratio stood at 9.91% in July-September 2020, whereas the corresponding figure for SMEs was a whopping 22.45% during the same period. However, it’s also to be mindful of the impact of Covid-19 last year, which troubled businesses of all sizes and was particularly hard on small enterprises. In fact, the NPL-to-gross loans ratio has been generally on a downward trajectory since 2016 when it stood at 30%, leaving aside the first three quarters of 2020.  

Another long-persistent trend in the dataset is the overwhelming share of working capital in the overall financing, hinting that the funds are being deployed towards day-to-day needs instead of being invested for more sustainable objectives. The proportion of SME loans classified as Working Capital stood at 68%, that of fixed investment was 24% while the remaining was for trade finance. 

However, according to those involved in this SME financing space, numbers don’t tell the complete story. A few months back, Karandaaz CEO in an interview with Mettis Global talked of an asset-liability mismatch where businesses were often borrowing for working capital but using the funds for making capital investments. Part of the reason is also the lower interest that’s charged on the former. 

One area where the policymakers could pay attention to is Islamic SME financing – which is made up of full-fledged Islamic banks and Islamic branches of conventional banks – whose share in the total has increased to 12% in October-December 2020, compared to 6% by March of 2016. With Shariah-compliant banking services growing in popularity, it’s an avenue that should be leveraged. 

Yet, the current numbers don’t present an encouraging picture. According to the SBP’s bulletin, SMEs occupy just a 3% share in the client-wise financing portfolio of Islamic banks, versus 5.3% for the overall banking industry.  

Despite superior performance in terms of asset quality indicators, with NPS-to-financing ratio at just 3.2% versus 9.2% for the overall banking, Islamic banks haven’t shown too much appetite for risk-taking. In fact, if anything, they too seem to be wanting a bigger share of the risk-free securities and have been actively calling for the government to issue more Sukuks. Unfortunately, this mindset of parking money in the safest available instrument while ignoring the asset-formation needs of small financing misses the key objective of capital markets. And unless it’s rectified, corporatization and sustainable growth will be nothing but pipedreams.