Small and Medium-Sized Enterprises
From the Yemen Enterprise Reviltalization and Employment Pilot Project.
In December 2016, the 18th replenishment of the International Development Association, the World Bank’s fund for the poorest countries, put private sector development squarely at the heart of our organization’s commitment to end extreme poverty and boost shared prosperity. In addition, the Internal Finance Corporation’s 3.0 strategy placed new emphasis on creating and catalyzing markets and scaled up the role of advisory services in providing firm-level support.
This new focus makes it even more important to answer the following question: Do we have sufficient evidence about the efficiency and effectiveness of the tools used by the World Bank Group to help firms grow in our client countries?
Building on a broad evaluation of the Bank Group’s support to small and medium-sized enterprises (SMEs), published in 2014, a recent report by the Trade & Competitiveness Global Practice, supported by the Competitive Industries and Innovation Program, reviews the experience to date of supporting SMEs through matching grant schemes. The report looks at the how and why of an instrument that has been used in more than 100 Bank Group projects since the 1990s.
Matching grants are short-term, temporary subsidies, provided to the private sector on a cost-sharing basis (typically 50 percent). The grants generally aim at building firms’ capacity and knowledge through the procurement of business development services (BDS), which include a wide variety of non-financial services such as employee and management training; consultancy and advisory; marketing and information services; and technology development and diffusion. For example, a matching grant initiative in Uganda targets businesses in priority sectors such as tourism, agribusiness and fisheries with the goal of diversifying their products and increasing exports. A similar facility in Afghanistan operates in four cities – Kabul, Mazar-e-Sharif, Jalalabad and Herat – and helps SMEs and business associations to improve product quality and processing technologies, and to gain market knowledge in order to expand their presence in domestic and international markets.
The economic rationale for subsidies to private firms is usually a perceived underinvestment in BDS. This could be due to market failures preventing a profitable investment in such services (e.g., lack of financing for intangible activities, insufficient awareness of the potential benefits or perceived high risk), or to positive externalities from an otherwise unprofitable private investment (e.g., knowledge spillovers). If these conditions are not present, however, matching grants could create distortions in resource allocation, could have limited additionality and spillovers, or could have non-durable impacts if they fail to address the underlying market failure.
The Trade & Competitiveness report reviewed virtually all matching grant projects financed by the Bank Group over the last two decades. Most of these have focused on SME development while some have also supported rural development. Over half of the reviewed projects are in Africa, followed by Latin America and the Caribbean. The average size of matching grant schemes is $11.5 million, with grants for agriculture projects typically being significantly larger than for SME development. The average number of beneficiaries per project is 450 and the average maximum cumulative funding going to a single beneficiary is $112,000, although this amount is much lower in many projects.
In terms of how, the report examines a number of common variables of matching grant projects, such as type of implementing agency and eligibility criteria. A key conclusion is that there appears to be no obvious correlation between the design features of matching grants and either positive or negative outcomes. Rather, matching grants need to be tailored to local circumstances and capacities.
The report does find that personalized technical assistance to beneficiary firms can increase the odds of success. In addition, contrary to perceptions, public implementing agencies generally outperform private consulting firms. Public agencies do particularly well in lower income countries where procuring large international contracts can be difficult and where the agencies know the local context. Whether public or private, strengthening of local capacities, broad stakeholder engagement, and transparent communication increase the chances that a matching grant will achieve its goals.
In terms of why, the report also examines how projects define what constitutes a successful outcome. About three quarters of the reviewed projects received a positive outcome rating. However, the definition of success varied widely, and rarely reflected measures of broad and sustainable economic benefit. Projects should articulate a sound economic rationale identifying a specific market failure. Otherwise, the benefits of a grant may not extend beyond the recipient firm or be sustainable in the long term.
For this reason, the report recommends that, when considering the use of matching grants, development practitioners identify a clear economic rationale, consider alternative instruments, carry out an economic analysis, assess the potential for additionality and spillovers, and establish a realistic exit strategy that would leave sustainable benefits. A strong monitoring and evaluation system is an equally important requirement and an essential tool for real-time assessment of impact, potential course corrections and learning. Strengthening these elements could help development practitioners and their clients maximize the benefits of this potentially powerful tool for private sector development and competitiveness.
To gain access to the full report, click here.
Against the backdrop of low oil and gas prices and fiscal consolidation, economic diversification and private sector development is a top policy priority for the countries of the Gulf Cooperation Council (GCC).
Inadequate access to finance, especially bank lending, is constraining SMEs in GCC countries. Only 11% of SMEs have access to credit and some 40% of SMEs cite a lack of financial access as a major constraint.
Bank competition in the GCC is among the lowest in the world. Strict entry requirements, restrictions on bank activities, relatively weak credit information systems, and a lack of competition from foreign banks and nonbank financial institutions all contribute to weak competition in the banking sector.
At a recent European Commission SME Envoy meeting in Ljubljana, Slovenia, the European group responsible for advising on policy and strategic directions for SME support in the EU discussed options for the way forward.
Battered by continued anemic growth since the 2008 global financial crisis, hit with a flood of Middle Eastern refugees, and (in early June) facing the possibility of Brexit, the mood was anything but upbeat and the future of “Project Europe” seemed to hang in the balance.
, account for 60% of jobs in many countries, and supply as much as 50% to national income. All of this makes SMEs’ contribution to the economy crucial. Yet, since the financial crisis, banks in many countries haven’t managed to bring their SME lending portfolios back up to pre-crisis levels. Many are deleveraging out of riskier lending such as SME loans. Venture capital in Europe remains well below its levels of 8 years ago. And SME capital markets and SME securitization of loans continue to be severely battered by the continent’s ongoing economic malaise.
The World Bank and Rabobank Foundation are teaming up to strengthen financial cooperatives in rural areas to improve financial services for smallholder farmers and agricultural SMEs.
Financial services in rural areas are scarce and expensive. Servicing smallholder farmers spread across wide geographical areas isn’t attractive to mainstream financial institutions as their transactions are small, their cash flows seasonal and returns on investments can be risky due to potential crop failures or weather calamities.
To get access to savings and credit, rural households and farms often establish cooperative financial institutions (CFIs). While CFIs have a strong local presence and knowledge, they often have weak institutional capacity and governance, lack access to information technology, and suffer from political interference. Also, the laws regulating CFIs are often inadequate and supervision is weak, all of which hampers CFIs’ ability to deliver financial services. Often, CFIs don’t fall under the purview of the main financial sector regulator and supervisor, but of other entities that don’t always have the required capacity and expertise.
With this week's kickoff of the 2016 China “Business 20” (B20) proceedings in Beijing, this is an opportune time to reflect on some of the key accomplishments of the 2015 Turkey B20. As many readers of this blog know, the B20 is the premier dialogue platform of the business community with the G20 policymakers representing the most important economies of the world, and it is influential in identifying and supporting policies that are crucial for overall economic development. I believe that taking stock of the past enables us to learn from both successes and failures, and helps sustain the momentum on what worked and generated the desired impact.
Looking back at my involvement as Chair of the B20 Steering Committee, what strikes me as a major achievement is the amplification of the voice of small and medium enterprises (SMEs). I believe that, if we want our economies to have healthy and inclusive growths, this must remain as a key priority for the upcoming B20 in China.
Participants in the Turkish G20/B20 process shared the assessment that SMEs’ potential was not being fully realized. SMEs account for about two-thirds of all private-sector jobs globally and about 80 percent of net job growth. They are the engine for equitable growth and poverty alleviation. And they are the backbone of the middle class and of social stability. Yet they suffer disproportionately from limited access to markets, finance, talent, skills and innovation. In addition, regulations also often put them at a disadvantage. Until recently, SMEs had lacked an organization that would champion their cause.
With these major issues in mind, and with strong deliberations of the B20 Leadership and support from the G20 Finance Ministers, last year TOBB and the ICC officially founded the World SME Forum (WSF), with the mission to help improve the overall growth and impact of SMEs globally, by effectively tackling the key challenges they face. WSF aims to provide SMEs with effective representation and to advance the recognition of the role of SMEs in the global economy by partnering with international financial institutions (IFIs) and development agencies. WSF has membership from associations and chambers working in the SME space from all over the world.
WSF is ready to represent SME interests with regional and global bodies, and to advocate for better rules and regulations among standard-setters.
As I am on my way to Beijing, I cannot help but think that this is indeed a major achievement, which will give the SME development agenda a much better chance at succeeding. WSF can be a “bridge” across B20 presidencies, so that we can ensure continuity in the crucial SME agenda. WSF can help avoid any loss of momentum on the implementation of the recommendations we develop during each cycle.
Even better, after B20 China officially decided to continue the SME Development Taskforce, which was started for the first time by B20 Turkey, they invited WSF to be a Business Network Partner for the Taskforce. WSF will therefore be coordinating the network and will help drive the ideas that emerge from the Taskforce discussions into implementation.
Ecuadorian bread by Vilseskogen, CC Flickr
The World Bank helps to design dozens of projects that assess and address the difficulties of reaching small business owners with services, which include anything from credit and technical assistance, to exports markets, value chains, technology and more.
A deeper understanding of the challenges, opportunities and risks small business owners face might help Bank staff and other development specialists to do an even better job.
For example, meet Reina, a baker in Quito, Ecuador. Reina operates a business with four workers, two ovens, and a range of sweet and salty breads popular with the neighbors. Her small shop has electricity most of the day and a reliable water connection most of the year. The display windows are filled with freshly baked rolls that hide the ovens, the small warehouse for raw materials and the occasional chaos that arises during busy weekends and holidays.
How did she get here? Reina worked for another baker for five years, learning the trade. She took a two-day course on business management from an institute on the other side of town. Then Reina took out a loan from an informal group of friends, who lend periodically to each other for business and home needs, to buy her first oven. Reina offered part-time jobs to a few relatives and a friend and trained them in the basics. And Panadería Estrella (the Star Bakery) was born. It is a story repeated thousands of times in emerging markets. This is how the shadowy informal sector creates work… and wealth.
With her investment on the line, Reina makes a number of decisions every day which can determine the bottom line of the bakery. As we go decision by decision, you will understand what she does and what she needs more easily. One decision leads to another and another.
I recently attended an interesting presentation about a truly impressive credit guarantee agency, the Korean Credit Guarantee Agency (KODIT), established 40 years ago with $44 billion in outstanding guarantees and 220,000 SMEs guaranteed annually. A truly impressive institution which has opened up bank lending to more and more SMEs, which otherwise would have gone unfunded and unserved. As one of the larger Partial Credit Guarantee (PCG) schemes in the world, the Koreans have clearly achieved remarkable results at an impressive scale.
The one thing that struck me most, however, was the slide reproduced below. KODIT explicitly uses a guarantee instrument on SME loans as a tool of countercyclical policy. So, when the economy enters a down turn, guarantees are more liberally applied to ensure that SMEs don’t go out of business and adversely impact the generally negative economic scenario. “Job Preservation” becomes more important than “Job Creation.” With 99% of registered firms in Korea being SMEs, and with 87% of Korean employment coming from SMEs,supporting this sector in a down turn is clearly very important.
Korea is not unique. During the early days of the Great Recession in 2008, the Small Business Administration of the United States of America increased SME guarantees in the face of an economic down turn. Since the summer of 2015, the Chinese government has begun to offer subsidized loans to SMEs to counteract the effects of the Chinese slow down. Countries such as Turkey, Ecuador, Nigeria, Kazakhstan, Myanmar and Egypt are increasingly seeking World Bank support for SME lines of credit, SME guarantee programs, and other forms of SME support. Supporting SMEs is clearly a well-recognized and frequently applied tool of economic policy.
Yet our own World Bank guidelines stipulate that SME-support interventions are meant to help achieve longer-term developmental goals – broadening and deepening financial markets so that financial systems can ultimately take on these types of lending without the need for outside intervention. In fact, a 2014 IEG Report on “The Big Business of Small Enterprise” criticized the World Bank, the International Finance Corporation, and MIGA for undertaking SME I, followed by SME II, followed by SME III, followed by SME IV, with no visible increase in the capacity of the underlying financial sector to sustain such lending on its own account, very little lengthening of the tenors of SME lending, and seemingly very little increase in the commercial banking sector’s comfort levels in dealing with a clientele which all too frequently is perceived by private lenders as being unduly risky.
It would actually seem, however, that SME Lines of Credit and other forms of SME support, are undertaken for several reasons but within two broad categorizations:
- To help catalyze the market in the development of longer term financing instruments (an output, not an outcome)
- Support employment generation (which is a prime motivation in the current global environment) or other “SME-related” objectives (such as diversification, innovation, geographic dispersion of economic activities, value chain inclusion, women’s employment, youth employment, etc)
- As a tool of countercyclical economic policy.
It would appear that SME support mechanisms can be a legitimate tool of countercyclical economic policy in an economic down turn. However, because speed is generally a prime pre-requisite in such an environment, these types of operations will not necessarily promote the pre-conditions for longer term market development for SME funding, an enhanced appetite for banks to lend to SMEs, or even increased support for “employment-generating” SMEs that may well be the desired target …………. and consequently, the criticism that we are not having a real lasting developmental impact.
Maybe the time has come start thinking about SME lending in two distinct ways:
- As a tool of countercyclical economic policy (much like fiscal support through a DPL, but directed at the private sector) and
- As a more developmental instrument (catalyzing longer term lending markets, developing instruments more attuned to “employment generating” SMEs, supporting a more robust financial infrastructure – including payments system and PCG support schemes, etc).
Green bananas. Saturday morning I head to the market to buy bananas, but I find only green ones at the stand. There is no large banana importer to complain to, no government bureaucrat to sympathize with my need for ripe bananas, and certainly no banana grower to chat with. I have to make an economically rational decision (buy them green, buy them later, or don’t buy at all) and move on to the apples, where the cycle repeats. This is a market imperfection that I understand and have to live with (although it drives me bananas).
But what about when we wear another hat, that of the Bank financial sector project designer? We are used to generating investment projects that fit different market situations, regulatory systems, and political realities. Under tight time constraints, we do what an economist might do – assume there is a market imperfection and brainstorm on the most appropriate effective solution. But a true economist would want evidence of the market imperfection from statistics, recent assessments, etc.
So what is a financial sector specialist to do? The first step is to understand which of the many imperfections represents the binding constraint – the one that blocks government and private sector counterparts from taking the first steps to correct a problem. This is where the economists come in.
Since more than 50% of small and medium-sized businesses (SMEs) worldwide lack adequate access to credit, the international community is proposing reforms that will help countries strengthen their financial infrastructure and make it easier for SMEs to borrow funds needed to operate and expand.