Characteristics Of SMEs In Developing Countries

SMEs in developing countries face an insurmountable task in accessing finance. Governments must therefore play a very active role in the “SME-Access to Finance” debate. But what exactly government’s role is, is still subject to debate.

Research has been able to identify which government interventions have not worked over the past decades in the SME lending market, however, recent studies are still struggling to define exactly, which policies can work under which circumstances.

Indeed, studies have shown that there is a trade-off between market failures and government failures, the tendency to remedy market failures through government interventions have not been that successful. There is no universal solution to government intervention.

What works in one country, might not work in others; a context-sensitive approach that takes into account country circumstances, is therefore called for (Honohan and Beck, 2007). Where government intervention is involved, the strength of governance arrangements might be an important factor to be taken into account to ensure success.

Least controversial is the role of government in providing the contractual and informational framework as well as, ensuring a stable macroeconomic environment. Government is the natural provider of key institutions such as legislation and court systems. Similarly, given the government’s monopoly over the issue of monetary instruments, ensuring macroeconomic stability is a natural government task. These are the necessary prerequisites for any SMEs policies and support programmes to be effective.

It is through these policies that the government can help push outwards the Finance Access Possibilities Frontier (FAPF) and ensure a long-term sustainable increase in SMEs’ access to finance. While many business reforms do not focus specifically on SMEs, they help close the gap between firms of different sizes and level the playing field. Through these policies governments help create environments that can then be used by financial institutions to reach out to SMEs with more expanded credit facilities to grow and expand the whole economy.

However, these environments are not always used and the financial system offers less credit facilities to the SME sub-sector; eventually, the equilibrium settles below the FAPF, which raises the question on government’s involvement in ensuring that the system moves towards the FAPF.

Some of these policies to push the FAPF outward might require more active government involvement. For example, improving the informational framework through the introduction of a credit information bureau is a specific area where government might have to actively promote.

While banks might be interested in establishing systems to share negative information, incumbent financial institutions might be less interested in sharing positive information. On the other hand, positive information sharing allows SMEs to build up reputation collateral and thus fosters competition. Overcoming banks’ opposition to share positive information can enhance the contestability of a financial system and might be an area where governments have to take a pro-active role.

Beyond encouraging competition, governments can also try produce a movement towards the FAPF by addressing hindrances such as coordination failures, first mover disincentives, and obstacles to risk distribution and sharing. While not easy to define in general terms, given their variety, these government interventions tend to share a common feature in creating incentives for private lenders and investors to step in, without unduly shifting risks and costs to the government (de la Torre, Gozzi and Schmukler, 2006).

There are three examples of government sponsored programmes that are yielding positive results. One is the creation by NAFIN (a Mexican development bank) of an internet-based market, which allows small suppliers to use their receivable from large credit-worthy buyers to receive working capital financing (Klapper, 2006). Another example is the Chilean program (FOGAPE) to promote lending to SMEs via the auctioning of partial government guarantees (Benavente, Galetovic, and Sanhueza, 2006).

Finally, the Mexican development fund, FIRA, has brokered a variety of structured finance packages to finance agricultural production (e.g., shrimp, corn) to realign credit risks with the pattern of information between financial institutions and different participants in the supply chains of these agricultural products (de la Torre, Gozzi and Schmukler, 2006).

While, these are quite interesting programmes, one is not sure whether risk is really not being shifted to government and taxpayers through such interventions and whether these interventions have strategies clauses that will allow the government to withdraw once its engagement is not needed anymore. There are also governance concerns stemming from a government intervention in a private market. Finally, from political economy viewpoint, such schemes might take away the pressure to implement the long-term institution building that is necessary to push out the FAPF and expand SME lending sustainably in the long-term.

For example, Credit Guarantee (CG) schemes feature prominently among market activist policies. While they also exist on a private basis, governments and donors have been aggressively pushing for their establishment to overcome the limited access to bank credit SMEs face. By providing a guarantee scheme, such as the one run by the Small Business Administration in the United States, it can help overcome the lack of collateral of most SMEs, but issues of appropriate pricing, funding and the institutional structure are important. While such schemes could be run on a self-sustainable basis, they often involve significant subsidies and contingent fiscal liabilities to cover losses.

While it is difficult to compute such costs ex-ante, it is even more difficult to measure the benefits, which would be partially captured by additionality, i.e. the share of borrowers that would not have gained access to finance if it were not for the CG.

An even more accurate measure would be the extent to which borrowers that would have gotten access to credit in a world without market frictions, could access the credit market due to GCs, minus the extent to which borrowers gained access through the CG that would not have gotten access in a friction-free world. Ultimately, the cost of any government intervention has to take into account the return on each dollar of taxpayer’s money in such an intervention compared to other interventions, including interventions outside the financial sector.

That notwithstanding, the government often does not intervene directly in the market in the case of most CG schemes – if credit assessment and monitoring is still left with the banks -the past forty years have seen many examples of market-substituting policies to foster SME lending, with the result balance tipping heavily into the negative. Such policies include directed credit, often combined with interest rate subsidies, and the establishment of development finance institutions focused on SME lending.

In summary, governments must play a meaningful role by finding creative ways to grow the SME sub-sector. Creative ways may include subsidies, credit guarantees, tax breaks, technical training, seminars and workshops, government set aside procurement programmes.

Undercutting market conditions often results in crowding out of private providers, even where the latter would be willing to enter due to changes in the general business environment or due to technological advances. Political subversion of these programs often leads to corruption and channeling of funds to political cronies or to specific electoral groups (Cole, 2004; Dinc, 2005; Khwaja and Mian, 2005).

Although, studies have shown that most government-managed financial sector programs result in high losses and non-sustainability in the long-run, governments must find the least cost means of growing the SME sub sector because of the significant impact they have on the economy.

The writer is an economic consultant and former Assistant Professor of Finance and Economics at Alabama State University. Montgomery, Alabama.