Is Sri Lanka keeping its small businesses small?

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

By Nishtha Chadha

Small and medium enterprises (SMEs) have been a hot topic of this year’s presidential election candidates. Across the spectrum of political parties, SMEs have repeatedly been highlighted as avenues for sustainable economic growth and new innovation. There have been an array of promises to uplift the status and capabilities of SMEs through targeted assistance mechanisms that seek to bolster the role of SMEs in the Sri Lankan economy. However, if the Government truly intends to empower local SMEs, there needs to be a holistic approach to policy reforms and programme implementation.

There is no doubt that SMEs make up a crucial part of the national economy. Accounting for 52% of total GDP and 45% of national employment, these enterprises present a wealth of opportunity for domestic economic growth (1).

Generally, SMEs tend to be labour-intensive and require less establishment capital than larger firms. As such, growth in the SME sector poses significant potential to create new employment opportunities and facilitate wider distribution of wealth across rural and regional areas. They also hold the potential to increase tax bases at a quicker pace than larger enterprises, thereby contributing to government revenue.

However, Sri Lanka still lags behind regional neighbours when it comes to SMEs as a percentage of total enterprises.

In India, Malaysia, and Singapore, SMEs make up between 95-99% of total enterprises, while in Sri Lanka, they barely make up 80% (2018). Moreover, despite their significant contribution to the economy, SMEs in Sri Lanka only account for a marginal proportion of total national exports, suggesting a severe disconnect between the interest of the SME community in expanding their market base beyond the domestic sphere and their practical ability to do so.

The Government itself has acknowledged the need to strengthen the SME sector and increase its export potential.

The National Export Strategy of Sri Lanka (2018-2022) explicitly acknowledges the need to “strengthen Sri Lankan exporters’ market entry capacities” and support “the integration of SMEs from across Sri Lanka into the export value chain”. As a result, the Enterprise Sri Lanka credit programme has been launched by the Government in an attempt to improve awareness and access to finance for small and medium entrepreneurs through a variety of loan schemes. These include interest subsidy loan schemes, donor-funded refinance loan schemes, and financial and non-financial support programmes. Enterprise Sri Lanka seeks to make the Government’s vision of creating 100,000 entrepreneurs in Sri Lanka by 2020 a reality, and has already disbursed Rs. 88 billion through the loan schemes since its launch.

A band-aid approach

While access to finance has certainly been cited as a common barrier to SME growth, there needs to be a more holistic effort to address the various other obstacles that currently deter small and medium entrepreneurs from achieving their export potential. The development of e-commerce has created an era of new opportunity for SMEs to engage in international trade at a fraction of the cost, and Sri Lanka should capitalise on this window of opportunity to reboot its economic growth. The renewed focus of politicians on SMEs does indicate some positive posturing.

However, there is a pressing need to change the narrative on SME growth. Although SMEs are the backbone of the national economy, they need to be supported to grow beyond this classification.

Regulatory burdens and poor access to information continue to remain major impediments to SME expansion.

There are over 20 ministries that serve the business sector in Sri Lanka, with numerous departments, authorities, and councils established under each of them. This has resulted in a major fragmentation of governance mechanisms, critical information gaps, and poor private-public synergy. Thus, in addition to improving access to finance, the Government needs to streamline its SME strategy and make opportunities more accessible to entrepreneurs.

The ultimate goal of SMEs should be to grow into large enterprises that compete at an international scale, and SME-related reforms should reflect these aspirations. Band-aid approaches that target singular obstacles to growth without looking at the bigger picture cannot cultivate the effective ecosystem for entrepreneurship that Sri Lanka needs, if it is to achieve high income status. Present requirements such as the minimum capital contribution of $ 5 million from foreign shareholders in companies that engage in retail trade are not in line with this growth agenda. SMEs should be encouraged to grow faster through partnerships with overseas businesses to access capital and skills. However, restrictions like these hinder the growth of SMEs in the retail sector.

Sri Lanka is already at great risk of falling into the “middle-income trap”, with high debt burdens and slowing national growth. Having recently achieved upper middle-income status, the economy can no longer rely on foreign aid inflows to facilitate economic growth and development. As such, the country must find ways to improve productivity and increase export volumes if it is to remain competitive on the world stage. SMEs present a unique opportunity to facilitate this growth by plugging into global value chains, capitalising on international markets, and driving innovation – but only if they are provided with meaningful resources to do so.

SME success stories from the developed world have demonstrated the importance of public-private co-operation for sustainable growth, and Sri Lanka should look to emulate this if it intends to move beyond its current middle-income status. As noted by the OECD: “Start-ups and SMEs are typically more dependent than large companies on their business ecosystem and, due to their internal constraints, are more vulnerable to market failures, policy inefficiencies, and inconsistencies…a transparent regulatory environment, efficient bankruptcy regulation, and judicial system are essential to support the growth of start-ups and SMEs, especially in innovative, high-risk sectors.” (10)

Thus, to escape the middle-income trap, Sri Lanka needs to make a real commitment to implement all facets of the National Export Strategy and streamline transparent regulatory mechanisms. If Sri Lanka’s next government truly intends to achieve its entrepreneurial vision, it needs to do more than make conflated promises to emerging entrepreneurs and commit to real reforms that will create a fruitful business ecosystem for growth.