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 Sajani Ramanayake
In recent months, there has been extensive debate around the topic of making Sri Lanka a hub for technology and innovation. Across the globe, small and medium enterprises (SMEs), particularly start-ups, have been proven as critical to fostering a culture of disruption and innovation. In Sri Lanka, SMEs are already an integral part of the economy and hold significant potential for achieving our economic vision. Despite this, many of these businesses continue to face debilitating obstacles to growth due to an unfriendly regulatory environment.
Why are SMEs important?
Contributing to 45% of domestic employment and 52% of Sri Lanka’s gross domestic product (GDP), the role SMEs play in the Sri Lankan economy should not be underestimated. While these businesses do form the backbone of the economy, there is potential for growth that should be explored.
The National Export Strategy of Sri Lanka (2018-2022) 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 this would help increase the overall generation of income in the country. Currently, Sri Lanka lags behind other Asian countries in terms of export figures, and the expansion of SMEs is a good way to facilitate much-needed growth. If SMEs are provided with adequate resources and opportunity, they can plug into global value chains, capitalise on international markets, and drive innovation.
Currently, Sri Lanka’s export portfolio is relatively limited, with a small amount of companies accounting for a majority of export revenue, with SMEs providing a very minor contribution. This lack of export diversification in Sri Lanka’s portfolio thereby makes it particularly vulnerable to the external economic environment and reduces national economic stability. Strengthening SMEs and their access to the export market could thereby present a viable solution to reducing these risks, while improving export earnings, diversifying our export portfolio, and transitioning Sri Lanka into a more complex economy.
What is stopping SMEs from growing?
A lack of finance has been identified as a key constraint by 59% of SMEs in Sri Lanka. SMEs lack the collateral that many lending organisations insist on and often cannot afford to pay the high interest rates charged on loans. Unavailability of accounts and financial information due to the inability to maintain proper accounting records and lack of know-how on business plan creation, also makes it difficult for SMEs to be eligible for loans.
Another problem that SMEs face is the sheer number of regulatory barriers. The clearing of imports and exports through customs as well as high credit periods can be challenging to small businesses. Taxes on imported raw material and capital goods also increase costs and reduce profits. There are also many licenses and permits that need to be obtained before obtaining state lands for business purposes, such as clearances from the Central Environmental Authority, Forest Department, and Department of Archaeology, depending on the nature of the business. This makes obtaining land difficult for SMEs, and deters potential entrepreneurs.
The lack of information and guidance for entrepreneurs about how to set up and expand their businesses is also a major hurdle. In a study conducted by the Ministry of Industry and Commerce, in conjunction with Ernst & Young and GiZ, about the institutional and regulatory framework relating to the SME sector in Sri Lanka, SMEs expressed a lack of understanding about potential export markets and opportunities, a lack of clarity on the process to obtain grants and lease agreements for state-owned lands for business purposes, and low awareness on applicable taxes and the benefits of registering for taxes.
What is being done to help SMEs?
One initiative that has recently been put in place is the establishment of “Empower” by the Colombo Stock Exchange (CSE) and Securities and Exchange Commission of Sri Lanka (SEC). Empower is a board dedicated to attracting SMEs to the CSE and seeks to improve access to finance for SMEs while also providing them with the opportunity to build credibility through the disclosure of information and by making governance standards more balanced. This not only helps attract investors, but also helps improve business visibility for the SME. The board allows SMEs to sell equity in order to raise capital – a major obstacle to growth for a large number of SMEs – essentially functioning as a miniature stock market for these enterprises. Listed companies receive guidance both during and after the listing process, and have access to one-on-one meetings, awareness sessions, and public consultations.
There are also other initiatives like export credit facilities provided by several banks seeking to ease the burden of pre and post-shipment financing, the Enterprise Sri Lanka credit programme which offers a range of loan schemes to SMEs, and workshops carried out by private sector companies such as Microsoft to help address a myriad of barriers faced by these businesses. Despite these initiatives, which are a positive step in the right direction, more needs to be done to help Sri Lanka cultivate a holistic ecosystem for SME growth.
One way to do this is by improving infrastructure facilities such as roads and highways to improve connectivity. This would assist in reducing regional differences in the setting up and operation of SMEs, as people and capital become more mobile. Sri Lanka also needs to streamline its regulatory mechanisms if it wants to help SMEs reach their full potential. Currently, there are at least 43 different institutions affiliated with SME governance in Sri Lanka, resulting in a climate of fragmented governance and poor information. Other potential solutions could include the creation of a dedicated export-import bank to ease access to finance and the establishment of an advisory board comprising exporters, academic experts, bankers, and professionals to enhance the ability of SMEs to formulate strategies and products that meet client expectations and emerging market needs.
If Sri Lanka wants to improve economic growth in the country, it is crucial that concrete strategies to improve productivity and increase export volumes are implemented. If Sri Lanka is to remain competitive on the world stage, SME growth is crucial.