Supporting the growth of small and medium-sized enterprises (SMEs) is essential for fostering economic development and addressing unemployment challenges. The significance of SMEs in driving economic growth cannot be denied, but strategies are needed to facilitate their transition into the formal sector through targeted financing schemes.

In a fresh effort to foster the growth of small and medium-sized enterprises (SMEs), the government has devised a plan to offer affordable credit facilities to these businesses. This initiative was extensively discussed during a recent federal cabinet meeting, highlighting the urgent need for an alternative financing structure tailored to SMEs. The aim is to unlock the sector’s potential for job creation and economic growth in Pakistan.

The finance ministry has collaborated with several banks, culminating in a scheme formulated by the State Bank of Pakistan to streamline SMEs’ access to bank loans. Accessible credit is vital for any business, facilitating growth, diversification, and day-to-day operations. However, the SME sector in the country has long suffered from a lack of this crucial resource due to limited access to banking services.

Despite various attempts to promote SME financing over the years, the impact has been limited. Many SMEs operate in the informal economy, lacking the documentation required for assessing creditworthiness and risk, which hinders their access to formal banking services.

It’s perplexing that governments have focused on encouraging banks to expand SME financing without addressing the root cause, which is the reluctance of businesses to enter the formal economy. Insufficient attention has been paid to the prohibitive costs and complex regulatory frameworks associated with formalization. The process involves substantial expenses, intricate procedures, legal compliance, and managing multiple tax rates, such as value-added sales tax.

Complying with the withholding tax regime is particularly burdensome for small businesses with limited resources, requiring meticulous record-keeping for numerous transactions throughout the year to claim tax refunds. Additionally, SMEs must navigate labor laws, union regulations, social security payments, EOBI contributions, and other formalities.

Blaming SMEs’ reluctance to enter the formal sector solely on tax avoidance is overly simplistic. A more effective approach involves reforming and simplifying regulatory processes, reducing bureaucratic hurdles, and implementing a comprehensive program to encourage formalization.

The focus should be on reducing the compliance costs of relevant laws and simplifying the taxation system. Additionally, offering tax incentives or exemptions to newly formalized businesses, providing support and guidance on compliance procedures, and implementing technology solutions to streamline administrative tasks should also be considered.

The Pakistan Business Forum (PBF) has proposed that a minimum of 25% of concessional financing, including the Export Finance Scheme, be exclusively allocated to SMEs in the export sector in the upcoming budget. This strategic allocation will not only foster the development of the small sector but also promote a more inclusive and sustainable economy. The PBF suggested that the State Bank of Pakistan (SBP) review its credit policies by setting a special quota to finance SMEs, noting that major concessional export loan facilities have primarily benefited large industries, leaving minimal financing for SMEs. SMEs contribute significantly to the national gross domestic product (GDP), accounting for around 40%.

Despite their importance, over 5 million SMEs face a substantial credit gap, receiving only 7% of private sector credit, far below neighboring countries like Bangladesh (25%) and India (18%). To approach the targets set by our neighboring countries, we must advocate for targeted and fixed SME allocations in concessional financing schemes, particularly those aimed at the export-oriented sector.

In India, over 96% of industrial units belong to small companies, accounting for 40% of the nation’s overall industrial production and 42% of all Indian exports. Small companies also provide various opportunities in rural and urban areas, contributing to employment generation. The Indian economy faces unemployment issues, and small firms have helped increase employment opportunities. Over the last six years, there has been a 110% yearly increase in job creation, with 7.56 lakh jobs created. India is home to 75,000 recognized startups, with 12% in Information Technology services, 9% in healthcare and life sciences, 7% in education, 5% in commercial and professional services, and 5% in agriculture.

The significance of the SME sector for our economy cannot be overstated. Most SMEs rely more on manual labor than larger businesses, making them crucial for employment generation. Given our rapid population growth combined with sluggish GDP growth, supporting such businesses can help alleviate the problem of high unemployment and underemployment in the economy.

Moreover, facilitating their transition into the formal sector could significantly expand our narrow tax base. Encouraging SMEs to formalize their operations must thus be a key component of the government’s economic agenda.

In conclusion, prioritizing the formalization and support of SMEs is crucial for sustaining economic growth and creating employment opportunities. By reducing compliance costs, simplifying taxation, and allocating targeted financing, governments can unlock the potential of SMEs as key drivers of inclusive and sustainable economic development.