Experience of SMEs in Crisis

Central Asia experienced its first post-independence economic crisis in 1998, which lasted up to 1999 following the Russian financial crisis. The channel through which contagion spread was through trade when Russia devalued its currency by 68% in 1998 and 326% in 1999 relative to pre-crisis ruble to US dollar exchange rate levels. Russia and the Commonwealth of Independent States (CIS) were Central Asia's main trading partner in the 1990s. This devaluation led to a loss of export markets in Russia and globally, as well as import penetration by Russian products in Central Asia. The exchange rate devaluation and volatility was compounded by weak commodity prices and by the banking system disruptions related to the crisis.

4.1 Effect of the Russian Financial Crisis in General

The Russian ruble devaluation led to the relative appreciation of Central Asian currencies, causing their exports to slump in their major trading market. The hardest hit were the countries that had significant trade links with Russia and other members of the CIS, especially Kazakhstan. Kazakhstan's GDP contracted by 2% in 1998, but also quickly recovered in 1999.

Before the crisis, a significant share of Central Asian countries' exports went to Russia and other CIS countries. Russia was a key export market for Uzbek cars and electronics, Kazakh chemicals, metals, food items, and light industry products. Both these countries exported more than a third of their total exports to Russia. Tajikistan exported (and still does) a huge number of laborers for Russian construction sector. Thus the ruble devaluation caused a significant rise in the region's current account deficit as a percentage of GDP (Table 6 [ PDF 54.1KB | 1 page ]). However, some countries like Kyrgyz Republic and Turkmenistan felt the export contraction not mainly through the depressed Russian market but, in the case of the former, more from the low prices and production problem in the mining sector, and in the case of the latter, from the suspension of gas exports to Ukraine¹⁸.

The imbalance in trade between Russia and Central Asia continued until the domestic currencies in Central Asia were allowed to float. Average depreciation in Central Asian currencies against the US dollar in 1998 and 1999 ranged from 147% in Kazakhstan to more than 1,500% in Turkmenistan. Kazakhstan's currency appreciated vis-a-vis the ruble by 39%, from a rate of 13.03 tenge to a ruble to 8.07, in 1998 and appreciated further to 4.85 in 1999, or a whopping 63 % exchange rate adjustment since the beginning of the crisis. Except for Turkmenistan, Kazakhstan had the deepest rate of adjustment from the precrisis levels relative to other Central Asian countries. The Kyrgyz Republic had the least exchange rate adjustment by 1999, appreciating only by 47% from the 1997 level (Table 6 [ PDF 54.1KB | 1 page ]).

Aside from allowing their currencies to float, Central Asian economies also adopted various trade restrictions in a futile effort to initially maintain the peg to the ruble. Examples of these measures included: introduction of 20% value added tax (VAT) in Kazakhstan on all personal imports from Russia, Uzbekistan, and Kyrgyz Republic; imposition of import quotas after local producers complain about unfair competition from imports; new licensing procedures; etc. In Turkmenistan, the government required all export and import contracts to be approved by the State Commodity Exchange. In Uzbekistan, the government banned the free unlicensed sales of food, mostly imported from Russia. Except for the Kyrgyz Republic, none of the Central Asian countries was a member of the World Trade Organization (WTO) at the time of the crisis, hence they were able to make discriminatory tariff changes against imports from specific countries, a violation of the most-favored nation principle which is sacrosanct to the WTO. On exchange flows, Uzbekistan increased the surrender requirement on exports, while Kazakhstan increased it on invisible transactions¹⁹ and current transfers. Other Central Asian countries adopted other similar measures to favor domestic producers.

Besides being hit by the ruble devaluation, Central Asia likewise suffered through the weakness in world commodity prices. At the time when oil prices were hitting a low of US$10 per barrel, the heavily commodity export-dependent economies had little else to offset the adverse impact of the exchange rate volatilities. It was not until 1999 when the price of oil and metals increased that Central Asia was able to raise export levels and revenues.

The decline in capital inflows due to the crisis and the disruption in banking activities raised foreign borrowing costs for all emerging markets. Kazakhstan, in particular, was severely affected as its banks intermediated huge flows of foreign capital and plowed them into the domestic economy, especially the mining sector. But as foreign investors became more circumspect about the former Soviet republics, the sources of capital dried up. Reportedly, international banks limited total loan exposures to these countries and made granting them more stringent. For example, the approval of any loans to Kazakh entities had to be obtained from the highest level of their headquarter offices²⁰.The Kyrgyz Republic, in turn, suffered from the drying up of liquidity when Russian and Kazakh bank subsidiaries operating in its domestic market limited funds and became extremely cautious.

Compared to the first half of the 1990s, with three or four digit inflation in some Central Asian countries, inflation was not a significant concern during the Russian crisis, except for the Kyrgyz Republic which saw its inflation soar to 36.0% in 1999 from 10.5% in 1998. Relative to precrisis inflation, price changes seemed to have slowed, perhaps as a result of the significant appreciation of their currencies with respect to the ruble, increased control in the regulation of monopoly markets, changes in VAT rates, and cheap prices for raw materials (Kalyuzhnova and Vagliasindi 2006).

4.2 Effect on SME

4.2.1 Capacity Utilization

The Russian crisis had different effects on different sectors of the economy. For example, relative to other producers, import substituting sectors have felt the pinch harder due to the huge inflow of cheap Russian goods to Central Asia. Kalyuzhova and Vagliasindi (2006) validate this through a panel data econometric estimate of capacity utilization of firms in Kazakhstan. The argument is that when firms face reduction in demand, they run down inventory, thus leading to a lower level of utilized capacity.²¹ The authors show that import substituting sectors exhibit lower capacity utilization during the period of the Russian crisis relative to other sectors, implying that the sector was more heavily affected by increased competition from cheap Russian imports.

One would have thought that many of the import substituting sectors must have been SMEs since the large enterprises in Kazakhstan are normally associated with the extractive sectors and export sector, and that, therefore, SMEs were those that should have suffered more severely from the Russian crisis. The authors, however, showed that this did not appear to have been the case. Their result, in fact, showed that, relative to other sectors, SMEs were less affected by the crisis evidence by their higher degree of capacity utilization.²² According to the authors, the higher capacity utilization, in turn, is due to the more flexible production structure of SMEs compared to large firms that are mostly SOEs or still partially owned by the government which has, therefore, “social obligations” towards the community and forced to retain employees as much as possible.

4.2.2 Sales, Investments, Exports, Employment, Debt

This apparently puzzling result appears to be also corroborated by the 1999 BEEPS. I consider only firms in the sample with annual sales not exceeding US$15 million which, as per definition used by the World Bank, is the limit for medium enterprises²³. I could not use the number of employees, as I did with the 2005 survey because the 1999 survey did not contain this information. As in 2005, the 1999 survey was conducted using a quota sample with targeted quotas on the basis of sector, size (based on number of employees), and location.

One of the questions in the survey that can be interpreted as providing some assessment of the Russian crisis' impact on SMEs asks whether the firm's sales, investment, and employment have changed over the past three years. As a result of the crisis, one would expect sales of SMEs to plummet and investment to take a back seat, but the result of the survey is, surprisingly, the reverse.

The number of firms that reported an increase in sales and investments over the three preceding years exceeds those that report a decrease (Figure 2 [ PDF 45KB | 1 page ]). Among exporters, the number of those that report an increase is roughly the same as those that experienced a decrease in exports. Only for “employment” did more firms report a decrease, while all the other variables appear to signify that firms were not that badly affected by the Russian crisis after all.

Though the question in the survey relates to the three preceding years, the answers of the enterprises in 1999 are still telling of the relatively little impact of the Russian financial crisis on Central Asian SMEs. It is as if the SME responses were saying that relative to how they were during the earlier part of the decade with all the transition difficulties brought about by the break up of the Soviet Union, the financial crisis is almost like a ‘non-event'. If the crisis had been highly significant in reversing whatever gains they have had since earlier times, many enterprises would have reported ‘decreases' in sales, investments, and exports over the past three years. But the survey result shows more number of SMEs reporting increases. For the lack of actual data of impact on SMEs, I take this evidence to mean that the result of the Russian crisis might not have been so dire, consistent with the same findings by Kalyuzhova and Vagliasindi (2006). On the other hand, that many firms report decrease in employment may be indicative of the restructuring programs of many privatized SOEs, whereby many superfluous laborers were removed. Is there a difference in the perception between exporting and non-exporting SMEs, and importing and non-importing ones? Further classification of the respondents did not exhibit any significant difference between exporters and non-exporters, nor between importers and non-importers.

4.2.3 Arrears

Other corroborating evidence of the relatively little impact of the Russian crisis on SMEs is the number of firms in arrears on payments for taxes, utilities, salaries, and supplies. An overwhelming majority of respondents reported that they had no accounts payable in arrears (90-day overdue accounts) either to the government or suppliers or workers. Of the firms that had arrears, many more said that the amounts were modest than those that said substantial (see Figure 3 [ PDF 44.6KB | 1 page ]). If there were significant amounts of arrears, they stemmed from late payments on accounts receivables, as customers were either unable to pay or requested to delay payments. Even then, most firms reported that the overdue accounts receivable amounts were modest. Since firms usually make use of liability payment arrears, especially tax arrears, as a cheap source of financing, this data indicates that, indeed, the SMEs did not appear to have been that badly scathed from the Russian crisis.

4.2.4 Perception of Major Obstacles

Comparing the firms' perception of major obstacles in 1999 and 2005, the surveys show that the SMEs' concern during the financial crisis was over the macroeconomy (see Figure 4a [ PDF 56.9KB | 1 page ] and Figure 4b [ PDF 76.2KB | 1 page ]). The survey asked firms to rate specific factors from 1 (not an obstacle) to 4 (major obstacle). I took the number of firms that considered the different factors as major obstacle as a share of the total sample, shown in Figure 4. More than 50% of surveyed firms considered inflation and exchange rates as major obstacles to their business, while only 46% indicated that financing was an obstacle. Other high-ranked factors are corruption, taxes, and policy/regulatory uncertainty. This result indicated how macroeconomic uncertainty posed a threat in the operations of many firms then and, by implication, financial crises exact real costs to the economy through the volatilities they create for firms. This concern over macroeconomy contrasts markedly with the result of the 2005 survey, taken at a time when the economy was generally stable. In 2005, macroeconomic considerations were not a major concern of firms. High taxes were a concern both in 1999 and 2005, but in the more stable period, it took a dominant place. Financing, too, was considered a major issue in both periods but, especially in the case of small firms, the cost of finance was a top concern in 2005. The other difference between the two surveys is that there was no single factor that was overwhelmingly considered as a major obstacle in the later survey. In 2005, for example, the top “vote-getter” (taxes) concerned only 21% of the firms, while in 1999, macroeconomic factors received “votes” from more than half of the sample.

The 1999 and 2005 BEEP Surveys were not conducted on the same set of firms to make a panel data. The BEEP Surveys included a panel component of 1,500 firms from the 2002 and 2005 surveys, but not from the 1999 round. The change in perception between two groups of respondents, however, still reveals an overall shift of business sentiment even if the set of respondents may have been different, in relatively the same vein as how the random surveys that are usually carried out on various population groups are used to assess the public sentiment on any social or political issue. These random surveys of public perception are, likewise, not panel data, but rather to be considered a snapshot of the public pulse at different points in time.

4.3 Effects on Trade Finance

Some questions in the BEEP Survey focused on financing obstacles. Here, more than 50% of SMEs considered high interest cost as a major obstacle and this share was the same among different groups: exporters, non-exporters, importers, and non-importers. The next three major obstacles cited in 1999 - collateral requirements, access to long-term loans, bank bureaucracy— were cited by a far lower percentage of firms that considered them as major obstacle (Figure 4). Interestingly, the ranking of these three factors permutes depending on whether the firms engaged directly in trade or not. In particular, for direct exporters and importers, collateral requirements came second, followed by access to long-term finance, and bank bureaucracy, while for non-exporters and non-importers, access to long-term finance was second, then bank bureaucracy, and collateral requirements.

Among the different formal financing arrangements that banks offer, trade finance is usually the least attractive to them, because it is typically a low-margin activity. However, it is also among the safest because they have clear, tangible collateral in the cargo that they fund. The 1999 BEEP Survey did not dwell in particular on trade finance, but Figure 5 [ PDF 77.3KB | 1 page ], below, indicates it must have been likely that, along with other financing, the cost of trade finance had likewise surged during the Russian financial crisis.

4.3.1 Weak Financial System

There are some factors that can explain the difficulty of access to finance, especially trade finance, of firms in Central Asia. One factor that the region shares with other transition and emerging economies is the weakness of the banking system. When the Russian financial crisis occurred, both Kazakhstan and the Kyrgyz Republic had just gone through a serious financial system crisis. The unstable financial position of the region's commercial banks, which was further aggravated by the Russian crisis, made them high risk counterparties of western banks in any trade financing deal. Various reports during the period on conditions in the CIS, of which the Central Asian countries are members, indicate that prior to the 1998 financial crisis, western banks were generally ready to confirm L/Cs issued by CIS banks. During the crisis, only very few banks remained willing to accept L/Cs issued by CIS banks.²⁴ It is likely the case that the same situation, if not worse, held true in Central Asia during the period. Since SMEs tend to get less favorable treatment from banks relative to large enterprises even during normal periods,²⁵ it can be surmised that during the Russian financial crisis, the financing situation for SMEs, could have only gotten worse.

The weakness of the banking sector does not only affect trade finance through the lack of trust from foreign counterparties; it directly affects the domestic provision of trade and working capital financing services to local exporters and importers. During a financial crisis, banks' weak condition makes them very selective in granting trade financing loans. In Central Asia, many local private banks issued L/Cs only to customers with the requisite funds on their account. This was almost equivalent to a cash collateral requirement by the issuing banks, making the financing operations of the firms more challenging.

As the region is dependent on commodities exports, Central Asia's trade financing needs are more for working capital and pre-shipment financing. Generally, without a working capital source, exporters have higher performance risk, i.e. the risk of not being able to deliver on time and according to desired quality. Hence, access to pre-shipment trade financing can help firms attract more international business. If exporters cannot deliver goods on time because of a lack of working capital, repeat business will be more difficult to obtain. But a weak banking system and a financial crisis make pre-shipment trade financing for working capital purposes more difficult and costly to obtain because the reluctance of banks to extend credit without burdensome collateral requirements is heightened during this period.

4.3.2 Knowledge Deficit

Besides the undercapitalization of Central Asian commercial banks, they also offer a limited range of services and relatively inefficient loan monitoring capacity. Particularly in the 1990s, they lacked experience in documentary trade operations as well as knowledge in other trade financing instruments such as forfaiting or factoring. Western banks often indicate that only a few banks in the region have sufficient know-how to act as an advising bank in an L/C transaction where a western bank acts as an opening (issuing) bank. In some cases, the region's banks also have standards for trade finance operations that differ from international ones. Moreover, the document-processing technology is out-of-date (UNECE 2000).

4.3.3 Risk Perception and Payment Method

The other major factor is the perception of a high risk level in Central Asia that affects conditions of payment for trade transactions. For example, the French Export Credit Agency (COFACE) classified Central Asia as a high risk area and, thereby, advised exporters to the region to negotiate on pre-payment terms if possible. In contrast, other former Communist countries like Poland and Hungary had been able to negotiate on open account²⁶ and documentary credit terms. The high risk perception, along with the lack of know-how of banks in documentary credits transactions, could be the reasons for the predominant use of the prepayment method not only in import, but also export, transactions in Central Asia and many CIS economies.

4.3.4 Trade Alternative

In Central Asia, countertrade among traditional Soviet-era partners still exist and, in fact, helped in times of financing difficulties. When access to bank financing was difficult, countertrade among CIS countries played a major role in maintaining trade volumes and supply in individual regions. Even in some countries where cash withdrawals were strictly monitored and controlled, barter activities thrived for some basic materials and consumption goods. To a certain extent, it is alleged that barter trade may actually be less costly and more convenient than cash- or credit-based trade due to high taxes, insecure property rights, imperfect credit markets, and rent-seeking behavior of financial intermediaries (UNECE 2000).

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