Government Support for SMEs

Central Asian governments recognize the importance of SME development in their countries' growth. But SMEs have yet to emerge as the real backbone of the Central Asian economies because large enterprises have historically dominated major industries like metal, oil, and gas. To assist SME growth, the countries have special programs funded by the government or foreign donor institutions. In Kazakhstan and the Kyrgyz Republic, for example, there are support infrastructures (business incubators, techno-parks), consulting and training centers, special tax regimes, outright financial support through loans and grants. Tajikistan is streamlining their SME policies to eliminate program duplication, and developing state policy and strategies to attract FDI to SMEs. Even Turkmenistan and Uzbekistan, which are the least market oriented in the region, have special financial and tax privileges in their laws for SMEs³³.

In the current global financial crisis, Kazakhstan's government has set aside US$4 billion emergency spending or approximately 20% of its GDP, out of which 117 billion tenge³⁴ (or roughly 25% of emergency spending) are allocated for SMEs. The government-owned holding company Samruk-Kazyna is managing the fund and agreed with 12 commercial banks to disburse money in February 2009 to finance SME purchases of fixed assets, operating costs, and refinancing of existing loans. The loans are capped at 750 million tenge (US$5 million) per borrower and with a seven year tenor. The government has also lowered corporate tax rates and removed the monthly tax pre-payment to help business enterprises.

In terms of trade finance, transition economies have varying degrees of SME support through direct export financing and export credit insurance. Government-sponsored direct export finance can take the form of pre-production financing of the domestic exporter, refinancing of export credits extended by commercial banks, or interest rate subsidies. Government-owned export credit agencies usually provide trade insurance to cover various trade risks (commercial, political, etc.) of non-payment as well as guarantees for trade transactions. These guarantees are often crucial for actual access to bank finance. Unfortunately, these types of support are not as well developed in Central Asia as in other transition countries. For example, in the UNECE (2000) Conference volume, only Kazakhstan was mentioned to have a government agency providing exporters with direct financing. Likewise, only Kazakhstan and Uzbekistan have government-supported export credit and insurance schemes that seem operational. The Uzbek Export-Import Insurance Company appears to be the best capitalized and the most active export credit agency in the CIS region.

Interestingly, what the SMEs are clamoring for from the government, over and above technical and financial support such as those mentioned above, are, actually, basic market reforms in the form of transparent and consistent regulations and tax policies, less corruption, lower cost of finance, as well as better infrastructure.

6.1 Market Reforms

In countries like Uzbekistan and Turkmenistan, a market economy has never been fully embraced, and the global financial crisis had just reinforced their resistance to move towards greater market reform. Although these slow reform economies have legally promulgated measures to develop the private sector, they neither constitute a coherent strategy or vision for the role of the private sector in the economy nor are they fully implemented. In Uzbekistan, for example, government control remains pervasive through its direct and indirect control of state-owned joint stock companies or enterprises managed through industrial associations. Through government procurement, the state has control over important food and cash crops. For example, cotton production is controlled through a central government scheme, limiting options of farmers to plant alternative crops. The government industrial policy and involvement in the economy undermines the creation of a dynamic private sector and fair competition culture and throttles the growth of SMEs.

In Central Asia, property rights, ownership of land, and land markets are among the basic reform that could support SMEs. Thus far, only Kazakhstan and the Kyrgyz Republic have managed to amend their constitutions to allow private land ownership. Tajikistan, Turkmenistan, and Uzbekistan still have limited land tradability either de jure or de facto (Tajikistan) (see Table 8). In Uzbekistan, for example, the state grants farmers only a time-bound right to use land, not full property rights. It also heavily regulates the scale and type of activities, including controlling the amount of land devoted to particular crops. The lack of clear property rights and tradable rights in land hamper agriculture in which many individual entrepreneurs depend and severely hamper their access to finance. It undermines efficiency and discourages investments. Removing this constraint would provide a big spur for agricultural growth and productivity.³⁵

Other areas of market reform that support SMEs are in the area of institutional quality, i.e. the quality of the regulatory framework as well as the institutions that implement them. For example, addressing tax policy through a simplification of customs and tax rules and procedures and removing bureaucratic red tape, can eliminate one of the most serious constraints to business. It is, besides, a frequent source of corruption. Reform could help many SMEs that operate in the informal economy, seeking to avoid legal taxes yet also paying a high cost for avoiding the law in the form of unofficial payments to corrupt law enforcers, to emerge from the gray sector.

Central Asian countries have made significant progress in establishing a legal and regulatory framework for businesses, although better enforcement is needed. The corpus of commercial laws, e.g. transactions law or insolvency law, are generally limited in scope and thus are assessed as ranging from low quality (for Tajikistan, Turkmenistan, and Uzbekistan) to medium quality (Kyrgyz Republic and Kazakhstan) (see Table 8 [ PDF 46.2KB | 1 page ]).

All the regulatory framework, no matter how well crafted, will be for naught without a comprehensive legal and judicial reform. An improved judiciary is critical to ensure the effective enforcement of constitutional rights and freedoms, to curb the arbitrary and predatory behavior of public administration and law enforcement agencies, to ensure better protection of property rights and contract enforcement.

6.2 SME Perceptions of Various Obstacles to Growth

I also used the 2005 BEEP Survey, once again, to assess the perception of business environment at the micro level. From this survey, I derive some implications of worthwhile government programs and support for SMEs.

Figure 10 [ PDF 100.7KB | 1 page ] provides a picture of what concerned firms, including SMEs, the most. The survey asked how problematic the different factors were for the growth and operation of the enterprise with options from 1 (no obstacle) to 4 (major obstacle). The graph shows the percentage of firms in Central Asia that consider the different factors as a major obstacle to their growth (i.e. rated them as 4). Among small firms, the cost of finance was chosen by most, followed by tax administration and corruption. Access to finance is somewhere in the middle of all the factors identified. For all firms, tax administration appears to have posed a greater concern than the cost of finance.

Various other reports add further qualitative assessments to the survey results. For example, a United Nations (UN) Economic Commission for Europe (UNECE) study³⁶ stated that in some Central Asian countries, firms cannot deduct some production expenses, e.g. credit for value added tax (VAT) on capital imports, including plant, machinery or building, from their taxable amount, even though it is the international accounting practice. This puts firms operating in these economies at a competitive disadvantage because they have to pay higher taxes. Other complaints are about the low state of executive discipline and the large number of inspectors that hinder entrepreneurial activities, the high level of corruption and growth of the shadow economy, time-consuming and bureaucratic licensing procedures, poor information dissemination for SMEs, or frequent changes of legislation. In Turkmenistan, the complaints center on the lack of commitment towards entrepreneurial activities. Government reforms of these basic regulatory issues would go a long way to facilitate growth of entrepreneurship.

6.2.1 Perceptions of Obstacles by Size of Firm

Are different sized firms affected differently? Are their perceptions significantly different from each other? To answer whether firms of different size differ in their perceptions of obstacles, I divided the respondent into SME (below 250 employees) versus large firms (more than 250 employees). I computed the respective rating averages from each group for each factor, then tested for significance of the mean difference. The result is reported in Table 9a [ PDF 62.5KB | 1 page ]. I also divided the firms into micro and small firms (below 50 employees) vis-à-vis medium and large (more than 50 employees). The latter result is in Table 9b [ PDF 65.1KB | 2 page ].

The result in Table 9a [ PDF 62.5KB | 1 page ] shows that for Central Asia as a whole, there is no difference in the perceived problem of the cost of finance across firm size, but in terms of access, SMEs find it relatively more problematic than large firms. However, when it comes to customs and trade regulations, large enterprises find it more a problem than SMEs do. The highest rating for both SMEs and large enterprises are the tax rates and tax administration.

In the Kyrgyz Republic, SMEs find electricity a greater concern than large enterprises do, but the reverse takes place for customs and trade regulations, labor regulations, and quality of labor. In Kazakhstan, Uzbekistan, and Tajikistan, the perceptions of all firms of the various obstacles to growth are not significantly different from each other, except for customs and trade regulation (Kazakhstan: with large firms showing a greater emphasis), street crime (Uzbekistan: SME firms reported higher scores ), and corruption (Tajikistan: SME emphasis was greater).

Table 9b shows a slightly different result. For Central Asia, the two groups' average perception of the obstacles diverged for electricity, customs and trade regulations, tax administration, labor regulations, and skills and available workforce. They did not, however, vary significantly in their perception of financing. In the individual countries, too, there were more significant divergences than in the previous table. For example, in Kazakhstan, small firms found access to finance, cost of finance, electricity, and transport, more of a concern than did medium and large enterprises, while the latter found customs and trade regulations more problematic than other types of firms.

One possible explanation for these two different results is that medium and large firms are not too dissimilar in their perception of obstacles and constraints to growth. Hence, when medium firms were put along the same group as micro and small enterprises, the group average of SMEs moved closer to that of large enterprises. But when medium firms were removed from the group, the constraints cited by micro and small enterprises came to the fore in a more obvious manner. This finding could be useful in designing policies for SMEs as a group.

6.3 Cost and Access to Finance

Since the financing problem figures prominently among the major concerns of all firms, I take a closer examination of this factor by dividing the survey response by firm size. Figure 11 [ PDF 100.8KB | 1 page ] shows the percentage of firms which indicated that cost and access to finance were major obstacles, by size of firms and by country. The result shows that in Kazakhstan and the Kyrgyz Republic, the cost of finance was indeed a major constraint, even more for small firms than medium and large firms. But in the Kyrgyz Republic, many large firms also appeared to be constrained by cost more than access to finance, with almost the same percentage of large firms and small firms indicating this factor as a major obstacle. The picture is rather different for Tajikistan and Uzbekistan, where access to finance took ascendancy over cost as an obstacle. This is perhaps because these countries have more backward property rights arrangements, making it difficult for firms to provide the required collateral in order to obtain loans from financial institutions. As small firms were typically unable to access finance, cost was not as much of a constraint to small firms as for large firms.

The implication of these results is that the best form of government support is again basic market reform— state provision of stable property rights is fundamental to financial access for enterprises. In other Central Asian countries that already have these basic conditions, reasons for the high finance costs, nevertheless, need to be probed. If this is due to high risk perception of SMEs by banks, then more and sustained special government funded low-cost loans may be of assistance to further promote SME growth.

6.4 Characteristics of Bank Loans

Looking closely at bank loans in Central Asia, the average cost (annual interest rate on loans) for all firms was 18%, 400 basis points higher than the average for all transition economies (Figure 12a–12c [ PDF 103.6KB | 2 page ]). Of the Central Asian countries, only Kazakhstan was right on the average for transition countries while the other three³⁷ have considerably higher cost, with Tajikistan having the highest (24%). As expected, small and medium firms borrow at much higher costs than large firms, almost 200–300 basis points above the rates for large firms.

The average loan maturity in Central Asia was also shorter by four months than the transition countries' average. In Central Asia, only large firms were able to borrow loans with 30 months tenor. Kazakhstan, again, was on the mark with the average for all transition economies, while Tajikistan and Uzbekistan, had considerably shorter loan maturities. The processing of loans also takes longer in Central Asia than the transition economy average, by an average of four days.

The value of required collateral is, surprisingly, lower in Central Asia than the average transition economy. Transition countries' average collateral value is 159% over the value of the loan, but Central Asia's average is 156%. This is because Kazakhstan and Uzbekistan had lower collateral value requirements compared with Tajikistan and Kyrgyz Republic. Interestingly, the range of required collateral values varied for SME and large firms. For SMEs, the maximum collateral value requirement went as high as 600% of the loan value, while for large firms, the maximum was 450%.

The collateral required was mostly composed of buildings, machinery, and equipment. Large firms had access to more sophisticated inventory and accounts receivables financing, while small firms had to use personal property as collateral.

On the issue of cost, as previously stated, low-cost government funded facilities or international donor grants for SMEs might be the best way to provide access to affordable financing and relatively longer-term financing for SMEs. The exceedingly high collateral requirements in some cases might also be linked to stringent bank regulations or excessive risk aversion, which the government could help reduce to more moderate levels.

6.5 Bank Loan Usage by SMEs

Thirty-eight percent of the Central Asian firms surveyed had a bank loan, while 62% did not have loans. Of these, 95% did not apply for a loan while 4% had their application turned down, and the remaining few have a pending application. If these percentages held steady for the entire Central Asian economy and if a similar structure existed in the 1990s, these might help explain why, based on the survey, the 1999 Russian financial crisis appeared to have a minimal impact on SMEs. For, if small and medium businesses did not avail themselves of loans from the banking system, then financial system disruption would, indeed, affect them little.

Asked for reasons for not using loans, most firms said they had no need for it, which perhaps implies that many enterprises are not yet so well versed with dealing with the market economy and financial systems. The other major reasons cited are: high cost of borrowing, problems with collateral, and burdensome application procedures (see Figure 13 [ PDF 101.2KB | 1 page ]). Firms with rejected loans attributed the rejection to their lack of acceptable collateral, the financial institution perceived a lack of profitability in their enterprise, and the lack of a credit history (Figure 14 [ PDF 101.2KB | 1 page ]).

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