Summary and Policy Recommendations

SMEs are the backbone of many economies, but in Central Asia, SMEs reaching their full potential still lies in the future. They are still new to the workings of the market, many just started in the 1990s, while the business and economic environment in which SMEs operated, though markedly improved since the beginning of the transition process, remain lacking in transparency and regulatory clarity. Yet, although SMEs have operated for only a short span of time, many studies already put their contribution to the economy anywhere between 31% and 45%, and their contribution to employment somewhere between 25% and 60%. There are an estimated 11 to 28 SMEs per 1,000 people in Central Asia, more than a third of the firms engaged in trade. Almost all small enterprises and more than 80% of medium-sized firms in Central Asia have been started from scratch rather than from privatized state-owned enterprises.

The paper discussed the effect of the Russian and the current global financial crisis on Central Asia. While the route which spread the contagion resulting from the 1999 Russian financial crisis to Central Asia was primarily through trade links, the current crisis is reaching the region directly through financial links, through the global financial illiquidity that is adversely affecting Russian and Kazakhstan banks with high foreign indebtedness, and through their subsidiaries in Central Asia, the rest of the region. For the first crisis, the paper presented some econometric as well as indirect survey data that appear to show that the impact of the crisis on SMEs might not have been so dire, compared with their previous condition after the Soviet breakup, because their production structure is more flexible than large SOEs or large enterprises that are partially owned by the government. In the current financial crisis, financing costs for enterprises have increased, including trade finance. But the paper conjectures that large firms are going to be harder hit than SMEs because of the former's heavier reliance on foreign bank borrowing and global capital markets. The possible adverse impact on SMEs would include weakness in demand, both domestic and foreign, which can affect their sales and profits, and thus their capacity to raise financing which, the surveys show, SMEs rely upon heavily.

On government support for SMEs, while government programs designed to promote the growth of SMEs are available, including special financial support during the crisis (in the case of Kazakhstan), what enterprises most clamor for, according to the survey, are basic market reforms. These include transparent and clear regulatory rules, stable property rights, lower taxation through the use of international accounting standards, less corruption, and better infrastructure. The paper shows slight differences in these concerns across countries as well as between large, small, and medium enterprises. The high cost of finance, a top concern especially among SMEs, is caused by SMEs being perceived as high risk and by their lack of required collateral. The paper derived implication for the need for government- or international donor-funded financing facilities that could provide cheap, longer term financing to SMEs. Just relying on market solutions will always result in very high financing costs for SMEs (because that is based on the rational decision taken by private financial providers, given the risk of lending to SMEs) and could, thereby, stunt the growth of many SMEs. Government assistance is needed to provide the affordable finance that SMEs need to grow.

Government financial assistance to SMEs, however, requires a stable financial system that can efficiently funnel government funds to the targeted sector. Here, there is enormous work that needs to be done. In some countries, like Uzbekistan and Tajikistan, the intermediation role of banks is still not yet fully appreciated. In these countries, banks still maintain their old communist era function as government agents—enforcing monetary and fiscal policy through the control of the supply of cash and liquidity, monitoring financial transactions, and automatically deducting taxes from depositors' account on behalf of the tax authorities. In addition, in Uzbekistan, the government restriction on cash withdrawals from banks has led many SMEs to conduct the bulk of their operations in cash, illegally, rather than go through the banking system where they cannot withdraw money from their own accounts, unless it is for purposes (within specific categories) allowed by the government.³⁸

Even in a country like Kazakhstan, which has more advanced banking systems and regulations, there is also a need to more efficiently attract domestic deposits to fund various business ventures. Efforts to promote the growth of a domestic pool of funds from local deposits have taken a back seat due to the availability of easy money that used to be raised from abroad. The painful lesson from the global crisis is that the financial system needs to rely a lot more on local deposits and domestic savings and lessen the dependence on foreign financing.

More SME financing may also be obtained from non-traditional sources, such as private equity funds. While in the past, this group of financing institutions could not enter the markets sufficiently due to government ownership restrictions or reluctance to sell SOEs, the global crisis has provided an opportunity for new ways of thinking. In particular, financing from private equity holds promise in that they have the long-term money necessary to grow and develop a business, provided that they are afforded appropriate exit strategies either through initial public offerings (IPOs) or sales to a strategic investor of the businesses they have developed.

For trade financing, considering that prepayment is most often required of importers from Central Asia, there is a large scope for government or private sector guarantees to create liquidity in international transactions. Hence, there is a need to develop functioning export credit agencies in Central Asian countries, where few are yet operational. Other steps that can be done, especially for Kazakhstan and the Kyrgyz Republic where the financial sector is relatively stable and more advanced, is to allow more trade finance instruments, other than L/Cs, such as factoring, receivables-backed financing, warehouse/inventory receipt financing, or supply chain financing, to be used in the country. Whether the government's existing regulatory framework allows for these other types of trade financing is an area that should be looked into.

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