Importance of SMEs in East African Community

Posted On February 18, 2017 , 12:00 AM Contador HarrisonPeriscope

East African Community (EAC) is a diverse and economically dynamic grouping of five Eastern African countries, collectively accounting for one of Africa’s larg consumer base. In East Africa, big businesses soak up the media’s attention but small to medium sized businesses are a crucial part of East Africa’s economic strength, yet they continue to face relatively depressed conditions.These firms businesses with up to 150 employees employ 80 per cent of East Africa’s labour force and contribute about 30 per cent to region’s businesses economic output.They are also crucial generators of new ideas. Data in my possession shows small businesses alone carry out a quarter of research and development in agriculture and manufacturing industries.That proportion is set to rise in the coming years, as growth sees emerging EAC countries close the gap on the major African economies by 2025. Small and medium enterprise development in EAC is a key strategy, focusing on supporting SME access to finance, markets and external opportunities, human resources development, information and advisory services, technology and innovation.The contribution of SMEs to economic growth, employment and development in the region plays an important part in achieving equitable economic development and regional economic integration.However, even though SMEs are the backbone of East Africa’s economy, they get only small portions of bank financing.Since the micro segment can employ a lot of people and produce cheap products, it is a main contributor to regional GDP and is widespread around the region. Several advantages to developing micro-segment enterprises are their strategic value in the economic growth of regional schemes and widespread economic distribution.

Based on the 2016 data, the total number of SMEs in East African region is well over 6 million. SMEs in the region can seek financing from various types of financial institutions, including banking institutions, development financial institutions, leasing and factoring companies and venture capital companies that provide equity financing. In addition, SMEs can also make use of various specific purpose special funds set up by the governments in the region to help SMEs. Data shows that banking system loans to SMEs accounted for a third of total business loans outstanding by the end of 2016. Most SMEs used their own internally generated funds and funds sourced from friends and family members to finance their operations. Indeed, only micro enterprises indicate that they rely on financial institutions for financing. A lack of collateral is the main obstacle faced by East African SMEs when seeking financing from banking institutions.This is followed by insufficient loan documentation and the lack of a financial track record, as well as business viability. All of them indicate a long processing time was also a problem.Nairobi is East Africa’s commerce, finance and transport hub. The Kenyan and Rwandan economies are known as one of the freest, most innovative, most competitive, most dynamic and most business friendly in the region.Kenya’s financial system remains sound, but industry must stand vigilant against rising risks. SMEs and firms with foreign currency loans could be more vulnerable under stress scenarios especially now that the country to a general election in August.Kenyan banks reported higher non performing loans ratios under stress scenarios for loans to SMEs compared to large corporations. As loans to large corporations form the bulk of banks’ corporate loan books, the higher stressed non performing loans ratios for SME loans would not severely impact banks’ overall asset quality.However, SMEs’ access to funding could be affected should Kenyan banks become more risk averse in their credit underwriting for SME loans.East African countries need to promote more financial inclusion to deliver financial products and services to a wider community that is under-served, including SMEs.

It would be ideal if the region can enhance the financing ecosystem in the region to benefit SMEs, including through cross-collaboration among various working groups in EAC. Initiatives to be explored could include setting up credit bureaus to facilitate the SMEs in establishing credit standing to improve access to financing, credit guarantee institutions to provide credit enhancement to SMEs that do not have collateral and other appropriate facilities or mechanisms that will provide financial access for SMEs.Also expanding the scope of financial access and literacy, as well as intermediary and distribution facilities, such as digital payment services to promote cost-reducing technologies and the development of financial services for smaller firms and lower income groups.Enhance discussion channels in EAC to develop best practices and exchange information as well as strengthen cooperation.It would be important to intensify the implementation of financial education programs and consumer protection mechanisms to bolster financial management capacity and encourage use of financial services.Promoting the expansion of distribution channels that improve access to and reduce the cost of financial services, including mobile technology and micro-insurance would also be very important step.East African politicians like to talk about the need to help small businesses but their policies are typically limited. For instance, several countries in the region have increased the value of assets small businesses can write-off immediately to help businesses’ cash flow.These policies are unlikely to lower the cost of capital for East Africa’s smaller businesses.The region must be careful not to introduce well-meaning but ill-thought out policies to help small business.Arguably, the best way to allay the costs of accessing finance is to reduce other costs that weigh disproportionately on smaller businesses, such as compliance with national and regional regulations, or remove any artificial barriers that prevent smaller firms from competing.