The anatomy of SME finance

Is SME finance beginning to take off in Pakistan? Consider this: net outstanding credit in the country rose by Rs110 billion in the five months ending November 2017. Of that Rs46 billion (42%) was borrowed by the SME sector. In the same period last year, net increase in outstanding credit was Rs43 billion, where Rs59 billion was obtained by the SMEs while the non-SMEs saw a net retirement of Rs16 billion. Both according to SBP data.

Now consider that SME loans are barely 5-6 percent of total loans (the rest being non-SMEs), and that active SME borrowers are estimated to be half the number of total SME borrowers because many of the loans in this segment have been in the non-performing category for over a long period of time. What then explains SMEs’ contribution to net credit off-take? There is no clear-cut answer to that, but here is an attempt based on patchy information weaved with a little bit of basic economic sense.

BR Research’s analysis of central bank data reveals that there are four broad business categories that dominate SME loans: manufacturing; ‘commerce & trade’; ‘transport, storage & communication’; and ‘real estate, renting & business activities’. Together, these categories have accounted for 88-89 percent of outstanding SME loans since the central bank began compiling business category-wise data in December 2015.

Net credit growth in the latter two categories stood at Rs16 billion in 5MFY18; half of that increase were borrowings by SME enterprises. With the economy picking up in the last two years, real estate activity has also picked up whereas rise in consumerism has stoked the demand for logistics business. This is also validated by the rise of consumerism and construction sectors in the Large Scale Manufacturing index of Pakistan Bureau of Statistics. That theme also reflects in the loans obtained by businesses in ‘commerce & trade category’ where loans by those involved in domestic wholesale and retail trade dominate the SME loans.

These loans are mostly for working capital needs – as is the general trend in SME loans. Working capital loans remain the bulk of SME finance with nearly 60 percent of SME loans in working capital category; 25 percent in fixed investments, and nearly all of the rest in trade finance segment. Although of course, these shares are different in different business categories. For instance, in the case of ‘transport storage & communication’ nearly 90 percent are fixed investment loans; in ‘commerce & trade’ 82 percent are working capital; whereas in manufacturing sector SMEs 74 percent is working capital loan, 14 percent trade finance and only 10 percent in fixed investment.

In the year to date, manufacturing sector players within the SME segment have borrowed nearly as much as the non-SME segment. While borrowing by non-SME in the textile sector dwarf the borrowings of their textile SME peers, SME loan growth in ‘food & beverage’ and chemical sectors, was higher than non-SMEs in 5MFY18. This is despite the fact that 90-95 percent of total outstanding loans in these two sectors are held by the non-SMEs. Does this mean that SMEs in these two sectors are growing faster than their non-SMEs peers?

The central bank’s latest 1QFY18 State of Economy report maintains “growing consumer base in the country has been the major pull factor encouraging domestic players to reposition, especially in the food and FMCG sectors. Edible oil, poultry and sugar manufacturers are all working towards gaining efficiency, attaining modern technology and reducing their production costs”.

The SBP has also highlighted that the financing needs of some edible oil manufacturers for installation of extraction plants contributed to borrowings for fixed investment, whereas the sugar sector too borrowed for fixed investment. “Anecdotal evidence suggests that some of the (sugar) manufacturers are diverting to energy-efficient processes to reduce operating costs”, the SBP said.

This column began by asking whether SME financing is beginning to take off in Pakistan. The increase in SME loans - for select sectors say food, chemicals etc - in 5MFY18 may be driving total net increase in outstanding loans. But with interest rates bottoming out (BR Research expects 100 bps hike in next 12 months), the green shoots in SME finance may not necessarily grow at the same pace next year. Still, given the size of SMEs in the country, SME finance is surely nowhere close to its potential. If only Pakistan’s Large Scale Manufacturing and Small Scale Manufacturing Indices were truly representative of the large scale and SME economy!