The Pitfalls of SME Financing: Trevor Manuel

 This is an address by Minister Trevor Manuel on Financing Business Innovation for Africa’s Development gathering held in May 2011

Thank you for the background note prepared for this Dialogue. It starts off by referring to the challenge to attain the Millennium Development Goals and the role of the private sector in alleviating poverty. This prompts me to ask the lawyers’ question – what is the mischief that we are trying to cure? Is it, as the background note suggests, a concern about our ability to attain the MDG’s, then we should focus on the quality of government services and the partnership between the private and public sectors in ways directed at the MDG’s themselves. If the mischief we are trying to cure is about the sustainability of business start-ups, then we need this in focus. If the mischief is the failure of finance to be sufficiently inclusive and supportive, then the solutions will lie in our understanding of financial intermediation.

I want to provoke a discussion about the need to support the creation of sustainable Micro, Small and Medium Enterprises (MSMEs) and financial support for this sector.

However, it would be impossible to discuss this task without a slightly wider pan of the global environment within which all business development happens.  For now, I would like to not focus on the big debates that occur in the context of the World Bank, the IMF and the G20 – debates that focus on issues such as global imbalances, capital flows and their direction, fiscal responses, and the like. We cannot, however, ignore the impact of the global changes on individual businesses. The key challenge has to be building sustainable businesses that outlive the cash injections from CSI budgets and stand up to the effects of market forces. A quick scan of the environment is therefore necessary and this scan will abstract five key global shifts – unemployment, inequality, the capacity of the state, the shift in the economic centre of gravity (West to East and North to South) and interests (whose interests are being served).

Unemployment 

In South Africa, the issue of unemployment, its causes and the proposals to counter it are hotly debated. But we need to understand the growing concern on a global level. Let us look at the USA, in part because there are good datasets available on a range of issues, including employment trends. Robert Wade1 suggests that whilst the official US unemployment figure is 10%, this number almost doubles when the number of part-timers desperately seeking full-time employment is included. Similarly, the Middle East and North Africa region is very topical, the unemployment rates range from 9.2% in Syria to 14% in Tunisia,  with average youth unemployment rate in the MENA region at 24.9%. In South Africa, as we know the unemployment rate (based on the QLFS released on 03 May) is 25%, up 1 percentage point in the 4th quarter of 2010. Jobs have been shed in sectors such as construction and transport, and the gains tend to be largely in the public sector. Now, if we had a reasonable measure for unemployment in Sub Saharan Africa, using the same standard ILO definitions, the number is likely to be much higher than we realise. Manufacturing is at a low 8%; mining, say 15%, no developed services sector and formal agriculture is actually a low employer!

It would also be important to understand who these unemployed people are, it matters whether the unemployed have previous work experience, or not and the sectors that they have worked in. Robert Wade also suggests, for example, that General Motors in the USA employed 52 000 hourly paid workers, down from 468 000 in 1970 – how did this happen? Are US citizens purchasing fewer vehicles? Have production processes changed? How much of it has shifted elsewhere? This is an important question, because the approach for assisting displaced auto workers would be quite different from trying to accommodate young people who have never actually worked. So, the questions in Africa have to include who the unemployed are? What their skills and educational levels are? What opportunities are likely to present themselves taking account of this? It is crucial that the causes of unemployment and the possibly skills deficits are fully understood if financial support is to be viable.

Inequality 

The growing inequality within societies must be understood – how and when did societies become as unequal as they now are? Again, let us look outside of Africa, and to the USA, simply because there is more current data available. Wade suggests that the top 10% of Americans possesses more private wealth (34% of the total personal wealth) than the bottom 90% (25% of the total). Or even in China where a mere thirty years ago, the Gini Co-efficient (an indicator that measures income inequality) was almost zero, to a point where it is now around 0.43. In fact, according to Forbes List, China had a heavier density of billionaires relative to GDP than the EU; Mainland China and Hong Kong has 89 billionaires, whereas Japan, with an economy almost as large, and with a higher average income, had 22 billionaires. So, what are the trends in Sub Saharan Africa? South Africa has only four billionaires and Nigeria has two, and significant as this indicator is, it is unlikely to be a useful proxy for Sub Saharan Africa.  The issue of inequality is very important for a discussion on business innovation because it helps us understand the prospects for innovation and development of small businesses. Any attempt at dealing with market innovation must, presumably include an appreciation of whether the prospective client base is too heavily indebted, or too poor to afford the goods and services on offer.

State Capacity

It is necessary to subject the capacity of the state to very close scrutiny. Whose interests is it likely to serve? Does it have the capacity to innovate support or support innovation and argue the toss, especially in circumstances where it borrows from the Multilateral Development Banks – an issue that affects most of the countries where the world’s poorest reside? Can it regulate effectively, especially when some of the investors happen to be large transnational corporations? Is the state capable of collecting taxes as per the tax schedules, in order to provide services to the poor in society? What do we know of the quality of public servants, of the quality of the legislatures and the laws that they pass? Is there the likelihood that the state would be captured by particularly interests? Equally, in regulating this sector, it is important that the state is aware of the unintended consequences of the regulations for emerging smaller enterprises. What may work well in regulating big business, may, in fact, be too cumbersome and create obstacles for entrepreneurs. I raise these matters because we need to start from the premise that change in the arena of business innovation and support to the MSME sector needs to be public- private-partnership, in the best sense thereof. In other words, the private sector cannot carry this load alone, nor some part of it be expected to contribute to development whilst its competitors are favoured either be contracts awarded and/or by lesser pressure to comply with regulations. So, if one is establishing an MSME, it is important to have an idea as to whether the state will be an ally or an obstacle to progress.

Global Shifts

It is a fact that there has been a significant shift in manufacturing from many parts of the world to countries such as China, Vietnam and Thailand. This question needs be understood in order to crack whether there is room for a niche to develop, particularly in manufacturing. If there is, heaven help us, a sense of little room for new ventures, especially where the barriers to entry have traditionally been low, then it limits the options – frequently to services.   Another reason why global trends are important is because arising from the Great Recession of 2008/9 there has been a tightening of lending criteria arising from the Basel 3 requirements to hold higher amounts of capital against risk. One of the consequences of this is that smaller operators and businesses without a track record are likely to be squeezed out. So, what are the lessons for start-ups from elsewhere? What do the experiences of countries as diverse as China, Brazil, India, Mexico and parts of Europe teach us? More precisely, what kind of sustainable MSME’s are likely to survive?

Interests 

 We must acknowledge that developmental responsibility does not rest with the state only and in that regard, let me raise this impolite issue of what we should expect from business.

Amongst my concerns are that businesses sometimes engage in cynical compliance with regulation – it is far too easy in  most companies to outsource employment, whether this be for support services or some other element of non-core business. The effort may masquerade as support for start-ups, but is in reality an outsourcing of the burden of being the employer of record. But, I raise this not to knock every effort by large business, and as the background paper suggests there are many, commendable examples. The question, however, is whether the same levels of generosity of spirit would find resonance where the start-up is likely to grow into a competitor. Whose interests are likely to be served by an initiative?

 

Development of Small Businesses

 But in respect of support for small businesses themselves, and before we get to the issues of inclusive finance, we need to ponder the challenges of MSME’s themselves. This cannot ever be a one-size-fits-all solution if we are to understand the question of starting and sustaining MSMEs. Schematically, the continuum of business development passes through the following milestones:

The germination of the idea – This process would be impacted upon by who is involved – and many studies tend to reflect that sustainable MSMEs are initiated by individuals or groups with some experience of the particular sector. The immediate problem is, of course, that the many millions of young people with promise, who have never worked tend to be automatically excluded. These numbers are so large, in South Africa it stands at approximately 4 million, and in a trendline that is increasing. But let us return to those who have some experience of the sector, assistance is required with the drafting of a business plan. Too frequently, the costs of even this exercise are as prohibitive as to discourage activity. We need to know what financing options are available to support entrepreneurs at this crucial stage.

Working Capital – Once the entrepreneur has cleared all the hurdles associated with the ideas phase, including having a business plan in hand, we start getting to the elements of inclusive financing. Who will assist and on what terms? Are the issues of access more important than regulation and interest rates? The common challenge cited by entrepreneurs is the inability to get financing in the absence of collateral but the dilemma of this situation is that in the absence of the finance to start a business, they are unable to provide this.

 

· Access to technology – What technological innovation is likely to be supported? Is there some kind of incubation available? Who will provide the entrepreneur with some livelihood whilst they incubate the idea and test the opportunity. Assume that such support is available, at what price will it be offered? The alternative of using existing technologies to start a business has its own set of accompanying costs implications.

 

· Access to Skills – Who will work in the SMME? At what wage rates? Where will new training be sourced? How does a start-up clear the hurdle of, say, the National Skills Fund, through which training is offered to contributing businesses? The issue of skills relates not only to matters of production but to basic management skills relating to finances, humans resources, capital resources and most importantly to managing risk. These are issues that are not budgeted for, nor financed and generally in the case of MSMEs these skills are acquired only through experience.

· Access to Markets – In many countries, such as our own, markets are neatly sewn up. A micro-brewer is unlikely to be able to market product even through local shebeens because the fridges are likely to have been supplied by the macro-brewer. Similarly, it is incredibly difficult for start-up manufacturers to get their products placed on supermarket shelves – between manufacturers and large retailers are a myriad of merchandisers who create their own obstacles, presumably within the framework of the law, but making it exceedingly difficult nonetheless. Competition and demand is driven largely by strong marketing campaigns backed by large budgets that are not available to MSMEs.

 

And when large retailers expand their horizons, they tend to retain the same supply chains they use in their country of origin, frequently compelling fledgling MSMEs to shut down.

In highlighting the challenge of financial access, it is important that we understand the some of the detail of other impacting factors such as drafting a business plan, the incubation period,

management of working capital and the quality of financial services. It simply has to be more than providing access to finance; the support and services provided must be nurturing to deal with the other business requirements. We need to understand the wide range of business opportunities and build in appropriate mechanisms to support and development businesses as diverse as a small traditional beading enterprise, a local furniture manufacturer or a spice company expanding to a national market.

Financial Inclusion

 In returning to the intermediation mischief, we must draw attention to the kind of financing. Looking at the South African experience, we adopted the Financial Sector Charter in 2003 which provides the basis of the sector’s engagement with other stakeholders and assigns targets and responsibilities to transform the sector. The key areas of transformation identified were improving access to financial services, human resource development, procurement policies, enterprise development, empowerment financing and ownership. The 2008 Annual Review of the Financial Sector Charter Council indicates that in terms human resource development, BEE procurement targets, Black management, most targets have been exceeded while access to long- and short-term insurance, empowerment of Black people through ownership and access to banking facilities were below target. While the performance has been mixed, having exceeded some targets but lagging on others, one of the innovations has been the Mzansi saving account that was established in 2004 to provide affordable banking services to the large amount of previously unbanked specifically of the LSM 1-5 market.

Globally, financial inclusion is getting more attention with the G20 having launched Financial Inclusion Expert group, the United nations has appointed Princess Maxima on the Netherlands as Special Advocate for Inclusive Finance and the Centre for Financial Inclusion launched at Accion International. While there may be some debate about the concept of financial inclusion, the Centre for Financial Inclusion proposes the following definition:

Full financial inclusion is a state in which all people who can use them have access to a full suite of quality financial services, provided at affordable prices, in a convenient manner, and with dignity for the clients. Financial services are delivered by a range of providers, most of them private, and reach everyone who can use them, including disabled, poor, rural, and other excluded populations.

G20 Principles for Innovative Financial Inclusion

 I have taken this circuitous route to try and explain that the finance related issues are only a small part of the wider discourse. In respect of inclusive finance, it is imperative that this gathering endorse the 9 Principles for Innovative Financial Inclusion released by the G20 leadership summit in Toronto last year. These principles are:

1. Leadership: Cultivate a broad-based government commitment to financial inclusion to help alleviate poverty.

2. Diversity: Implement policy approaches that promote competition and provide market-based incentives for delivery of sustainable financial access and usage of a broad range of affordable services (savings, credit, payments and transfers, insurance) as well as a diversity of service providers.

 

3. Innovation: Promote technological and institutional innovation as a means to expand financial system access and usage, including by addressing infrastructure weaknesses

4. Protection: Encourage a comprehensive approach to consumer protection that recognizes the roles of government, providers and consumers.

5. Empowerment: Develop financial literacy and financial capability.

6. Cooperation: Create an institutional environment with clear lines of accountability and co-ordination within government; and also encourage partnerships and direct consultation across government, business and other stakeholders.

7. Knowledge: Utilize improved data to make evidence based policy, measure progress, and consider an incremental “test and learn” approach acceptable to both regulator and service provider.

8. Proportionality: Build a policy and regulatory framework that is proportionate with the risks and benefits involved in such innovative products and services and is based on an understanding of the gaps and barriers in existing regulation.

9. Framework: Consider the following in the regulatory framework, reflecting international standards, national circumstances and support for a competitive landscape: an appropriate, flexible, risk-based Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) regime; conditions for the use of agents as a customer interface; a clear regulatory regime for electronically stored value; and market-based incentives to achieve the long-term goal of broad interoperability and interconnection.

It is important that these principles be given life and the key question is ‘Who monitors these countries?’ What mechanisms are in place to ensure that it’s not just words on paper but that it is given life. Who ensures that the leaders who endorsed it have monitoring and evaluation mechanisms in place to ensure that the divides are bridged?

Conclusion

I want to conclude by reiterating the need to understand financing business innovation in relation to the contextual constraints that are inherent in the MSME sector and specifically the constraints in Africa. While the Principles for Innovative Financial Inclusion adopted by the G20 proposes significant changes, we must ask who will be accountable for ensuring that the financing of MSMEs happens in a new paradigm. I want to make a plea for that new paradigm, a conscious new beginning for sustainable MSMEs in an environment that facilitates with tough support but with attention to detail to impact on every element of our scan of the environment. I remain passionate about the need to support the activities of MSMEs. I am deeply concerned that there is an inadequate appreciation about just how difficult it is to start anything other than survivalist activities and how even more difficult it is to transit from micro-to-small and how big the leap from small-to-medium is. We need this knowledge in order to catalyse the development of more sustainable businesses. We need to maximise the return of every cent spent in support of enterprise development. We have a responsibility to work to minimise the enterprise failure rate. And yes, in this context, understanding the tenets of inclusive finance and working to ensure that access means exactly that, should bind us together in a single endeavour for transformation.

 

  • This is a sober view of the country’s SMME sector

  • I just want to say, My partner and I started research on a exporting project a couple of years ago. My partner is from West Africa Nigeria and myself from South Africa. We have managed till now to get our business registered and are really at start-up. My concerns regarding this topic is that, I don’t really think their is so much resources out there for sme. We had to struggle just to get where we are now, what about the bigger hurdles we have to cross in future? is that when we only gonna get recognized. We knew then we have a good business idea. And now it seems like the big fish with the money is walking all over us, just because they have easier access? Some of which is the same people we went to for help, and they would look at us so pathetically, but now are raving about what we knew then is gonna be a success. We are now more educated and I actually thank these guys for treating us the way they did other wise we would have never known that you have to suck information out of the right resources, in order to win your business dream. Every body is always talking about “REASONS WHY SME’S FAIL” Well
    We kind of have first hand experience, the good thing is that we grew a never quit attitude and we took all the critizem and turned it around to use to our advantage. Last I want to ad, starting a business requires funds, and if you ad up all the small amounts you use here and there just to get started, with no experience there is sharks out there, that will take you for all you have, because every body just want to make money. But I suppose every body can’t get all the insights.

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