SME’s problems require immediate attention

‘‘Unless the government extends a bailout package immediately to the Small and Medium Enterprises (SME) sector, a minimum of 60% of these enterprises would collapse, throwing a considerable number of the sector’s employees out on the streets’, Chamber of Small and Medium Industries president Aloy Jayawardene told the Monetary Policy Consultative Committee of the Central Bank of Sri Lanka on Feb. 11.

"The SMI sector is not interested in the reduction of interest rates but in a bailout package as none of the SMEs could go to any bank for facilities, as they have hypothecated 100% of their assets to their respective banks, as none of the banks would extend credit without collateral’, Jayawardene explained to the Committee.

He pointed out that the government should take this threat facing the SMEs seriously and go to the extent of suspending labor laws to allow employee lay-offs. These measures should be prevented from being challenged in court until the crisis is over, he proposed. ‘Our bank loans, interest on loans, taxes and other rates should be put on hold for the next two years. The government should understand that SMIs are the vital cog in our country’s economy, and that they represent 70% of it. A kick start should be given to the SMEs if the economy is to develop’, Jayawardene explained.

Importance of the SMEs

The backbone of the economy is the small and medium sector which accounts for over 70% of the Gross Domestic Product. They, like all businesses, require credit for credit is the life blood of business. In the export sector large and established business concerns, when they get foreign orders to export tea, rubber or other product, go to the bank and obtain packing credit by showing the confirmed order. The export order is fulfilled by the exporter then buying the tea or other product, storing it and getting it ready for shipment. After the goods are exported they obtain payment and settle the credit. The system is well established and in place for many decades. But in the case of local supply orders, the supplier has no means to obtain credit to buy the goods and process the order.  In some countries there are domestic Letters of Credit and domestic bills of exchange. But we only have the promissory note or the post dated cheque as credit instruments.

The Sri Lanka Chamber of Small and Medium Industries has been making representations to the authorities pointing out that after the global melt down of last year the banks have curtailed credit to them. They have pledged all the assets they own to the banks and cannot provide any more collateral by way of property. Now that the demand in the country is reviving they say they need more credit to fund their working capital. But the banks are risk averse and unwilling to extend more credit without more collateral.

It is a situation that requires a hard look by the authorities. If the small and medium industries collapse there will be a serious lacuna in the economy. Big firms cannot undertake all operations in-house. They need to outsource some activities which are too small in scale for them to engage in. They need to buy raw materials and intermediate goods from the small and medium scale enterprises. Some of the well-established enterprises like the listed companies with high market capitalization provide advances along with their orders to the small scale enterprise who is the recipient of such order. But they will not give hundred percent of the value of the order.

In any case the small and medium enterprises that supply to big companies have to establish sound relations over a long period to establish the necessary trust. Business moves entirely on trust and confidence. So it is important that the small and medium enterprises build sound and lasting relations with their principals who provide them orders to supply goods or services.

We see the adverse effects of the collapse of small and medium scale enterprises in the North; there are hardly any such enterprises in the Vanni. Large construction projects, be they road construction, irrigation or electricity require sub contractors. They need to have small enterprises producing say cement blocks or transporting metal or sand. If the main contract were to undertake all these ancillary activities the project will be delayed for a long time and increase costs. For example if there are no carpentry shops or brick makers in the neighborhood, their  products will have to be transported from distant areas reducing the flexibility and increasing the cost of production of the product or service.

Labor Laws

The Chamber has pointed out that several small and medium enterprises have been forced to lay off their workers. The Labor Laws are a millstone round their necks, they say. They cannot get rid of staff without being required to pay high severance pay. They have requested the government to temporarily suspend the operation of the Labor Laws and allow them to retrench staff. They also point out that any retrenchment involves litigation which too is costly for them to defend and request that the government temporarily suspend the operation of the Labor Laws and the recourse to the courts by any employee or union of employees and fast forward closure. The country cannot afford to see the collapse of the small and medium scale enterprises. They play a key role as support industries for all capital investment projects and need to be supported and protected.

Payment delays

 Even the government sector enterprises delay payments to these small entrepreneurs. There are instances of government departments delaying payments to them for months. They point out that generally government institutions take3-6 months to settle bills. This means that the small and medium enterprise is unable to recover his costs included in his original supply price quoted and accepted by the government buyer. So the government must instruct its officials to promptly settle dues for any goods or services supplied by the private sector.

During Russia’s transition from Communism to Capitalism the payment arrears problem led to the collapse of the economy in the late nineteen nineties. We should not let a similar situation arise here. According to the Financial Regulations officials are forbidden to place orders and receive supplies unless the budget estimates include provision for them. This regulation was strictly implemented by the colonial government which punished officials who delayed payment. Unfortunately these standards have now been eroded.

Re-schedule loans

The SME sector enterprises also find it difficult to repay loans taken previously at high rates of interest. Explaining the fallout of the crisis on entrepreneurs, Jayawardene said that the majority of these businessmen are today failing to pay their monthly installments and interest on loans obtained from commercial banks subsequent to having mortgaged their residential homes, properties and even cars with the banks. Consequently, ‘banks are attempting to take over their mortgaged assets’ to compensate for their anticipated losses.

The banks too are in a bind on this score as their Gross Non-Performing Loan ratio has gone up from 6.3% in 2008 to 8.8% by end September 2009 and that of the licensed specialized banks increased to 10.7% from 8.9%. For the Finance companies the ratio has gone up to 10% up from 6.5% in 2008 and for Leasing Companies it has upped to 7% in June, up from 4.8% in end 2008. But these ratios are still too low to threaten the stability of these financial institutions in general and do not call for any sweeping measures as in the case of the crisis in confidence caused by the collapse of Golden Key Credit Card Company due to premature sudden withdrawals.

‘Commercial banks have restricted the granting of ToDs to the SMEs. Even at the present rate of 26%-28%, banks are reluctant to extend this facility. Some of our entrepreneurs extend credit to most government institutions with whom they transact business. We request the Central Bank’s intervention on allowing ToD facilities to government supplies at a nominal rate of interest, based on the receivable amount from government institutions. It is noted that government institutions generally take over three months to settle our bills and in some cases this extends from 5-6 months’, Jayewardene pointed out.

Consequences of Deflation

When there is a disinflationary situation all business enterprises find it impossible to repay from their current earnings the loan servicing charges on loans borrowed at the previously high rates of interest during the days of high inflation. So some relief by way of reduction of interest even including the waiver of interest should be considered by the banks to which they owe money. It is not that these enterprises wish to cheat the banks but they genuinely and sincerely are unable to repay the loans. Our grandfathers used to narrate about the dire situation caused by the Great Depression of 1929.

The Chamber has appealed to the Central Bank to intervene with the banks and ask them to restore the Temporary Overdraft facility which has been suspended for them. They are requesting that at least for supplies to the government, the banks be called upon by the Central Bank to allow temporary overdrafts on the aggregate of receivables due from the government. This appeal deserves the consideration of the authorities. They warn that unless a bailout package is offered to them, some 60% of the firms in the sector would have to close down. So the authorities should look into the problems of the small and medium enterprise sector as a matter of priority.

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