SMEs and Budget 2012: Strong Steps, but Tax Relief is Half the Story


By Anushka Wijesinha, Research Economist – IPS
  • Ministry of Finance has delivered, now time for SME-mandated government institutions to sharpen their focus and address the vital issues
Budget 2012 is clearly the most SME-friendly budget in recent years. A comprehensive set of tax and financial proposals, specifically intended to strengthen and develop the SME sector have been put forward in the budget proposals announced by H.E. the President on 21st November. Business Chambers with a strong SME interest, like the NCCSL and the FCCISL, have commended the budget for its focus on the SME sector.

This article takes a look at the important SME-promotion proposals contained in the budget, but also argues that promoting the SME sector requires a look beyond just tax relief.
As is clear from Table 1, apart from the SME-specific concessions and exemptions, many other concessions will have a positive impact on SMEs engaged in particular activities.
Table 1: What is in Budget 2012 for SMEs?: Snapshot of the Proposals
Definitional issues

A few areas are yet to be clarified, and would likely be done in the implementation documents that would follow the Budget 2012. For example, the minimum investment requirement of Rs. 25mn for a new “small scale enterprise” may be a challenge. Most small-scale enterprises have much less in terms of fixed capital. This concern also applies to certain bands of minimum investment in the “medium-scale” category – Rs.100mn-200mn — is a steep investment for a standard Sri Lankan medium-scale enterprise. The level of investment will also vary widely depending on the nature of the activity. An enterprise engaged in gem cutting and an enterprise engaged in canned fish production may both have similar turnover to be classified in the “medium” category. But the minimum investment needed in each will be quite different. In all of this, a key issue that emerges – in fact a recurring challenge – is that of the need for a common SME definition. Commercial banks, the Central Bank, EDB, IDB, business licensing authorities of the government, etc., all have slightly different definitions, and this causes various problems for an SME in participating in the various schemes/services offered by each of them.

It’s not just about taxes

So, yes, the tax burden on SMEs has been reduced in Budget 2012. This builds on the reduction to 10% of corporate tax rates for SMEs introduced in Budget 2011. But SMEs need more, and it’s not just about tax incentives. SMEs in Sri Lanka are facing numerous other constraints that need to be simultaneously addressed in order for these valuable fiscal incentives to have maximum impact.

Electricity constraints

In a visit last week to a couple of Industrial Estates which are home to small and medium industries (SMIs), it emerged that electricity issues are severely hampering their operations. One medium-scale industry that produces rubber products for the Swedish market, employing nearly 500 people, noted that it faced 118.5 ‘electricity down hours’ last year. This is an average of over 2 hours a week, but in some weeks it peaked to as high as 10-14 hours. At a recent public-private consultation, an industrialist remarked that at the Ekala Industrial Estate there have recently been 14 electricity ‘brown outs’ in as many days. The Yarlpanam Chamber has noted that of around 24-26 working days in a month, they enjoy only about 10 days of reliable power supply. A small industrialist in the Kalutara district lamenting on the impact of the electricity issue on his ceramic ornaments operation remarked (translated from Sinhala), “the power brown outs not only ruin our machinery, they cause production delays, increase costs, and cause a higher proportion of rejects”. So, although connective infrastructure in areas outside Colombo are improving, and electricity coverage is reaching 80-90% in many areas, electricity reliability and continuity that impinge on SMEs profitability needs to be addressed quickly.

Financing SME growth

The proposals contained in Budget 2012 are very progressive and important further steps in improving the access to finance for SMEs were announced. They are:

  • Out of the funds available in the Investment Fund Accounts in banks (which was introduced through Budget 2011 to ensure long term finance), 10% must be lent to the agricultural sector and a further 10% to be lent to SMEs.
  • State-owned banks (Bank of Ceylon, People’s Bank and Regional Development Bank) will each set up a special SME bank branch in all districts within 2012, and all other banking and financial institutions also encouraged to set up such branches in all districts.
  • Interest income from such banking and other fee levying activities will enjoy a reduced income tax rate of 24% (from the standard 28%).
  • A government guarantee of 50% for those banks that provide loans to restructure SMEs to improve their performance

These are important proposals. Many regional entrepreneurs complain that bank branches in their area are not SME-friendly and do not know how to evaluate loan applications with an “SME lens”. One entrepreneur in Batticaloa remarked that “most branch managers just don’t know to deal with us, they sometimes treat us like dirt, a nuisance”. The setting up of dedicated SME banking units is, therefore, an important first step. Meanwhile, it is important for all banks to train all their regional banking staff -particularly loan officers and branch managers – on how to cater better to SMEs, which is the majority of their client base in the regions. The Central Bank could also consider some mandated training/orientation for these officers on ‘SME Banking Best Practices’, similar to the mandated training it conducts for bank directors on corporate governance and other issues.

The 10% mandated SME portfolio is also a useful step. But it needs to be carefully monitored by the regulator to ensure it is not abused. For instance, ensuring that a bank doesn’t provide the majority of the portfolio to a few, low-risk enterprises, at the larger end of the SME chain just to comply with the requirement.

At a recent private-public dialogue on the cut-flower industry organised by The Asia Foundation in Nuwara Eliya, it emerged that the awareness of SMEs on special loan schemes is minimal. Out of 10 cut-flower associations, representing dozens of cut-flower SMEs, not one of them were aware of the two concessionary loan schemes offered by the Central Bank (the ‘Saubhagya’ and ‘Viskam’ schemes). There’s clearly a disconnect with the generous and valuable loan schemes on offer and their utilization by the SME sector. Commercial banks must do more to actively disburse concessionary credit lines available to them from multilateral financial institutions, to SMEs.

We could also think of innovative models like revolving funds, financed possibly by donors, that are housed in one or more selected local bank branches, and are used to finance specifically targeted enterprise sectors that are of particular importance to a region – for example, the tourism and cut-flower sectors in Nuwara Eliya. This type of ‘policy-based lending’ would help direct credit to sectors that have the most potential to grow that locality’s economy, provide employment, and reduce poverty.

The role of the Regional Development Bank (RDB) is also now more important than ever in taking up the cause of SME banking. The Lankaputhra Bank (LPB), which was meant to be a strong development bank after merging with the SME Bank and cater better to SMEs, seems to have lost its way.

Business development
Another key area is on business development and organizational improvement. Many SMEs do not get necessary advisory and technical support for technology upgrading, improving management and accounting practices, enhancing efficiency, and boosting productivity. Institutions like the IDB, mandated to assist SMIs need to take a strong look inwards to see if they are providing the services they are mandated to provide, and whether the services they do provide are useful and sufficient for the SMEs to grow to the next level. These SMEs don’t need basic support. A closer look at many of them will show that they have set up without any generous tax holidays unlike the BOI projects, and operated in trying times. They have grown gradually and won foreign markets. They certainly do have the potential to go to the next level, but getting the right support package is key – taxation and access to credit are only two elements in this. Entrepreneurs are asking for not just lower taxes and cheaper credit, but a more holistic support. As one entrepreneur in Nuwara Eliya said, “what we want is a package of support, not just better access to loans, but also help with technology, and help with market development, along with it”.

Again, we have much to learn from neighbouring countries. For example, in the Philippines, SMEs are partnered with Universities and other tertiary training institutions in local areas that have management faculties. Senior students in business administration and related subjects in these institutions run ‘business clinics’ at subsidised fees for local SMEs. This is a ‘win-win’ scenario – the local SMEs are able to get affordable assistance on business improvement, while the students get hands-on business experience and real world insight – thereby improving their non-academic skills and enhancing their employability.

Getting serious about SME strategy

It’s time we got serious about the National SME Policy that is still under formulation, despite a draft being presented at a stakeholder discussion almost a year ago. We need to build on the strong SME White Paper of 2002. Since the formulation of this document there has not been an all encompassing national strategy document for SME development. Sri Lanka needs to learn from its Asian neighbours in developing this SME strategy. A good start would be looking at the Philippines comprehensive ‘Magna Carta for SMEs’ document, which has very relatable ideas and transferable concepts like SME credit guarantee schemes and strategies to encourage subcontracting between SMEs and large enterprises.

Once the National SME Policy is ready, there needs to be a taskforce to implement the various elements. The taskforce should include representatives of all relevant stakeholder groups – both from the public as well as private sector. Currently there are a myriad of programme and interventions, all of which are strong individually, but are hampered by the disconnect with each other and therefore cannot have the impact that they actually could. This fragmentation and overlap leaves SMEs confused on what programmes are on offer. The National Enterprise Development Agency (NEDA) needs to play a vital coordinating role and assume leadership once more as the apex SME body – this was what was expected of it when it was initially set up as the ‘SME Authority’ under a proposal of the 2002 SME White Paper.

“The SME sector is the future”, Treasury Secretary Dr. P.B. Jayasundara said at a post-Budget forum organized by Ernst & Young this week. The importance of SMEs has clearly been identified and articulated. The Ministry of Finance has done its bit by announcing a variety of SME-focused proposals. It is now time for the other government institutions mandated to develop the SME sector like NEDA to sharpen their focus, coordinate and collaborate more for maximum impact, and work closely with the private sector on really growing Sri Lanka’s SME sector.

Yes, tax concessions are a vital component in the SME-strengthening effort, and the Budget 2012 has much to offer for SMEs. But tax concessions should not be thought of as the panacea for the struggles of Sri Lanka’s SMEs. Other issues are often equally constraining, and more needs to be done about them. Of course, it is unrealistic to expect such non-tax related policy support from a Budget, but SME supporting institutions have to come into action and address these vital issues without further delay.