Supporting Growth and

Competitiveness of SMEs in Sri Lanka

3 Areas to Consider

Anushka Wijesinha
Chief Economist
Ceylon Chamber of Commerce

Pathfinder - Konrad Stiftung Workshop | Colombo | 23 May 2017

 Context: what we already know
SMEs are Key to
Inclusive Growth
Wide geographical
spread within a
country and wide
sectoral coverage

93% are micro (< 5

employees)
4% are small (<10
employees)
3% are medium
(<100 employees)
Context: what we already know

SMEs face numerous challenges to growth and

competitiveness
Finance
Taxation
Technology
Business development services
Managerial capacity
Markets and information

The focus today is mainly on Finance, Taxation, Technology

1. Access to
Finance
Exploring the evidence
World Bank Enterprise Surveys: Among 610 firms
surveyed, access to finance was the 2nd-most cited
business environment constraint (30% of firms)

IFC micro-study: significant proportion (40%) of firms

interviewed mentioned that insufficient access to finance
had been a main obstacle either when starting or
expanding their business

IPS-NCCSL Survey: 50% of respondents considered access

to finance as their most significant constraint; 91%
considered it as one of the top five constraints on their
businesses
Top constraint to business: Access
to finance vs. other factors

Source: Wijesinha and Perera (2015), Banking on SME Growth

Exploring the evidence

Inability of financing development/expansion plans

was the most significant reason for inadequate access to
finance (working capital is less problematic)

69% 31%
more difficult to more difficult
access finance for to access
development/ working capital
expansion finance
Exploring the evidence

The majority of respondents (60%) noted that formal

channels were their main source of financing of which
government banks were the preferred option (37%).

40% acknowledged that informal sources were part of

their financing options, with the majority coming from
friends/relatives and local moneylenders

Of those currently using informal sources, 75% declared

that they would prefer using formal financing sources
Where do SMEs go to for finance?
Current Sources of Finance for SMEs Reporting A2F as Most Significant Constraint

Source: Wijesinha and Perera (2015), Banking on SME Growth

Further evidence
IPS survey on manufacturing SMEs in Western Province

Only 44% of enterprises sought access to finance in the last

financial year, the majority (79%) sought it from commercial
banks.

Of those that did not seek finance from formal credit channels,
the second most-cited reason (19%) for it was that application
procedures were too complex (the first being that the enterprise
had sufficient capital).

Other reasons included need for formal registration (15%),

interest rates not favourable (4.6%), collateral requirements were
too high (1.3%), did not think it would be approved (2.6%), and
size of loan and maturity were insufficient (2%)
Further evidence
IPS Survey on women entrepreneurs in the SME sector

Support received from financial institutions to start and grow their businesses was
not satisfactory

According to male and female survey respondents from five districts (Moneragala,
Batticaloa, Anuradhapura, Kurunegala and Matale) nearly 60% percent disagreed or
strongly disagreed with the statement that support received from financial
institutions were good

Only 20% indicated satisfaction about the services received from financial
institutions

Of the 44% of women-owned SMEs that had applied for a loan in the previous
year, development banks were the main source of funding

Of recent women-owned start-ups, only 34% had obtained finance via banks loans
or local finance companies. 66% had raised capital from informal sources like
friends, relatives, and neighbours, also through gold pawning
Entrepreneur Perceptions on Support Received from Financial
Institutions to Help Grow the Business

Source: IPS (2014)

New Conceptual Framework: Twin-Pillar Approach
Wijesinha and Perera (2015)

Access to Finance

Availability Bankability
Twin-Pillar Approach

Private sector credit availability,

particularly SMEs
Spread of financial system and
efficiency in intermediation
Availability Special SME funding lines
Influenced by overall monetary
policy, liquidity levels in the
market, level of government
borrowing and credit availability
to the private sector
Twin-Pillar Approach

Financial literacy
Ability of firms to produce
bankable business proposals
Bankability Providing solid financial
statements & prove effective
financial management
Ability of banks to assess SME
proposals
New instruments for SMEs
Availability vs. Bankability

1. Not just an issue of not having access to the banking

network or funding lines being available

2. Bankability is determined by both demand and supply-

side factors

Demand-side: SMEs intrinsic weaknesses

Supply-side: Limitations within the banking sector

Demand-side factors
Lack of transparency and financial discipline
Compliance with tax and other regulations
Lack of sophistication in financial reporting (SLFRS has helped)
Link between informality (and factors driving that) and access to finance
Tax implications are a major driver of non compliance and poor financial
reporting
Lack of solid financial information make it difficult for banks to assess credit
worthiness

Management Weakness
One-man-show / no proper management structure / blurring of lines between
business and personal
No specific skilled professionals in-house for financial reporting / bookkeeping
No succession planning / leadership

Competitiveness Factors
The lack of access to markets, market information, and effective supply chains
Technology underdevelopment, poor quality products/standards and labour issues
Demand-side factors

Other issues

Administrative delays and difficulties in obtaining

permits and licenses from government institutions -
banks unable to provide credit without proper
documentation

Lack of proper insurance coverage for the SME segment

- high risk profile of SMEs make banks hesitant to lend
to SMEs that do not have proper insurance coverage
Supply-side factors
Limited staff that is skilled in SME lending: requires a
different banking approach, expertise in handling SME
customers than normal corporate or retail customers,
specialised SME risk management techniques

Lack of diverse and innovative banking products and

services: aimed at start-ups and small businesses; limited
range of SME-focused or SME-friendly financial products

Specialised SME Centers: expensive to operate, not

always well-staffed by qualified business development and
advisory team
Recent trends in SME lending
In line with Government
efforts to promote the SME
sector in recent years, the
banking sector of Sri Lanka
has diverted more attention
towards serving this
segment.

87% of SME lending came

from private banks, 13%
from state banks

Industrial sector SMEs

relatively larger share of
SME loans; agri-based SMEs
have received the lowest.
What makes it hard to assess bank-level SME lending?

Very little published data is available from individual banks as to

their SME lending portfolios

A closer look at company Annual Reports along with key informant

interviews revealed some information for a few of the larger banks.

NDB Bank: 10-15%; DFCC: over 50%; NTB: 22%; Sampath: 40%

Cannot determine the lending to small enterprises vs. medium-

sized

No consistent classification of SME loans by banks when reporting

to CBSL (in meeting the mandated lending portfolios)
Are funds concentrated amongst the more medium end of the
spectrum?
Some solutions for Sri Lanka to consider
SME Credit Guarantee Fund: Capitalised by banks and
CBSL, branch network, staffed by mix of finance
professionals but also business graduates, 70% loan coverage

Small Business Credit Scoring: many examples of

specialised SME credit scoring and credit rating; can be a
best practice adopted by collective of banks rather than
imposed by CBSL

Business Development Services: important link to

improving SMEs ability to develop bankable proposals,
improve accounting. (35-46% reported that lack of BDS was
a constraint in accessing formal finance)
Emerging issues & challenges

Concessionary credit lines won't be as generous as before

- SL now a middle-income country

Need specialised credit lines for technology upgrading,

technology development - needed now esp. with GSP+

Malpractices by finance companies - aggressive lending

Plans to exempt loans below Rs. 500,000 from CRIB

Emerging trends to watch

Donors using new tools: ADBs SME credit auction; GIZ

supporting NTBs SME Academy

Microfinance to SME while finance cos getting in to micro

Closer to customers: PoS devices by HNB Grameen;

Union Bank going on mobile, motorbike, cable TV

Peer-to-Peer lending and FinTech: eZcash, mCash, Kashmi,

Rukula
2. SMEs and
Taxation
SMEs and Taxation: Firm-level Survey

First time taxation and SMEs had been looked at

Survey methodology: Harmonized questionnaire in

administered in 2014 across three districts in the Western
Province of Sri Lanka - Colombo, Kalutara and Gampha. A
total of 450 enterprises were surveyed.

Sampling frame: Database of registered SMEs with the

National Chamber of Commerce of Sri Lanka

Complemented by series of KIIs and FGDs

SMEs and Taxation - What Our Survey Revealed
SMEs unaware of, or cannot avail, concessionary tax rates
and tax concessions they are eligible for

Many SMEs are below the tax-free threshold and

therefore are not in the corporate income tax net
Only 38% were registered with IRD; 41% were tax payers

Very few SMEs are VAT compliant - lack of awareness of

benefits + misguided perception of negatives

Compliance is burdensome and costly; limited professional

tax advice; unfair treatment by tax officers; weaknesses in
dispute settlement processes
SMEs and Taxation - Tax Concessions

97% do not receive tax incentives or concessions

Deeper analysis needed on which factor is biggest driver:

minimum investment thresholds too high?
lack of awareness and education?
absence of tax advisors to guide SMEs on how to take
advantage of these?
wilfully avoiding taking advantage, as it forces tax
registration?
SMEs and Taxation - VAT
Preference to stay away from VAT; perception that VAT is
burdensome to their business.

Non-VAT compliant SMEs may be able to circumvent the

payment of VAT on sales but are unable to reclaim VAT credits
on inputs, leading to higher costs.

Non-VAT compliant SMEs lose out on the opportunity to do

business with VAT compliant firms as most VAT compliant
firms seek to trade with other VAT compliant firms (in order
to input VAT refunds).

Majority of respondents (72%) were of the view that VAT

compliance leads to increased raw material costs
SMEs and Taxation - VAT Compliance

A revealing finding was that on the frequency of visits by

VAT officials, 95% per cent of enterprises had never been
visited.

Important implications for strengthening tax compliance

and expanding the tax net.

While an SME may not be currently VAT-liable, by not

visiting for long periods tax officials miss out on finding
SMEs that become VAT liable as the business progresses
SMEs and Taxation - Perceptions on Tax

96%: prevailing number of taxes/the number of

instruments deployed is too high

96%: prevailing tax laws and tax structure was

cumbersome, procedures to fulfill compliance are too
complex, and hurting business growth
ad-hoc changes in tax exemptions, concessions, and special
provisions.
difficult to interpret tax laws, and frequent changes.
for e.g. April 1st tax changes not yet gazetted, no notice from
IRD on when.
SMEs and Taxation - Policy Implications
Tax registration should come with business registration,
regardless of taxable threshold

Reconsider the tax-free threshold (or consider the high

threshold as a de facto tax concession for SMEs)

The low tax registration has implications for longer-term

tax compliance; while high threshold has implications for
current low tax-GDP ratio.
Many sectors that have been growing (construction, whole and
retail trade, tourism) have high SME presence

Enhance awareness of benefits of VAT compliance

3. SMEs and
Technology
SMEs and Technology - Issues
These insights are based on observation + research for WB & GIZ
No formal survey done yet - forthcoming

Fragmented institutional space and breakdown of earlier

ecosystem
NERD-C and IT does R&D
IDB does tech transfer and extension
DFCC does development financing

Key tech transfer institutions like ITI, SLSI, NERD-C only based in
Colombo - no regional offices!

Apart from University of Moratuwa and now University of Uva-

Wellassa, state universities do not have proper tech transfer offices,
industry-research collaboration, technology licensing offices, etc
SMEs and Technology - New Developments
Some recent trends in angel, seed and VC funding - e.g. Blue
Ocean Ventures, MTI Idea2Fund
But barriers: largely Western Province based; English-
speaking pitch and demo days.

For start-ups - new incubators, accelerators, co-working

spaces have come up
Again mostly in Western Province, and mainly digital
economy focussed
Given economic structure in the Provinces, startups in
sectors like food processing need incubation

Budget proposal to set up a VC Fund of Funds with part

donor money (ADB) and part government money
Concluding
Thoughts
Concluding Thoughts
Finance: Overemphasised role of availability, underemphasised bankability
Over reliance on rounds and rounds of concessionary loan schemes
refinanced by donors
Need to focus now on strengthening SMEs intrinsic weaknesses that hurt
access to finance as well as improving banks SME lending competencies

Taxation: Relatively under explored topic, but some issues becoming clear
Tax compliance among SMEs is low for multiple reasons
GoSL may need to consider revising tax-free threshold or at least make
registration compulsory
VAT needs better messaging among SMEs
Compliance procedures/costs are burdensome and need fixing

Technology: Support to access technology (primarily tech transfer)

In this, both access to an ecosystem and access financing need addressing
Need to set up a clearing house for SME technology access like Steinbeis