SMEs: A Boon to the Sri Lankan Economy

Small to medium-sized enterprises (SMEs) are regarded as an essential strategic sector in the overall policy objectives of the Sri Lankan Government. It is also seen as a driving force of change for inclusive economic growth, regional development, employment generation and poverty reduction. In 2015, the Ministry of Industry and Commerce developed the National Policy Framework for Small Medium Enterprise (SME) Development as an effort to help create jobs and generate income, improve the performance and competitiveness of SMEs, and to increase SME participation and contribute to the wider Sri Lankan economy.

The Government of Sri Lanka recognizes SMEs as the backbone of the economy, as it accounts for more than 75% of the total number of businesses, provides employment for around 45% of the population and contributes to 52% of the gross domestic production (GDP) of Sri Lanka.

Despite being such an integral part of the Sri Lankan economy, SMEs in Sri Lanka are faced with numerous challenges that limit their growth potential and prevent them from expanding locally as well as in international markets. These challenges have been present for quite some time and have affected SMEs to an even greater extent during the COVID19 pandemic era as well. According to a journal article published by the Institute of Certified Management Accountants of Sri Lanka in 2018, it was highlighted that some of the main obstacles that were hindering the growth and development of SMEs in Sri Lanka were due to: a weak business environment (e.g., issues related to cash flow, high taxation, and inconsistent government policies), poor infrastructure (e.g., lack of access to efficient transportation facilities, industrial estates and telecommunications facilities), insufficient access to finance (e.g., high interest rates for loans, stringent analysis by financiers for obtaining loans, insisting on collateral and non-acceptance of third-party guarantees by financiers), and restricted access to technology and low computer literacy rates (e.g., use of enterprise resource planning (ERP) systems at the SME level is still quite low, and knowledge in the field of applied ICT is still moderate). Furthermore, entrepreneurs in the SME sector face obstacles that limit their expansion due to internal issues such as insufficient financial literacy and discipline (e.g., lack of knowledge on personal and business-related financial management, budgeting, and investing), which prevents entrepreneurs from making informed and effective decisions on how they hope to utilize their financial resources. Moreover, studies suggest that SMEs find it difficult to negotiate with suppliers and other stakeholders when conducting their business activities due to the lack of recognition and poor public reception in Sri Lanka. However, out of all the obstacles listed above, lack of access to finance is one of the greatest challenges faced by SMEs in Sri Lanka.

In Sri Lanka, there are two main types of financial support mechanisms available for SMEs. On one hand, you have numerous government initiatives developed by government bodies such as the Ministry of Industry and Commerce, the National Enterprise Development Authority (NEDA) and the Small Enterprise Development Division (SED) and so forth. On the other hand, most of the funding comes from banks, both state banks and private banks. According to a recent study conducted by the performance consulting company Sandbox Consulting (Pvt) Ltd., titled ‘Micro Enterprise and the Sri Lankan Economy – Post-COVID Insight’ in 2020, the study elaborates on a few of the key issues faced by SMEs in Sri Lanka in the current economic climate. The study found that SMEs in Sri Lanka have continuously struggled to gain access to investment credit from the country’s banking sector. Even with the necessary access, businesses have had to resort to premium rates, often more than 10% per annum, and the alternative of borrowing from sub-prime lenders is still at a higher rate of interest. According to the report, over the past three decades, SMEs in Sri Lanka have paid approximately 20% per annum as interest on their borrowings, which is an astoundingly high rate when compared to what other SMEs in South Asian countries have paid. One of the main reasons for the high cost of borrowing are the absence of audited financial statements, limited management skills, and the lack of access to large scale collateral that can be offered to undo the lending risk that the banking system is not ready to accept.

Sri Lankan Banks offer various types of financial assistance for SMEs. Local banks have SME development schemes that provide loans, short-term loans, line of credit facilities, and permanent overdraft facilities and so on. Each bank has their own eligibility criteria for SMEs to draw out loans and request guarantees, mortgages over moveable or immovable property or any other security acceptable to the bank to be offered as collateral, and have varying repayment periods, and interest rates. However, studies seem to suggest that SMEs find the interest rates offered by these banks to be extremely high, and sometimes fail to secure investment credit from banks to fuel their business ventures due to the lack of access to large scale collateral to offer as security. Making entrepreneurs having to resort to use their personal savings as investment capital to fuel their businesses.

Apart from financial assistance provided by financial institutions, other organizations also provide alternative types of support for SMEs. Hatch is one such example, it is a coworking space designed to promote innovation, growth, and collaboration between startups in Colombo. In 2019 Hatch signed a partnership with the Good Life Accelerator (GLX) Program, which is an international accelerator program in Sri Lanka designed and initiated by the GIZ SME Sector Development Program (on behalf of the German Federal Ministry for Economic Cooperation and Development). The GLX Program housed at Hatch seeks to support local entrepreneurs with a specific focus on areas of food, agriculture, wellness and travel, and green initiatives to go global, fostering economic growth in Sri Lanka. Lankan Angel Network (LAN) is another example of other organizations offering support to develop Sri Lanka’s SME sector. The Angel Fund, which is an initiative of LAN, is a platform that enables angel and private investors to invest in high-growth early-stage Sri Lankan ventures, specifically technology startups in Sri Lanka. It is apparent that Sri Lanka needs more alternative support mechanisms for SMEs much like the examples mentioned above, and more development banks and venture capitalist firms, in order to help finance entrepreneurs, up and coming startups and support the SME sector in Sri Lanka.