SMEs poised to emerge as key drivers of region's growth

Small and medium-sized enterprises (SMEs), that form the backbone of an economy, are expected to play a greater role in the development of the Middle East in the coming years as markets evolve and become more competitive, according to a new report.

Standard Chartered Bank in its latest report 'Middle East – The rising importance of SMEs' highlights how SMEs can help in the creation of jobs, diversify from hydrocarbons and add to the GDP. However, there are many factors in the region that need to be dealt with to support SMEs.

In mature and key emerging markets SMEs contribute significantly to the GDP.

But it is the public entities and large conglomerates that define the business environment in oil-exporting countries in the Middle East, mainly the Gulf region, whereas SMEs play a more dominant role in countries such as Egypt and Jordan.

According to economists at the bank, the strategic importance of the SME sector in the Middle East is explained by two factors – job creation for a young population and development of private sector to reduce economic reliance on the oil sector in Gulf countries and improve living standards in other countries of the region.

The data in the report shows the percentage of the population under 24 years of age is 57 per cent in Saudi Arabia and 35 per cent in the UAE. Currently, the oil and gas sector employs only 1.5 per cent of the labour force in the Gulf oil states. Enough jobs must be created to absorb a flood of new entrants into the job market in the very near future.

In the UAE, for example, while SMEs contribute only 30 per cent of GDP, they account for 86 per cent of employment. The expansion of the SMEs and private sector is vital to increase employment generation. The overall private sector contributed only 39 per cent of the UAE's GDP in 2008, according to estimates from the UAE Federation of Chambers of Commerce and Industry.

The percentage is similar in Saudi Arabia. Both countries are dominated by public sector firms, largely in the hydrocarbon sector. But as they seek to diversify their economies, private sector and SME development will play an important role.

Lebanon, Jordan and Egypt also have young populations. In Egypt and Jordan, more than 50 per cent of the population is under 24 years of age, while in Lebanon the figure is above 40 per cent. These countries are plagued by high unemployment and encouraging entrepreneurship can break that trend. Also, as mentioned above, SMEs can play a key role in improving standards of living in lower-income countries such as Egypt, Lebanon and Jordan.

According to UNDP statistics, more than 40 per cent of Egypt's population lives on less than $2 (Dh7.34) per day. In countries such as the UAE and Saudi Arabia, where per capita GDP is higher, SME development can foster competition and create a stronger private sector.

SMEs in oil-producing countries tend to be dominant in the services sector. Most of the SMEs in the UAE, for example, are based in Dubai, the world's third largest re-export hub and a service-based economy.

The services and trading sectors are likely to generate maximum jobs as they are more labour-intensive than other sectors. The same is true of Saudi Arabia, where SMEs are most active in the commercial, hotel and construction sectors.

In Egypt, rapid population growth means there is a need for more labour-intensive industries. Egypt's minister of trade and industry has said the country must maintain six per cent annual GDP growth in order to keep the unemployment rate steady. Therefore, services and other labour intensive industries are likely to prosper, given that labour in Egypt is relatively cheap. In Jordan, the industrial sector is likely to see high growth because of the government's export-oriented policies.

In Lebanon, SMEs dominate the trade sector. However in the past few years, construction, services sector and tourism have also become important.

Even though SMEs can contribute to the growth of economies in the region in a big way, there are several problems that hinder SMEs from becoming a big player.

SMEs have been hit in a big way by the global downturn. "SMEs' size, coupled with their lack of access to credit, makes them more vulnerable than large corporates to the deteriorating economic environment. Credit conditions have tightened and SMEs – which rely heavily on banks for lending – are finding their access to funding restricted," said the report. Besides limited credit, falling demand from foreign countries is also putting pressure on SMEs.

"Falling exports to the US and the EU have hurt economies such as Lebanon, Egypt and Jordan. Jordan's exports to the US, for example, fell by 10 per cent year-on-year in May 2009 and its total exports slumped by 21 per cent.

"The UAE and Saudi Arabia are more dependent on Asia for imports and exports and we expect a stronger Asian recovery in H2 2009. However, amid generally weak global economic conditions, SMEs are at a disadvantage relative to larger firms because they do not benefit from economies of scale. Since banks are more reluctant to lend to SMEs, contracts with SMEs are often the first to be cancelled."

Financial institutions are also generally reluctant to lend to SMEs even in normal times. "They are classified as riskier." In the UAE, Lebanon, Jordan and Egypt, banks generally do not lend to firms unless they have been established for at least one year, said the bank.

"In Egypt, SMEs contribute 80 per cent of GDP, and a combined 78 per cent of the country's SMEs are in the trade and manufacturing sectors. Yet bank loans extended to private businesses in the trade, industrial, and services sectors accounted for only 60 per cent of total bank loans [in local-currency terms] in April 2009. The remaining 40 per cent of loans went to non-private businesses in these sectors and to the agricultural sector, the household sector, non-governmental organisations (NGOs) and foreign institutions," said the report.

SMEs also have difficulty in accessing credit in the UAE despite its more developed economy. A study by Dun & Bradstreet (D&B) on SMEs in the UAE, as quoted in the report found that banks generally reject 50-70 per cent of credit applications from SMEs due to the higher risk and applicants' failure to meet loan conditions.

The D&B study showed that 55 per cent of the SMEs were unable to get the credit they required. SMEs often lack organised financial statements, transparency and financial discipline, making it harder for them to access credit, according to the report.

In Lebanon, only eight per cent of SMEs currently have loans, and just 4.2 per cent received formal loans during the start-up phase, according to the UN Economic and Social Commission for Western Asia (Escwa).

The current situation has made it worse for SMEs to get finance when credit is generally tighter, leading to more problems for them. Liquidity is particularly tight in the UAE. So, in the current uncertain environment, credit standards have tightened and applications for unsecured loans – which SMEs usually get – are at a disadvantage as banks seek collateral.

In Saudi Arabia, despite government initiatives to ease liquidity, credit growth has been weak. In second quarter of 2009, bank credit – loans, advances and overdrafts– fell by 0.7 per cent year-on-year versus 28 per cent growth a year earlier.

While Jordan, Lebanon and Egypt have healthy advance-decline ratios and adequate liquidity, current market sentiment is not conducive to lending. However, battling SMEs can get a boost with the right government policies, said the bank.

Egypt has announced that SME assets held by banks will be exempt from the central bank's 14 per cent reserve requirement. Egypt also launched the Nilex bourse for SMEs in late 2007 to help them raise equity.

The authorities, in co-operation with NGOs and multilateral organisations, have revved up efforts to correct some of these market failures.

In Lebanon, the International Finance Corporation created a risk-sharing facility that expands SMEs' access to finance.

Financing is not the only hurdle as start-ups also need capacity building and management training. Shortage of skilled labour, limited management and technical know-how and the cost of building capacity are other problems to be dealt with.

Jordan, Egypt and Lebanon have partnered with multilateral institutions to create programmes to tackle issues beyond financing. Jordan's National Fund for Enterprise Support provides technical assistance and training in areas such as business planning, financial analysis and IT applications.

Jordan, Egypt and Lebanon have all created business development centres aimed at advising and supporting SMEs. Without such technical assistance, the sector's development would be unsustainable.

Moreover, the business environment in Lebanon, Jordan and Egypt is not favourable to new businesses. In the World Bank's 2009 'Ease of Doing Business' report, Egypt ranks 114th, Jordan 101st, and Lebanon 99th. The low scores are largely due to excess bureaucracy and inefficiencies.

According to the report, key hurdles in Egypt include obtaining construction permits, hiring workers, paying taxes, enforcing contracts and closing a business.

However, the government has made notable progress in addressing some of these problems. The World Bank rated Egypt among the top 10 reformers globally for the third time in four years, and the top regional performer, added the report. Jordanian and Lebanese governments are working towards addressing the problems too but still a lot needs to be done.

According to the 2009 'Ease of Doing Business' report, Jordan's ranking fell to 101 from 94 in 2008, whereas Lebanon's ranking held steady at 98 versus 99 in 2008.

"The UAE and Saudi Arabia need to further improve the environment for SMEs, in our view," said the bank report. In the UAE, the Abu Dhabi Council for Economic Development has emphasised the importance of supporting SMEs during the current downturn.

The Ministry of Economy, along with the UAE central bank, has said it will start a loan programme targeted at entrepreneurs looking to start SMEs although no date has been set for the launch of the programme.

The Khalifa Fund, a corporate body set up by the government to support SMEs in Abu Dhabi, is planning to launch a multi-million-dirham venture capital fund to fill the gap in the market for SME start-up financing.

The UAE is also drafting a competition law intended to combat anti-competitive practices, and is considering revising its investment, industry and company laws.

According to the 'Ease of Doing Business' report, the UAE's business environment ranks 46th out of 181 countries, up from 54th in 2008.

At the emirate level, Dubai has taken initiatives to foster growth in the SME sector, with assistance directed in particular at UAE nationals. For example, government departments are required to source five per cent of their goods and services from local companies owned and run by nationals, and the emirate has provided a tax exemption of three years for new companies founded by young nationals.

The Dubai Chamber of Commerce and Industry also assists the SME sector.

The Khalifa Fund in Abu Dhabi and the Mohammed Bin Rashid Establishment for Young Leaders in Dubai provide financial and technical assistance to local entrepreneurs and are expected to finance an estimated 100 new SME projects this year.

The UAE Government has also set up a programme with a local bank to help local SME owners expand their businesses. Business licensing fees have been reduced by up to 30 per cent and other government charges were frozen to help SMEs.

While all of these initiatives are important to the expansion of the SME sector, the UAE could also consider allowing 100 per cent foreign ownership. Bureaucracy, red tape and clarity of laws are other issues that should be addressed, said the report.

Saudi Arabia is trying to simplify the business start-up process. Saudi Arabia's key deficiency for entrepreneurs is contract enforcement and the judicial system needs to be reformed to clarify bankruptcy and other corporate laws.

Moreover, full foreign ownership is not allowed in the certain sectors.

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