Investing in SMEs: Hitting the Right Note

Much has already been said and written about crippling liquidity crunch facing SMEs in Nepal. Despite the presence of numerous banking and financial institutions and investment funds in the market, entrepreneurs continue to struggle to finance their enterprises. Diverse set of stakeholders, including the government of Nepal, have taken upon themselves to help entrepreneurs in dire need of capital.

In order to aid enterprises, the government has exercised policy and programmatic interventions. For example, Nepal Rastra Bank (NRB) mandates BFIs to contribute certain per cent of their portfolio to so-called deprived sector lending. Moreover, NRB has also started loans up to Rs 1.5 million at subsidized interest rate. In a similar vein, different ministries have introduced loan schemes to support entrepreneurs with varying scale of capital needs, as little as Rs 60,000 up to Rs 500,000 per individual borrower, such as Women Entrepreneurship Development Fund, Micro Cottage and Small Industries Fund, Youth and Small Entrepreneur Self-employment Fund, and Rural Self Reliance Fund.

The multitude of such initiatives is indicative of the government’s interest in fostering entrepreneurial growth in the country. However, there is limited research that examines the effectiveness of these efforts in meeting capital needs of SMEs in Nepal. Elsewhere, research suggests that such approaches do little to promote the growth of SMEs. According to a 2006 technical report, prepared by the University of Kansas, that examines the government’s role in the entrepreneurial process, the government can achieve tangible results in entrepreneurial growth via policy measures consistent with economic freedom, such as removing regulatory barriers and reducing compliance burdens and leave the matter of liquidity constraints to investors.

Nepali entrepreneurs can benefits from the investor ecosystem, consisting of impact investors, private equity and venture capital funds, slowly taking grounds in Nepal. While the government has expressed its unfazed commitment towards creating an investor-friendly environment in Nepal, its policies speak otherwise. In a recent seminar on blended finance and impact investing organized by Samriddhi Foundation and Mennonite Economic Development Associates, representatives of pioneer investment funds in the country pointed out that despite a growing appetite among foreign investors, it is extremely difficult to channel investments into Nepal.

Prominent among entry related barriers facing investors is minimum foreign direct investment threshold set at Rs 50 million, which was increased from five million in May last year. While proposing the said threshold, the Ministry of Industry, Commerce and Supplies argued that Nepal needs large scale investments in mega projects, while smaller investment demands can be catered to by local investors. It would be wrong to assume that small investments have little to contribute to Nepali entrepreneurs. At a time where many enterprises, with innovative and untested business ideas, have a hard time finding risk-taking investors, limiting the competition within investors via measures protecting domestic ones does not bode well for entrepreneurial growth in Nepal.

Apart from policy bottlenecks in investment, entrepreneurs face compliance burden while operating businesses in Nepal. With multiple regulatory compliances enterprises must satisfy, they spend more time navigating onerous process through different regulatory agencies, rather than dedicating their energy on producing goods and services to appeal to the demands of customers. For example, the repetitive filing and reporting obligations mandated by the Companies Act is a point in case. The Act requires companies to file the same set of financial statements and audit reports at the Office of Company Registrar (OCR) and Inland Revenue Department (IRD), although they submit tax return and audited accounts to IRD every year as per the Income Tax Act, 2058. Time-consuming compliances, such as this one, eating away at entrepreneurs’ resources, one cannot expect them to become productive and efficient.

The problem of low investment appeal and subsequent liquidity constraint in SMEs in Nepal is not only tied to government regulations. Equally important is good corporate governance, which not only ensures sustainable growth and success of businesses, but also factors in on investors decisions to whether or not invest in a company. You cannot expect to attract investment when companies are run in a one-man army approach, without policies and procedures in place to ensure transparency, corporate accountability and, safeguarding the company, telltales of bad governance. On the investor’s side, patience with return on their investment is crucial. Unlike real estate or stock market, where one may receive dividends overnight, investing in SMEs require years to be able to make payoffs. Thus, education and risk-awareness among investors is as important.

The number of loan schemes to advance entrepreneurs’ access to capital makes it evident that the government is cognizant of the needs of SMEs in Nepal. However, with a restrictive policy environment, such efforts may prove to be a case of misplaced good intentions.

– This article was originally publised by Bidhyalaxmi Maharjan in The Himalayan Times on 26 January, 2020.