The SME (small and medium enterprise) sector has been identified as a key engine of growth and innovation for the economy. But in spite of the emphasis on developing Pakistan’s SME sector, access to finance for small and medium businesses still remains elusive. Providing access to finance in order to fully realise the potential of the SME sector has been accorded top priority by policy makers and government. Recently, the State Bank of Pakistan Governor, Yaseen Anwar observed that the SME sector still remains financially excluded and with Pakistan’s exploding population, the country’s youth-bulge currently represents a mass of unfulfilled expectations.
The SME sector represents over 90% of all enterprises, employs 75% of the non-agricultural workforce and contributes 30% towards the national GDP. However, the absence of finance has frustrated the development of this vital segment of the economy.
Recognising the urgent need to develop Pakistan’s SME sector as a means of driving economic growth, the U.S. Agency for International Development (USAID) recently announced the multi-year Pakistan Private Investment Initiative (PPII), a private equity investment programme which will invest in Pakistan’s SME sector. Additionally, PPII seeks co-investors to participate in the programme and enlarge the base of available investment capital.
The project was carefully devised after undertaking comprehensive research over a year which largely involved analysing access to finance in Pakistan, the challenges faced in increasing access to finance, holding discussions with large and small scale entrepreneurs and the government who stressed the importance of providing ‘trade just not aid’. As Vinay Chawla, Deputy Coordinator Economic & Development Assistance US Embassy, explains, the fund will have a “demonstration effect” highlighting the economic benefits unleashed by investing in SMEs. “We target investment sizes of USD half a million to USD five million. The real fundamental belief we have based on global research is that if you give access to finance solutions to SMEs, you can create jobs,” says Chawla.
With Pakistan’s economy facing unprecedented challenges, PPII is particularly timely, “The credit rating has fallen twice in the last few months, the ability of this government to borrow is becoming more and more expensive but we have full faith and confidence that by investing in the private sector and making investments, that is the best way to create jobs for the future,” asserts Chawla.
However, in spite of the setbacks facing Pakistan’s economy, Chawla elaborates on the US government’s optimism about Pakistan’s economic future, “We want to highlight our confidence in the Pakistani economy. Pakistan is often cited as part of the N-11 (The Next Eleven) and that is really where growth in the future is going to be. If you look at the statistics in Pakistan, you have got a huge age dividend compared to the rest of global economy; Pakistan is the second largest producer of buffalo milk, the third largest producer of cotton – so these statistics tell you that there are huge opportunities. Foreign direct investment that has come into Pakistan has done quite well so we see Pakistan as open for business.”
He highlights the unique nature of PPII which will be led by the private sector with limited government involvement, “We are going straight to the private sector and we are trying to leverage our money at least on a one-to-one basis but we are hoping for two-to-three.” This means that funds as large as $50 – $100 million could be deployed which would be tremendously beneficial for Pakistan’s economy. “It’s a large country but we feel that we can demonstrate some positive impacts,” says Chawla.
Theodore P. Heisler, USAID’s senior economic growth advisor comes to Pakistan with extensive expertise in private equity. A seasoned economist, he underlines the overarching objective of PPII: “We are looking to support SMEs because that is where the economic growth comes from. We are looking to support job growth through SMEs.” He also stresses the overwhelming role of the private sector in this landmark initiative, “We are looking to have limited US government involvement and actually have the private sector run this. That is a change from typical past practices in that we are looking for a private sector solution to leverage US government funding which can satisfy the needs of the market better than any government can.”
He highlights how this pioneering project will serve as a precedent for other companies who have been hesitant about providing financing for SMEs through private equity, “We are trying to demonstrate the untapped potential of investing in SMEs in Pakistan. The market is so broad, so expansive, there is no private equity here so there is a lot of room for follow-on investing or parallel investing with other funds.”
For optimal impact and to minimise risk, the PPII programme will launch at least two funds. Heisler elaborates, “Multiple funds diversify financial risk for the investors, it diversifies operational risk because instead of putting all your eggs in the single proverbial basket you have got more funds in operation, so you are diversifying risk, you are reaching more companies and more SMEs. So we are expanding the reach of this money, we will create more jobs that way.”
PPII will pave the way for the development of Pakistan’s private equity industry and Heisler explains the fundamental role of private equity in economic development, “We are really looking to spawn a private equity industry that does not exist in this country. Private equity tends to invest in growth companies; such companies are where the economic growth comes from and the job growth comes from. So by supporting the private equity industry we are supporting economic growth and we are supporting job growth.” He shares powerful statistics to illustrate private equity’s contribution to economic development, “In the US private equity funds as an industry is 1% of GDP. US GDP is $15 trillion so that is $150 billion. In the UK it’s more than 1% as a percentage of GDP, in India it is four tenths of 1% which sounds small but it is still a $7 billion market.”
Though PPII cannot solely cater to Pakistan’s swelling population demographic, the programme can act as a catalyst to spur the development of Pakistan’s private equity industry. Chawla discusses the array of possibilities engendered through private equity, particularly in bringing in local banks which have met with little success in reaching the SME sector: “Whereas a bank today might not lend to an SME, they may lend to a fund that invests in SMEs – a fund that has a strong track record.”
Since SME financing is considered by many banks as a high risk activity, Heisler explains how PPII will provide an alternative route to link banks safely to the SME sector, “We are proposing to bring in structured tools for helping banks who want to lend to our investee companies, we can contribute equity and the local banks can contribute debt. So we are helping a little bit at the margin to help banks to learn how to lend to SMEs. They have tried with limited success.”
By catalysing access to finance for SMEs, PPII will play a leading role in increasing growth opportunities in this sector and in developing Pakistan’s entrepreneurial talent – an objective which resonates deeply with policy makers as a crucial means of alleviating poverty and bolstering sustained economic growth.