Enhancing Access to Finance for Micro and Small Enterprises in Egypt

10th Global Conference on Business & EconomicsISBN : 978-0-9830452-1-2

10th Global Conference on Business and Economics

October 15-16, 2010

Enhancing Access to Finance for Micro and Small Enterprises in Egypt

Dr. Sahar Nasr

World Bank, American University in Cairo, and British University in Egypt

Phone Number: +2-010-544-7706

10th Global Conference on Business and Economics

October 15-16, 2010

Enhancing Access to Finance for Micro and Small Enterprises in Egypt

Dr. Sahar Nasr

Lead Financial Economist and Associate Professor

The World Bank, the American University in Cairo, and the British University in Egypt

+20105447706

Abstract

Many governments of developing countries perceive micro, small, and medium enterprises as engines of employment, poverty alleviation, and broad-based economic growth. Growth and development of micro and small enterprises in developing countries can increase poor people’s opportunities, security, and empowerment. Firms that start small but do a good job of responding to market demands become larger. With scale comes productivity, bringing better salaries for workers. Larger firms tend to thrive for a longer period than smaller ones. The challenge, then, is to create an environment in which new entrants with drive and good ideas can get started in business, and good firms can grow.

Accessing finance is a make-or-break issue for many micro and small enterprises in the developing world. Micro and small enterprises are major contributors to the gross domestic product and employment in economies around the world, yet their financial needs are underserved, which holds back their growth. Where financing is available, it is usually out of reach because of short payback periods and excessive collateral requirements. Nonbank financing options, such as leasing, are not always available. In many developing economies, certain segments of the population, primarily women, are excluded from business activity, because traditionally they do not own land, which is often the preferred collateral for loans.

Enhancing access of micro and small enterprises to finance has always been an important component of the Egyptian government’s agenda. This paper gives a broad overview on the micro and small enterprise sector in Egypt, constraints impeding their growth, and policy efforts undertaken by the government. The paper would also discuss how far did micro and small enterprises in Egypt get affected by the economic slowdown resulting from the global financial crisis, in addition to suggesting means by which access to finance for micro and small enterprises could be enhanced.

Keywords

Access, finance, micro, small, business, enterprise, Egypt, financial crisis

Introduction

Accessing finance is a make-or-break issue for many micro and small enterprises (MSEs) in the developing world. MSEs are major contributors to the gross domestic product (GDP) and employment in economies around the world, yet their financial needs are underserved, which holds back their growth. Where financing is available, it is usually out of reach because of short payback periods and excessive collateral requirements. Nonbank financing options, such as leasing, are not always available. In many developing economies, certain segments of the population, primarily women, are excluded from business activity, because traditionally they do not own land, which is often the preferred collateral for loans.

Enhancing access of MSEs to finance has always been an important component of the Egyptian government’s agenda. Over the last four years Egypt‘s government has implemented significant structural reforms. These have included liberalization of trade, a complete overhaul of the tax system, restructuring and improving financial sector regulation, and privatization of state-owned enterprises (SOEs). These reforms led to a friendlier investment climate which, in a favorable global economic environment, generated a strong private-sector supply response. Real GDP growth increased from an average of 3.5 percent during FY01-04 to around seven percent between FY06 and FY08—a record compared to the previous twenty-five years. Egypt also accumulated significant net international assets in FY05-FY08, due to both internal and external factors.

Despite the progress made, Egypt faces many challenges in maintaining sustainable economic growth, and addressing economic, social and regional inequalities. The global economic slowdown that began in 2008 has adversely affected growth and employment in Egypt. In FY09, growth decreased to 4.7 percent and is expected to increase to only 5.5 percent in FY10 as the global economy recovers. Employment growth is expected to fall to 2.3 percent, and the unemployment rate is expected to increase to about 10 percent by FY10.1 The real sector, especially MSEs have also been negatively affected by the slowdown in economic growth, as evident in a recent World Bank survey of 200 firms. Such an adverse impact is worrisome, as MSEs account for over 99 percent of Egyptian enterprises, 85 percent of non-agricultural private-sector employment, and, correspondingly, almost 40 percent of total employment.To meet these challenges, Egypt needs to diversify the sources of economic and employment growth, and raise the efficiency of resource allocation without exerting undue pressure on the already strained environment. One potential source of growth is MSEs, which over the past ten years have made an important contribution to GDP growth, job creation, and export earnings.

Study Methodology

This paper gives a broad overview on the micro and small enterprise sector in Egypt, constraints impeding their growth, and policy efforts undertaken by the government. The paper would also discuss how far did micro and small enterprises in Egypt get affected by the economic slowdown resulting from the global financial crisis, in addition to suggesting means by which access to finance for micro and small enterprises could be enhanced. It draws on data from the World Bank Investment Climate Assessment (ICA), Investment Climate Survey (ICS), and the ICS recall questionnaire. The ICS of 1,156 enterprises from the manufacturing sector was carried out in October 2008, using the World Bank standard methodology. The recall questionnaire of 566 enterprises was conducted in October 2008. About 70 percent of the ICS sample is made up of small and medium firms, about 85 percent of which are owned by individuals or families. Large firms— firms employing more than 150 workers—account for about 30 percent of the sample. In about 35 percent of the sample, a woman is a main shareholder; in 15 percent of these firms, women own the majority of the firm. The limitation of the ICS is that it reflects only the perspective of entrepreneurs who established firms; it does not reflect the views of those who were unable to do so because of barriers in the business environment.

Overview of Micro and Small Enterprise Sector in Egypt

MSEs make up over 99 percent of private enterprises in Egypt and account for 85 percent of non-agricultural private sector employment and almost 40 percent of total employment. MSEs have been the primary absorber of labor force entrants over the past eight years and contribute significantly to employment generation, albeit much of it is of an informal nature. Micro and small enterprises are also the major provider of products and services for local markets, particularly lower-income segments with limited purchasing power.

Although the stock of micro and small enterprises has grown at an average annual rate of over four percent during the past ten years, and micro and small enterprise employment has increased at an annual rate of over five percent, the micro and small enterprise sector is highly vulnerable. The average Egyptian micro and small enterprise has only 2.3 workers, and almost three-quarters of all private enterprises have fewer than 3 employees. Over 80 percent of micro and small enterprises are informal enterprises, with low value-added, low production quality, and poor export performance.

Micro and small enterprises are subject to a legal and regulatory framework which is cumbersome, bureaucratic and not sensitive to their operating realities. They face several other constraints, including difficult access to formal financing, business development services, markets, information, technology, skilled labor, and adequately priced inputs. In spite of more open markets and increasing foreign direct investment, because of their limited capacity and capability, the benefits from this are not trickling down to these enterprises. And although the numbers of both micro and small enterprises, and micro and small enterprises employment have been on the rise, this has not resulted in a reduction in the level of poverty; in fact, poverty levels have increased in recent years.

Definition of Micro and Small Enterprises

There has been controversy regarding the definition of micro, small and medium enterprises by different entities and organizations (Table 3.1). The Small Enterprise Law 141 of 2004 defines micro enterprises as companies or sole partnerships with paid-up capital less then LE50,000, and small enterprises as companies or sole proprietorships with paid-up capital between LE50,000 and LE1million, and with 6–50 employees. The Central Agency for Public Mobilization and Statistics (CAPMAS) acknowledges this definition, but in practice uses number of employees, defining micro-enterprises as up to 5 employees, small enterprises as up to 50 employees, and medium and large enterprise as having over 50 employees.[1]

The definition of CBE is also broadly consistent with regard to number of employees, but markedly different with regard to paid-up capital. Banks tend to use annual turnover as the defining characteristic of enterprise client, given its relevance to loan analysis and repayment capacity. SFD uses a cut-off between micro and small enterprise loans of LE25,000. This cut-off is broadly in line with the World Bank definition of micro as having an average loan size of up to 3 times per capita GDP.

Size Composition

Egypt’s enterprises, like enterprise sectors in most developing and developed countries, are mostly micro in size. According to CAPMAS, 92.5percent of enterprises are micro, 7.3percent small, and less than 1percent (only 0.2percent) is medium and large. Only about 1.5percent of private sector enterprises have more than 10 employees. While the predominance of micro enterprises is not in itself unusual, the number of private sector medium and large enterprises, and the proportion of the private sector workforce that they employ is low by regional and international standards. Micro and small enterprises in Egypt tend to have very small amounts of capital. Around 59percent of enterprises with 1–4 workers have capital of less than LE5,000 (less than US$1,000) and only 6percent of all enterprises have invested capital of more than LE50,000 (less than US$10,000), according to Labor Market Panel Survey Data for 2006.

The proportion of micro and small enterprises is growing. While micro and small enterprises accounted for 73.5percent of total private sector employment in 1996, their share had jumped to more than 85percent in 2008. On the other hand, medium and large enterprises witnessed a decline in their share of employment by almost half, from 26.5percent to 14.7percent during the same period (Table 3.2).

Sectoral Breakdown

As is typical in developing countries, micro and small enterprises are concentrated in the trade and services sectors. Of the total micro and small enterprises, 59percent are in wholesale and retail trade, 27percent in services, and 14percent in manufacture as of December 2008 (Figure 3.1). The manufacturing share for small enterprises dropped from 46percent in 1996 to 38percent in 2006 and further to 14percent in 2008. However, over half (51percent) of medium and large enterprises are in manufactures, up from 46percent a decade ago. Despite making up the vast majority of firms in Egypt’s private enterprise sector, the contribution of micro and small enterprises to exports is very low–estimated at only 4percent of total exports in 2008, by value.

Gender in the Micro and Small Enterprises Sector

There is only limited participation of women in self employment and micro and small enterprises ownership. Women-owned micro and small enterprises make up 18percent of the total number of micro and small enterprises. As size grows, levels of female ownership decrease even further. Not only are women less likely than men to be involved as micro and small enterprises owners, their enterprises are reportedly smaller, less likely to employ other workers, more likely to be in retail trade, less likely to export, less likely to be registered, and to have lower levels of capitalization.

The presence of women in entrepreneurial and micro and small enterprises activity mirrors their low participation in the labor force generally. The unemployment rate for women in Egypt is four times greater than that for men. There are over one million women in the labor force who would like to work but who cannot find employment. Therefore there may actually be greater potential for women participation in the enterprise sector than men, proportionately. The picture is better for microfinance, with women making up 74percent of the active clients of SFD-supported MFIs.

Informality

Informality in Egypt’s enterprise sector is high, at an estimated 37percent of GDP. Egyptian Labor Market Survey Data for 2006 indicated that over 83percent of enterprises are informal and over 70percent of private sector wage workers are engaged informally. Even medium and large firms hire nearly a quarter of their workers informally (without a secure contract, social security, etc). Manufacturing micro and small enterprises are much more likely to be registered (70percent) than retail and services (less than five percent).

Constraints on Enterprises

The 2009 Investment Climate Survey (ICS) for Egypt indicated the primary constraints for manufacturing firms were uncertainty about the macroeconomic and regulatory environment, a shortage of skilled workers, tax rates, corruption and access to finance and cost of financing.[2] The gap between the small, medium and large enterprises is especially severe in terms of access to finance (Figure 3.2). According to the Egyptian National Competitiveness Council estimates in 2008, around 40-60percent of the costs of doing business arise from regulatory burden.

Access to Finance for Egyptian Micro and Small Enterprises

There is widespread consensus on the significant contribution of micro and small enterprises to employment creation, poverty alleviation, economic growth, social cohesion, and local and regional development. Lack of formal credit often hinders these enterprises from formal entry or from developing their potential. The fact that micro and small enterprises often receive less finance or face worse conditions than larger firms can put them at a competitive disadvantage, and will seriously harm long-term growth and development through under-investment, a waste of entrepreneurial resources, a reduction of productivity, and a lower growth rate.

Access to finance is important for growth and economic development. Having an efficient financial system that can deliver essential services can make a huge contribution to a country’s economic development. Greater financial development increases growth, reduces economic volatility, creates job opportunities and improves income distribution, as has been established by a great deal of empirical literature. A well-functioning financial market plays a critical role in channeling funds to their most productive uses, and allocates risks to those who can best bear them.

Globally, micro and small enterprises’ credit limitations in access to formal finance has been mainly attributed to the high administrative costs of small-scale lending, asymmetric information, the high risk attributed to their lack of collateral and inadequate capacity to prepare business plans and local applications. Although the reasons apply to industrial, as well as, developing and emerging economies, they tend to be more significant in the latter, where institutions underpinning credit markets are often less developed. The larger the firm, the easier its access to bank credit and the better are the loan conditions it receives. Loans to large customers are encouraged by banks through employee incentive schemes, which are often based on the amount of credit granted.

In addition, the vast array of alternatives to domestic bank loans available to large firms, such as recourse to capital or international financial markets, augments their bargaining power at the time of negotiating a loan contract. In contrast to large firms, micro and small firms are often less able to meet their financing needs. Without sufficient finance, micro and small enterprises are unable to expand their businesses and to introduce productivity enhancing technology. This limits dynamism and competition, adversely affecting the economy as a whole.

Enhancing access of MSEs to finance has always been an important component of the Egyptian government’s agenda. Strengthening the legal and institutional architecture for MSE finance is a key pillar in the government’s financial sector reform program. In particular, while the first generation of the Financial Sector Reform Program (2004-2008) focused on financial stability, the second generation reforms (2009–2013) focuses on financial intermediation and improving access. Key components of this program include, establishing under the Ministry of Investment the first Egyptian Financial Supervisory Authority (EFSA); setting a legal framework that will define and regulate Microfinance Institutions (MFIs); issuing CBE Decree 2408 of 2008, reducing reserve requirements on the funds used for loans to small enterprises; the launching in 2008 of a stock exchange for smaller firms—the NILEX to improve access to equity capital by small firms; issuing a new law on secured lending; and further improvements in the services offered by the credit bureau. In addition, SFD has recently launched a Micro and Small Enterprise Development Strategy (2009–2013) aiming at improving the environment for MSEs.