SMEs as strategic drivers of African socio-economic transformations: challenges and policy prescriptions

Keynote speech delivered by Ambassador Juma V. Mwapachu - President of Society for International Development & Former Secretary General of the East African Community - at the 3rd African Governance, Leadership and Management Convention,  August 5-9, 2012 (Whitesands Hotel, Mombasa, Kenya)


The overarching theme of my presentation is how best to promote the development of small and medium enterprises in Africa as strategic drivers of wealth and job creation. The presentation will examine this topic from a number of perspectives, notably, the linkages between enterprise culture and SMEs, the primacy of SMEs in wealth and job creation, how SMEs can generally address poverty and social exclusion, and finally the challenges that SMEs face within the context of securing requisite finance. Much has been written about the pivotal role of SMEs in the economic development of African countries. There is little doubt that well established SMEs can become the engine of social and economic development. In fact, in many African countries SMEs account for about 50% of job creation. In Tanzania for example, it is estimated that a third of the GDP originates from the SME sector. In South Africa, on the other hand, SMEs in 2010 generated 22% of the country’s GDP and 55% of all jobs. In this context, a policy thrust to grow successful SMEs must take pre-eminence if long term sustainable economic development and transformation of Africa is to be realised. The bedevilling question is consistently how to forge successful SMEs. let me preface a discussion on the challenges that face the growth of SMEs in Africa with the following perspectives.


First of all, the place and role of SMEs is not simply an economic issue; it is fundamentally a political one. On the one hand, globalization has unwittingly brought about the marginalization of SMEs most of which would have sprung from small value adding manufacturing processes and trading activities particularly agricultural based. Somehow, agriculture which is the mainstay of economic activity in African countries has not been developed as an industry as to be bundled into the concept of SMEs. Part of the reason why the African youth shun farming is because they do not view it as a business; it is not an industry on the basis of which knowledge and expertise can be harnessed and utilised. Where agriculture has been integrated into the industry cluster, it has mostly been through medium and large scale commercial farming involving commodities such as coffee, tobacco, tea, sugarcane, edible oils and floriculture. And the drivers of such agribusiness have largely been either global companies, African multinationals or firms of richer nationals of Asian origin. Put differently, globalization has contributed to the erosion of economic spaces for indigenous SMEs to grow.


In turn, the rise of China in the African economic space, particularly in the past decade, has brought about a dislocative pressure on indigenous SMEs in Africa and notably in the EAC and SADC regions where Chinese economic influence has been particularly dominant. It is estimated that 80% of the Chinese companies currently operating in Africa are SMEs. The downside of Chinese SMEs operating in Africa is that they normally use their own Chinese workers and thus fail to contribute to local job creation. Indeed, Chinese nationals now compete with small business nationals in what are traditional urban market places. This local Chinese trading phenomenon is further heightened by the monopoly of Chinese consumer goods, some of them being counterfeits, that now pervades African markets and which upset the level playing field for locally produced goods from SMEs. Resultantly, some of these African countries have experienced significant job losses and the erosion of opportunities for wealth creation. In Nigeria the government has adopted strict regulatory measures to curb Chinese imports by requiring importing Chinese companies to setup production units in the country. In the EAC region, the problem of counterfeits has become so large that given its cross-border characteristic, the EAC has had to enact an Anti-Counterfeits Law which is about to be passed by the East African Legislative Assembly. The law will put to check the EAC Customs Union being turned into a counterfeits market.


There is yet another dimension why SMEs constitute a critical political issue. It relates to the agenda of economic empowerment of indigenous populations to participate more prominently in wealth creation. Fifty years after independence of most African countries, the majority indigenous Africans are yet to be economically empowered to own small and medium enterprises. South Africa, post 1994, engineered the Black Empowerment Programme. Its result and impact has in some cases left a sour taste in society given the inequalities in wealth that have emerged within the African citizenry. In Uganda, under Idi Amin, there was a fascist approach to such empowerment. In Tanzania, from the early 1990s, the government was confronted with a barrage of criticism for lack of a clear policy of empowering the indigenous population. In fact, a feud arose between the emergent African business class and the Tanzanian-Asian business class at that time following heightened concerns about the lack of such a policy. Thus the wealth divide currently seen in some parts of Africa along racial lines and which raises serious political sensitivities, is partly fuelled by the lopsided structure of ownership of SMEs. Clearly, if this ownership structure is not quickly redressed, it could precipitate social conflict particularly where the wealth divide becomes perceived to benefit the African political class through corruption.


Another critical political dimension of SMEs in Africa centres on what is now described as the youth bulge. In the context of the EAC region, the youth population aged between 15 and 34 years in 2010 was 48 million or 35% of the total population of 139 million. The overall youth population which includes the under 15 years, is expected to grow to 178 million in 2030 representing 75% of the population. 31% of this youth population will live in urban areas. With this youth bulge, the job crisis will be accentuated. In this context, the growth of SMEs, many of which will be urban based, will thus be critical in creating jobs to fit this population growth. It is estimated that EAC’s labour force will grow by 27 million people between 2010 and 2020. The huge question is where will the new jobs come from to absorb such a labour force? One answer is increased Investments in SMEs. The EAC is particularly seized of the grave potential of social instability emerging in the region if there will be failure to create the extra jobs. The ghost of Kenya’s post election violence in 2007-2008 and the nascent violence that featured in Tanzania’s and Uganda’s general elections in 2010 and 2011 respectively hang in the air and have to be nipped in the bud. The angst of the youth not able to secure decent jobs must constitute the policy response. In December, last year, the EAC Heads of State adopted an EAC Industrialization Policy and Strategy that seeks to guide the EAC towards attaining an industrialized economic status by 2032. This is an ambitious strategy considering that even EAC’s economic powerhouse, namely Kenya aspires in its Vision 2030 to attain a middle income status by 2030.


The action plan for implementing the EAC industrialisation strategy includes the development of a regional industrial upgrading programme supported by the United Nations Industrial Development Organisation (UNIDO) at a cost of USD 20 million plus over the period 2012-2016. The main thrusts of this programme are to enhance the competiveness of SMEs. The programme also seeks to contribute towards value addition in SMEs. Additionally, the programme will improve the business and regulatory environment, strengthen institutional support systems, promote technology transfers, industrial innovations and improve enterprise level investments and productivity in SMEs. The action plan includes the establishment of a Regional Credit Guarantee Scheme to enhance credit to SMEs, which would reinforce the national credit guarantee schemes, as well as the development of an SME incubation programme geared at nurturing innovative ideas.


Unfortunately, many African countries exhibit significant government incapacity to effectively support the creation and promotion of local SMEs. However, there have been attempts to address this shortcoming in some African countries. For example, under President Kikwete’s leadership, the Tanzanian government has since late 2005 created a special ministry to cater for economic empowerment of indigenous budding entrepreneurs. The President also launched an economic empowerment fund whose resources are appropriated by Parliament from the national budget. The Fund is intended to provide risk seed capital that would support budding indigenous entrepreneurs. It is important to note, however, that what is critical in growing SMEs rests significantly on creating a broad supportive economic environment and not simply offering capital. The World Bank Doing Business Reports on the EAC countries have in the past three years consistently affirmed this fact. In sum, addressing frontally the urgency to grow SMEs in Africa has to be viewed from both the economic and political perspectives. The future of Africa’s social and thus political stability hinges not only in promoting the development of SMES as a key catalyst of economic growth but also, and importantly so, working out mechanisms to broaden the ownership of SMEs by enabling indigenous populations to become entrepreneurs and wealth creators. Contextually, the recent rise in resource nationalism in Africa is, to a large measure, prompted by a growing perception that globalization effects at national levels are responsible for entrenching perverse social inequalities. On the other hand, there is also an enduring view that the post-colonial economic structures of ownership have sustained a legacy of perceived racial-based wealth inequalities reflected in the obtaining chasms in the control of wealth in some African societies.


Let me turn to the large question on how to promote an enterprise culture which basically means how to forge an entrepreneurial spirit in Africa. It is through this process that Africa can broaden the base of the SME sector and catapult greater wealth and job creation. There is a view, and Professor Ali Mazrui is one of its leading proponents, that the enterprise culture or capitalism in Africa is impeded and even undermined by a culture which treats capital as a source for consumption rather than for promoting savings and investments. As Mazrui puts it, Africans are predominantly “conspicuous consumptionists”; they largely suffer from what he describes as “indulgent exhibitionism”. This view may be farfetched. Yet there are a number of cases in Africa which have experienced corporate failure because of lack of a robust enterprise culture. I am thus led to hold that the quest for state- driven economic empowerment of indigenous populations may not be the key strategic solution to the promotion of a successful enterprise culture in Africa. It is important therefore that the entrepreneurship spirit is rather cultivated through the education system, in the same way that the curriculum on citizenship in schools has over the years been able to engender a powerful culture of civic responsibility in some countries and I have in mind, as an example, the Mwalimu Julius Nyerere era of leadership in Tanzania. Part of the reason why job creation has for too long been associated more with one being employed rather than with one employing oneself, is in fact because the entrepreneurial spirit has never been sufficiently developed as part of the national culture in Africa. Thus successful mainstreaming of the SME sector in wealth and job creation has to fundamentally address the underlying factors that have so far impeded the growth of an enterprise culture in Africa. To try and jump the gun in appreciating that Africa must go through the promotion of an enterprise culture and not simply thinking that the provision of capital to business start-ups can stimulate the growth of the SME sector, can be a recipe of business failure. It is critically important, therefore, to associate what are seen to be the conventional impediments to the growth of SMEs with the development of enterprise culture.


Notwithstanding the foregoing remarks, it has to be admitted that the growth of SMEs in Africa faces a number of generic challenges. I will now proceed to outline some of these challenges and propose important interventions that could be effected in their resolution. The first and common challenge is the lack of access to appropriate capital from both the banking sector and the capital markets. There is a general perception in the financial sector that lending or provision of capital to SMEs is risky business due to a number of reasons: high mortality rates of SME businesses, poorly prepared business proposals, the lack of reliable collateral, suspect management capabilities and skills and obscure historical records of the operations of the SMEs.


In order to create a supportive environment for banks to lend to SMEs, the problem relating to collateral was uniquely addressed in Tanzania in the early 2000s. President Benjamin Mkapa had invited Hernando de Soto, the author of the famous book, The Mystery of Capital, to advise the Tanzanian government on how best to fungicide property rights into capital. The result is the establishment of a programme called MKURABITA with the mandate and task of titling peoples’ fixed assets like land and housing so that the titles can be used as collateral for accessing credit from banks and financial institutions. However, the MKURABITA project faces serious budgetary constraints and has thus failed to fulfil its lofty mandate as envisioned. With respect to the role of African capital markets, it has to be conceded that these vehicles generally lack special instruments suited to the capital needs of SMEs. Indeed, many capital markets in Africa are still evolving and, where they exist, with the exception of capital markets in South Africa, Egypt, Nigeria and, somewhat, Kenya, their depth and liquidity is still very low. Specifically in the EAC region, this capital market liquidity challenge has given rise to the proposal to forge regional financial market integration.


With the support of the World Bank, the EAC is working closely with national capital market authorities to create a regional capital market whose flagship will be a regional stock exchange. Under the project, a uniform regulatory framework is being formulated. The rationale of this programme is that a well-functioning, liquid and robust regional capital market will leverage efficiency, lower transaction costs and spur cross-border economic activities. It is envisioned that a robust regional capital market can become a viable vehicle for bolstering financing options for SMEs and, thereby, catalyse a faster growth of SMEs. Such alternative option for financing SMEs, especially for providing equity financing, should rid the necessity for SMEs to rely solely on bank credit where the conditions for finance are too rigorous and harsh for SMEs to fulfil.


Going forward, it would be necessary, in enhancing the role of SMEs in African economies, to develop exclusive Stock Exchanges for SMEs because the conventional stock market listing qualifications applicable to large companies in terms of minimum share capital, profit history, pre-tax profit and annual listing fees are well beyond the capacities of SMEs. Thus, Stock Exchanges that are devoted for SMEs would best bolster the confidence of SMEs in raisings low cost capital from capital markets. Such SME-dedicated stock exchanges are beginning to emerge in Africa; an example is AltX, which is Africa’s first alternative stock exchange for SMEs, a partnership between the Johannesburg Stock Exchange Limited and the South African Department of Trade and Industry. A similar model could be replicated by the Nairobi Stock Exchange and later by the East African Stock Exchange currently under consideration.


Another model of financing for SMEs that needs to be enhanced and improved relates to the creation of Credit Guarantee Schemes engineered by the central banks in the EAC and other African regions. The Bank of Tanzania and the Bank of Uganda, for example, have led the way in promoting such schemes whereby loans are given to SMEs as well as farmers through licensed banks. The Central Banks guarantee such loans. In the case of Tanzania, the loans do not exceed USD 330,000 equivalent in Tanzania Shillings with payment durations of between 1 to 5 years. Under the scheme, central banks share the risks with the licensed banks on the guaranteed loans up to 50% of the principal amount. The guaranteed loans so far are for SMEs involved in manufacturing, agro-processing and services such as tourism. They also cater for non-traditional exports. In the context of developing markets for SMEs across borders in Africa, it will be essential to develop innovative regional credit guarantee schemes of the type that the EAC is considering to establish and which might later take a continental wide dimension. Such a scheme would enable SMEs that are focused on production of goods and services for cross border trade to secure risk working capital as well as trade finance from commercial banks. In the EAC region, the East African Development Bank may consider to foster the role currently undertaken by the central banks in providing credit guarantees for loans to regional-focused SMEs.


Another interesting feature in developing appropriate financial intermediation for SMEs is the role of special investment funds that can fund commercial banks to reduce their risk profiles in lending to SMEs. For example, in the European Union, a large number of SME loans are granted through securitization programmes. These programmes enable commercial banks to offload their credit risks to the capital markets and thereby take up greater exposure to the SME sector. Evidently, the availability of efficient securitization markets has leveraged the availability whilst reducing the costs of financing in the primary lending markets. There is thus need to explore the securitization of SME loans in Africa as a basis for enhancing access to debt finance. Such a development would need the establishment of special platforms for transferring credit risks to capital markets. In turn, African countries may also consider putting in place the equivalent of the European Investment Fund (EIF) which provides funding to commercial banks to leverage their lending capacities for extending loans to SMEs. Such securitization of SME loans would open up possibilities for banks to also attract capital for SMEs from pension funds. Here again, development banks like the Development Bank of Southern Africa (DBSA), the East African Development Bank and similar development banks in West Africa could explore the possibility of establishing such special investment funds of the EIF-type. I believe that the African Development Bank has already crafted such a scheme which maybe the President of AfDB who is attending this Convention may tell us more about.


Finally, brief remarks on the development of Commodity Exchange in Africa. Much has been said and written about the Ethiopian success story in this area. Suffice to state that the idea of commodity exchanges is picking momentum in many countries in Africa. Commodity exchange programmes are no doubt well suited to protect farmers against price turbulence including seasonal variations in commodity prices both nationally, regionally and globally and which invariably diminish farmers’ earnings. To the extent that these trading platforms reduce the negative impact of middlemen, commodity exchanges when well managed can become effective means in poverty reduction, wealth creation and reducing high incidents of wealth inequalities. Significantly, the idea of middlemen has to be viewed beyond the conventional perception ruling these days and resulting from the adoption of new liberal economic policies, as a reference to private traders. A notorious middleman in some African countries is actually represented by state marketing boards which set administered prices for various agricultural commodities which are now in tandem with international or even national market prices. In Tanzania, for example, cashewnuts and cotton farmers have recently resisted selling their commodities to these marketing boards because the prices offered are far below export prices. In fact, members of Parliament in Tanzania who originate from the cotton growing areas, have this past month threatened to stop cotton farmers from selling their cotton to the Cotton Marketing Board unless the price per kilo of seed cotton is fixed at a minimum of Tshs 1000 per kilo which is equivalent to 0.63 US cents per kilo. What this scenario conjures up is that commodity exchanges would best work where governments also address the role of state marketing boards to ensure that they do not undermine the fundamental benefits which Commodity Exchanges are intended to offer to farmers. In the Ethiopian case, it is interesting to note, that on average, the share of the final export price for export commodities traded at the commodity exchange that goes back to the farmer has risen from about 38% pre establishment of the Commodity Exchange to about 70%. In the light of Africa’s fragmented markets where transport infrastructure is poor, costs of logistics are very high and internet connectivity is yet to have territorial spread, partly due to electric power deficits, the key challenge in developing Commodity Exchanges is thus how best to organise effective trading platforms. Clearly, these platforms cannot operate efficiently if they are overly centralized nationally. A system whereby the key agricultural commodities, namely cereals such as maize, wheat, rice as well as beans, but also including inputs such as seeds and fertilizers, can be warehoused at decentralized local areas and provided with the full commodity exchange facilities would be most appropriate. Currently, most African countries are yet to legislate supporting legal and regulatory frameworks to enable Commodity Exchanges to operate. It would be particularly important in the context of the EAC where there is considerable cross-border trade in agricultural commodities and where issues relating to food security are now being addressed and harmonized on a regional basis the development of commodity exchanges should take a regional outlook. The EAC Secretariat and the Eastern Africa Farmers’ Federation agreed in March this year on the need to modernise trade in commodities in the EAC region and on the establishment of a regional commodities exchange platform. Of course, it would be essential that the EAC countries and particularly Tanzania, which has often been intransigent over allowing cross-border exports of food, open up their borders more resolutely to allow freer trade in food commodities. The viability of an East African Commodity Exchange crucially rests on this policy rationale.


Juma V. Mwapachu