Threats to SMEs growing in Nigeria

Bunmi runs a fashion design shop in Abuja. She also imports shoes and bags from Asia. Last year, she decided to begin producing her brand of T-shirts. “The machine that I needed, cost me $18,000 to get it from China.

I wanted to get the money at the official exchange rate through my bank. The process was just too tedious for me, with the documentation required and the two weeks needed to get the money. I went and bought the dollars at Zone 4 and put it in my dorm account. It was the money I sent to China to get the machine.

Bunmi’s story is not unique. It is a story and experience shared by most SMEs in Nigeria who have been crowded out of the official FX market by bigger firms.

Access to foreign exchange, access to credit, and over-regulation remain three of the most severe constraints for Small and Medium-sized Enterprises (SMEs) in Nigeria.

SMEs include a wide range of businesses, which differ in their dynamism, technical advancement, and risk attitude. Many are relatively stable in their technology, market, and scale, while others are more technically advanced, filling crucial product or service niches. Others can be dynamic but high-risk, high-tech “start-ups”. Researchers and practitioners agree that SMEs are crucial contributors to job creation and economic growth in both high and low-income countries

SMEs tend to be 90 percent of all firms, says Professor Rajneesh Narula, the John H. Dunning Chair of International Business Regulation at the Henley Business School, University of Reading. As a result, he notes, “they tend to employers of a large portion of the population. They tend to be small, they tend to be located more evenly across the economy

According to the Nigeria Bureau of Statistics, SMEs in Nigeria have contributed about 48% of the national GDP in the last five years. With a total number of about 17.4 million, they account for about 50% of industrial jobs and nearly 90% of the manufacturing sector, in terms of the number of enterprises.

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In normal times, a 2020 world bank report notes, “most SMEs do not grow, but remain at the same size or exit, with a minority exhibiting rapid growth in productivity or scale. However, a minority of disruptive startups have the potential to shape economies through new and more productive business models. The loss of these disruptive, innovative SMEs may cause permanent scars to the economy”.

The report further noted that compared to large firms, “SMEs are more likely to close their operations permanently. Consistent with this observation is that SMEs are more likely to run into financial difficulties and file for insolvency or bankruptcy”.

A stronger SME sector can bolster Nigeria’s resilience by broadening and diversifying the domestic economy, thereby reducing the vulnerability to sector-specific shocks and fluctuations in international private capital flows.

However, pressures, including over-regulation, are threatening the sustainability of SMEs in Nigeria. In a 2020 PwC MSME survey report, 57 percent of CEOs surveyed cited multiple taxes and levies, lack of coordination of federal and state agencies, and the absence of technology platforms as challenges in paying their taxes

“There are too many government institutions creating transactions costs for these small firms,” Professor Narula noted. “From the cumulated burden of federal, state, and local tax authorities to the Policeman on the street collecting bribes, SMEs are subjected to transactions costs that make the cost of doing business higher and higher and make these SMEs unable to make profits”.

Alongside overregulation, obtaining finance is the most pressing problem SMEs face. According to PwC, the SME credit market, however is notoriously characterized by market failures and imperfections. Policy inconsistency in foreign exchange management by the Central Bank of Nigeria that has culminated in the breakdown in FX supply fundamentals is a key component of these failures and imperfections.

Duro Kuteyi, the National President, Association of Food and Agro Processors (AFAP), had in 2020 appealed to the Central Bank of Nigeria to assist Small and Medium Enterprises to easily access foreign exchange for procurement of machinery. He had noted then that SMEs face major regulatory challenges, especially when they needed to convert funds to dollars at the CBN official exchange rate to import the machines.

The World Bank in its November 2021 edition of its Nigeria Development Update, warned that the primary macroeconomic challenges disturbing growth were issues around the predictability and credibility of exchange-rate management, as well as an insufficient supply of foreign exchange (FX).

The government’s exchange rate management policies, it noted, “continue to discourage investment and fuel inflation. Exchange rate stability is a key CBN policy objective, and to preserve its external reserves the CBN continues to manage FX demand and limit the supply of FX to the market.”

The report further noted that “while the CBN has raised the nominal official exchange rate three times since the start of the pandemic (by 15% in March 2020, 5 percent in August 2020, and 7% in May 2021), FX management remains too rigid to respond to external shocks. Meanwhile, exchange-rate management has emerged as one of the key drivers of inflation”.

Imports are typically the first trigger of SMEs’ FX exposures. SMEs says the CBN, are entitled to a maximum of $20,000 per quarter to import physical goods to the country at the official exchange rate. The facility is strictly for SME sized businesses with employees ranging from11 to 199 and asset base between 5million to 500million. To access FX at the official exchange rate, SMEs are required to fill Form Q, a form introduced by CBN specifically for processing forex for SME, write an application letter to the bank, indicate the offshore beneficiary details, submit a proforma invoice, and must have a banking relationship with the bank for, at least, six months.

Yet, bureaucratic bottlenecks, documentation processes and timing to get forex from the banks crowd out small business owners.

The segmented exchange rate policy says Professor Narula is unsustainable. “It wasn’t sustainable some forty years ago when Buhari was in power; it is not sustainable now. Dual exchange rates are not viable at all. It is just throwing money into a hole. As a matter of fact, it creates an incentive not to produce locally and to focus on importation. This will not grow the economy” he said.