Opinion: Catalyzing MSMEs amid rising poverty?

By Indika Hettiarachchi

As Sri Lankan economy is recovering from the economic crisis, there are lot of discussions on catalyzing the ailing micro, small and medium enterprises (“MSME”). MSMEs are believed to be accounting for around 90% of all businesses in Sri Lanka. Surveys indicate that over 20% of MSMEs were closed down during 2018 – 2022 period, and 89% of surviving MSMEs are severely impacted by the economic crisis resulting in over 20% cut in MSME jobs.   

Sri Lanka’s economic crisis has also increased poverty. Recent estimates suggest that Sri Lanka’s poverty has risen to a level between quarter and a third of the population (2022/23) - a significant increase from 11% of the population reported in 2019 (prior to the economic crisis). Economic forecasts suggest that poverty levels are expected to remain above 20% during next few years. Rise in poverty has also shrunk Sri Lanka’s middle class to less than 50% compared to around 75% before the crisis. 

Rising poverty to weaken domestic market

Despite large number of programs to catalyze MSMEs, prevalence of high level of poverty is likely to be an obstacle to revive the sector. This is because MSME sector’s reliance on the local market which is expected to remain sluggish during next few years. MSMEs serving the local market are also going to see increased competition from imports - as import restrictions imposed during the height of the economic crisis are being removed. Also emerging markets export push by world’s major export countries are likely to create a challenging environment for local MSMEs.    

Low level of MSME exports

Despite MSME sector contributing to a comparatively healthy share of over 50% of Sri Lanka’s GDP, it is primarily catering to the domestic market! MSMEs are estimated to be contributing to only 5% of Sri Lanka’s exports (2016). This is a sharp deviation from other countries in the region. Indian MSMEs contribute to around 45% of country’s exports, and Bangladeshi MSMEs account for around 75% of exports. Even Pakistan MSMEs contribute to 25% of country’s exports. This is also reflected in a recent survey done by ILO which indicates that only 4% of surviving MSMEs in Sri Lanka are engaged in export related businesses. 

Majority of programs to catalyze MSMEs sector in Sri Lanka do not focus adequately on transforming the MSME sector to be export oriented. These programs mostly focus on improving supply side issues such as improving access to finance, increased female participation, etc. All these initiatives are futile if target MSMEs do not have markets to sell their products and services! For examples providing capital to a business to improve production capacity is only going to weaken the sustainability of such business, unless there is a good market and a good plan to sell their products! 

Catalyzing MSMEs through exports and direct-to-customer sales 

If Sri Lanka to catalyze MSMEs, it is crucial to do so by transforming entire MSME sector to be export oriented. Interestingly, Sri Lanka Exporter Barometer Surveys show that since 2021 (inception of the periodic survey) that SME exporters are finding higher number of new export opportunities/leads compared to large firms. Perhaps this trend is a reflection of a global phenomenon where smaller suppliers are preferred over large businesses. 

Many emerging countries have also renewed efforts to boost MSME exports since Covid pandemic. For example, India is expected to create a dedicated state body to promote MSME exports focusing on industries such as handloom textiles and ayurveda/ herbal products. 

D2C trade expansion. 

Another common problem many MSMEs face is the need to depend on “middle man” to sell their products. This is very challenging in small and shrinking markets like Sri Lanka where MSMEs have to compete with large businesses, MNCs and (cheap) imports. However it is possible to overcome this issue to a certain   extent by embracing D2C (“Direct to Customer”) model where manufacturers sell direct to customers. 

In India, D2C businesses have been a great success, and large number of Indian MSMEs have gone global using D2C model. D2C model has done well small markets like Hong Kong as well, and in Vietnam, D2C (e-commerce) exports have reached USD 3.5 billion (2022) to account for 1% of country exports. 

There is no reason why D2C model could fail for Sri Lankan MSMEs. Surveys show that consumer loyalty to established brands are declining in Sri Lanka, in favor of cheaper and newer brands/products. Besides there are some successful Sri Lankan businesses who have gone international using D2C model to overcome local market limitation. 

(Indika Hettiarachchi is an independent private market investment advisory professional and an entrepreneur. He can be reached at – indika.h@jupitercapitalpartners.com)

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