In the Spotlight: Financing Micro, Small and Medium Enterprises for Growth and Job Creation

Micro and Small and Medium Enterprises (MSMEs) play a key role in economic development of a country and  have proven capability in job creation and promoting stability. According to the Harvard Institute of International Development, MSMEs have enabled the industrialization of most of the world in the last century and contributed to increasing wealth of nations. MSMEs are important to Armenia for the same reasons, and even more, since over 40% of Armenian GDP is generated by MSME sector.

Prior to the recent financial and economic crisis Armenia enjoyed continuous high growth rates which were mainly fueled by external savings. Nevertheless, the global crisis affected Armenia significantly as the economy declined by 14% in 2009. Still, during 2010-2014, the average GDP growth rate equaled 4.2% and as a result the GDP reached its pre-crisis level, yet it is still below 2008 levels in dollar terms. In the aftermath of the global financial crises and amidst ongoing geopolitical turmoil, Armenia is faced with some economic challenges and a large informal economy. Due to developments during the last 5 years, the structure of the economy has changed significantly. Currently, the largest sector of the economy is agriculture with about 20%, followed by trade (13%), construction (12%) and manufacturing (10%). And considering that most of MSMEs, especially those in regions of Armenia, are involved in agriculture, MSMEs can be an important vehicle to address these issues.

Yet despite their extolled virtues and potential, most MSMEs in Armenia still have trouble getting finance to invest, which limits their ability to grow. According to FED’s survey, more than 56% of MSMEs in regions said that they will become more efficient and profitable if there is additional financing. A recent study by FED, entitled “Financing the Growth of MSMEs in Rural and Under-served Markets,” emphasizes this fact and reveals  that the reasons for these challenges are not just on the side of the lenders, but also stem from lack of demand from businesses and lack of awareness of how to use finance to do better. There is also a chronic situation that affects willingness to lend and contributes to high costs, and that is the challenges faced by lenders in getting paid back if a loan goes sour. In this regard, there is room to improve the speed and fairness of debt collection.

The Government, together with the Central Bank, can create an environment which allows for innovation and competition amongst financial institutions and leads to more interest in MSMEs lending. There is work to do, but progress is being made. The new law  on Registration of Secured Rights on Movable Property will make lending easier to MSMEs, particularly those in rural areas, that do not have traditional collateral, like real-estate. FED studies show that over 68% of loans in regions of Armenia are collateralized by real-estate and approximately 15% of loans are provided without collateral (mainly by guarantees). Loans with equipment or fixed assets, cattle stock and precious items collateral are rare and one of main reasons for that is absence of the relevant regulatory framework. Immediate implementation of that law will help set the stage for new types of credit. The same way as ACRA, the credit reporting agency, which has just past its 10-year anniversary, has grown to become one of the most successful reporting agencies in the region, helping to improve access to credit by offering information on hundreds of thousands of borrowers, the new register of movable collateral is expected to increase financing opportunities for MSMEs and reduce associated costs for financial institutions.

The private sector also has a role to play in improving conditions, as  the Government or Central Bank cannot do it alone. MSMEs have to become more active in communicating their challenges and providing accurate information about their business. Financial institutions need to work with MSMEs to resolve market constraints, not just avoid them.

Despite having fairly sophisticated, diversified and stable financial system, Armenian banks have had varied experiences with the MSME sector. FED studies showed that level of MSMEs distrust towards financial system is quite high and is especially prominent when there are savings or free resources. About 39% of MSMEs and 53% of agricultural farms that have free resources or savings do not trust banks and do not deposit with banks.  Distrust is expressed also in borrowing from banks and financial institutions, as 25% of MSMEs and 46% of agricultural farms are not willing to borrow on market terms since they do not trust and believe that banks and financial institutions are risky (and not their businesses).

On the one hand this is not surprising given the economic challenges, but on the other hand it is surprising given the untapped lending opportunities and the innovations that are being applied around the world to expand market reach. Technology is being used to deliver credit, manage risk, and reduce costs. IT platforms and supporting regulations for digitization of credit can develop quickly in Armenia with active public-private cooperation. Universal credit organizations have filled the void of missing credit using group and social-lending models. They still remain small, but have a higher market share than banks in the majority of regions. According to FED’s survey. If they accessed cheaper, dram-based funding and co-developed products with banks, they could play an even larger role in improving financial inclusion where everyone wins.

Considering the experience of other countries, the answer to better financing conditions is a comprehensive solution – reliable credit contract enforcement, an infrastructure that supports different types of collateral, continual innovation, tools for managing risk, alternative channels of financing, etc.

In this way an ecosystem for finance can develop that is composed of many different types of institutions with finance providers, like UCOs, lending at the bottom of the pyramid, helping small enterprises grow into larger borrowers to be served by banks and maybe someday the capital markets.

Given the right environment to thrive, MSMEs could help transform the economy and keep Armenians working in Armenia. Among the businesses consulted for USAID’s study, more than half indicated that that they would increase investment if they could secure better financing. Improving access to finance would enable healthy MSMEs to become reliable suppliers to larger businesses, support rural development, and increase exports.  

The impact on the economy – and for that matter many communities – can be substantial if we can replicate the experience of the EU and other countries around the world, where MSMEs contribute to well over 50 percent of GDP. Armenians around the world have done very well running businesses where access to finance is good. Imagine what can be achieved in Armenia if our MSMEs get the credit they need.

USAID Finance For Economic Development (FED) Program

DISCLAIMER: The views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government.