INFLUENCE OF INFLATION ON THE PERFORMANCE OF SMALL &

MEDIUM SIZE ENTERPRISES:

A CASE STUDY OF OWINO MARKET, KAMPALA

BY

.....................................
REG NO: ……………

A DISSERTATION SUBMITTED IN PARTIAL FULFILLMENT OF THE

REQUIREMENT FOR THE AWARD OF A DEGREE IN BACHELOR
OF BUSINESSS ADMINISTRATION OF CAVENDISH
UNIVERSITY UGANDA

AUGUST, 2019

i
 DECLARATION
I declare that this report is a result of my own independent investigation. It has not been
Submitted to any other institution for any award of degree or any other qualification in any
university.
Signed: ……………………………

Date: ……………………………..

.....................................

ii
 APPROVAL

This dissertation has been submitted to the University Board of examiners with my approval as
University Supervisor.

Sign: ------------------------------- Date: --------------------------

DR. ……………………………

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 DEDICATION
I dedicate this work to my parents and friends for having support, and encouragement
throughout my studies to attain this level of education.

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 ACKNOWLEDGEMENT

My appreciation goes to Lecturers of Department of Business Administration Cavendish

University, Uncles, Parents and entire friends.
Also my lecturers who have enabled me acquire knowledge. Special thank goes to my great
supervisor, who has worked tirelessly and sacrificed his time from commencement to
denouncement of my research to ensure that I do not only complete this research but also be well
equipped for any other research that might come my way.

I owe huge thanks to all my class discussion group members right from first year to the final
semester. You stand to be heartedly treated and thanked because without you getting through
would have been a myth.

Special thank goes to all my friends as well as all the respondents who took their precious time to
answer my questionnaires and gave me the relevant data which has really given shape to this
book. Sincerely you contributed positively to my life and may the almighty God reward you
amazingly.

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 TABLE OF CONTENTS
DECLARATION ii

APPROVAL iii

DEDICATION iv

ACKNOWLEDGEMENT v

TABLE OF CONTENTS vi

LIST OF TABLES ix

LIST OF ACRONYMS x

ABSTRACT xi

CHAPTER ONE 1

1 .0 Introduction 1

1.1 Background of the Study 1

1.2 Statement of the Problem 3

1.4. Objectives of the study 4

1.4.1 General objective 4

1.4.2 Specific objectives 4

1.5. Research questions 4

1.6. Scope of the Study 4

1.6.1. Geographical Scope 4

1.6.2. Subject Scope 4

1.6.3 Time Scope 4

1.4 Significance of the study5

1.8 Conceptual framework...............................................................................................................5

CHAPTER TWO 6

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LITERATURE REVIEW 6

2.1 Introduction 6

2.2 Theories on inflation. 7

2.3 Causes of high inflation 8

2.4 Small and Medium Enterprises 10

2.4.1 Performance of Small and Medium Enterprises 11

2.5 Factors that commercial banks consider when Giving Credit to Small and Medium
Enterprises 15

2.6 Conclusion 16

CHAPTER THREE 17

METHODOLOGY 17

3.1 Introduction 17

3.2 Research Design 17

3.3 Survey Population 17

3.4 Data sources 17

3.5 Sampling techniques 18

3.6 Data Collection 18

3.7 Measurement of variables 18

3.8 Validity and Reliability 19

3.8.1 Validity 19

3.82 Reliability 19

3.9 Data Analysis 19

CHAPTER FOUR 20

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PRESENTATION AND ANALYSIS OF FINDINGS 20

4.0 Introduction 20

4.1 Findings on the demographic characteristics of the respondents and SBEs 20

4.1.1 Gender and age of respondents 20

4.1.2 Respondents’ level of education attained 21

4.2.1 Problems encountered in financing the business through borrowing 23

4.2.2 Period of repayment of loans 24

4.2.3 Inflation perception on borrowings 25

CHAPTER FIVE 27

DISCUSSION AND INTERPRETATION OF THE FINDINGS 27

5.0 Introduction 27

5.1 Discussion of findings 27

5.1.1 Summary of findings on the impact of high inflation on the growth of SBEs 28

5.2 Suggestions on how SBEs should deal with high inflation 28

CHAPTER SIX 30

CONCLUSION AND RECOMMENDATION 30

6.0 Introduction 30

6.1 Conclusion 30

6.2 Recommendations 31

REFERENCES 33

Appendix I 36

QUESTIONNAIRE 36

viii
 LIST OF TABLES

Table 4. 1: Showing gender and age of the respondents...............................................................18

Table 4. 2: Showing education level of respondents.....................................................................19

Table 4. 3: Showing Sources of finance and their proportionate financing...................................20

Table 4. 4: Showing repayment period of loans............................................................................22

Table 4. 5: Showing perception inflation in Uganda.....................................................................23

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 LIST OF ACRONYMS

BOSS Bank of Uganda

CBs Commercial Banks

FIs Financial institutions

MFIs Micro Finance Institutions

NGO Non-Governmental Organization

SBEs Small and Medium Enterprises

TBs Treasury Bills

SNBS Uganda National Bureau of Standards

SACCOS Savings and Credit Cooperative Society

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 ABSTRACT
The study set out to examine the influence of inflation on performance of Small business
Enterprises at Owino Market in Kampala Uganda. The study was basing on the objectives that
high inflation has greatly affected the financial performance as well as investment levels in SBEs
forcing investors and potential investors to depend on own savings and funds from friends and
relatives.

The study used a cross sectional, descriptive and analytical design. This design was adopted so as
to exhaustively study the variables; data was collected based on the objectives and questionnaire
was distributed to 50 respondents which was rated 99.5% .

Findings showed that 16% of study sample got their finances from Micro-finance institutions
because; the inflation were lower compared to commercial banks, most businesses met
requirements to borrow from MFIs and most MFIs offered financial management guidance.12%
borrowed from CBs because; funds were readily available from the bank, the interest charged
was not fluctuating and availability of information concerning commercial banks. 8% of the
respondents got funds from other sources for instance, sale of property because they were at
reach. Own savings and family sources form the most important sources of initial capital forming
36% and 28% respectively. Also according to further research they form important sources of
additional capital. This is because their conditions are lenient as compared to the others. Though
other sources of financing are also lenient from the research we found out that some people do
not have those extra sources of funds like a property to sell and if it is available they are not
willing to make it the opportunity cost of investing hence the low percentage.

The researcher recommendated expanding their activities in order to reach out and assist more
SBEs to foster growth in this young and important industry and restructure their loan programs
from group-based loan schemes to individual based loans schemes, which are easier to access.
This is because with the current economic hardships, it is difficult to get groups to guarantee
loans for individuals. In conclusion, the research has established that the inflation charged on
borrowing play a vital role in obtaining the finances of SBEs thus determine the growth,
financial performance and investments in the SBEs.

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 CHAPTER ONE

1 .0 Introduction
This chapter presents issues on background to the study, statement of the problem, objectives of
the study, research questions, scope of the study, significance of the study.

1.1 Background of the Study

Maintaining price stability and growth together in an economy is one of the central
macroeconomic policy objectives of most developing countries in the world today. In order to
promote economic growth and strengthen the purchasing power of the domestic currency for the
Ugandan economy, emphasis has been laid by the Central Bank of Uganda on maintaining
stability in prices through the use of expansionary or contractionary monetary policy, (Umaru A.
& Zubairu A. A., 2012). One of the financial problems experienced by Argentina, Brazil, Bolivia,
Africa and Latin America amidst others is inflation Deo Gregorio (1992). In general, inflation
can be defined as the rise in the level of prices maintained over a given period in an economy. In
other words, it refers to the general rise in the price of various goods or services thus leading to a
fall in the purchasing power of a countries currency, (Lipsey R.G. & Chrystal K.A., 1995).

Inflation is an economic situation and it occurs where an increase in the supply of money is
greater than the amount of goods and services produced in a country, (Piana V, 2002). Inflation is
categorized into various degrees and they are as follows: hyperinflation (3 digits % points),
extremely high inflation (50 % to 100%), chronic inflation (15% to 30%), high inflation (30% to
50%), moderate inflation (5% to 25%-30%) and low inflation (1%-2% to 5%), (Umaru A. &
Zubairu A. A., 2012). An economy where the purchasing power of money is expected to retain
acceptable value, low level of Inflation is beneficial for consumers and businesses to make long
term plans. A low inflation rate leads to lower nominal and real interest rate that in turn reduces
the cost of borrowing. An economy where inflation is low, “households” will be encouraged to
purchase more goods that are durable and increase the rate at which they invest. This will lead to
an increase in productivity and mass production of goods and services thus boosting economic

1
growth. Inflation at a low level is necessary for economic growth, (Hossain E, Ghosh B.C, &
K.Islam, 2012)

A situation whereby inflation is on a high level is harmful to the economy because a high
inflation rate has negative effects on the economic performance of general activities. High rate of
inflation makes firms and households channel their resources from activities that are productive
to other nonproductive activities to enable them reduce the burden of bearing inflation tax.
Because of this, there is a high risk of losing money due to variability of relative prices leading
also to a high chance of windfall gains. (Leijonhufvud A, 1977) is of the opinion that high
inflation makes financial authorities use different instruments such as the fiscal and monetary
policies to protect their financial assets from inflationary erosion. High inflation leads to a
decline for labour available, thus leading to a decrease in production and in turn low growth.
Zero inflation is not also encouraged in an economy because it is equally unsafe and harmful, it
makes an economy stagnant (That is a period where economic growth increases at a very slow
rate and is usually characterized by unemployment) in the economy.

The Small business Enterprises present the most dynamic economic foundation for growth,
income and employment creation. The Government has continued to support the Small business
Enterprises through economic, financial and regulatory policies that provide an enabling
environment and sustainable growth and development. More private sector involvement has been
encouraged through a wide range of measures and incentive policies to improve the micro-
enterprises operations such as access to credit is being emphasized. Small business Enterprises
are being encouraged to start the production of some intermediate industrial inputs particularly
on a sub-contracting basis between the large and small firms, MAF, (2010).

Small business Enterprises are presumed to be behind most of the socio-economic transformation
in Urban and Rural towns, and play a significant role in Uganda's development process. This is
because during the early stages of economic development these enterprises embodied unique
evidenced by the rapid rate of investment and enterprise growth. The development of the sector
is therefore critical in reducing poverty in Uganda. SBEs are generally under-capitalized,

2
suggesting major operational difficulties in accessing credit and pursuing corporate goals,
National Bureau of Statistics (2018).

Enterprises that successfully sought out credit receive very modest amounts; probably reflecting
the level of the activities in which enterprises are involved. The implication is that since the
micro-enterprises sector does not have adequate access to credit, its potential role in reducing
poverty and in Uganda's socio-economic transformation is unlikely to be realized.

Since 2011, the Uganda government has implemented a number of policy measures under the
Economic Recovery Programme to create an enabling environment, where the private sector is
encouraged to participate in economic growth. The annual inflation rate has been brought down
to the current single digit levels and economic activities have been deregulated to pave a way for
the private sector to become the engine of growth, Cooperative Bank of Uganda, (2012).

Korengold, (2011) noted similar findings in Latin America in his research regarding small
business loans. This revealed the benefits of small loans to “tiny” businesses, as they were
alternatives to the bank loans which attracted high inflation. Designing these appropriately so
that they catered for the particular needs of the SBEs borrowers (in terms of the rates and pay-
back periods, etc) and also assist in creating jobs, Korengold, (2011).

In the last few years, it has become evident that there are high inflation prevailing in Uganda on
borrowing from financial institutions and banks. This has had a direct impact on the Small
business enterprises because the contraction of credit availability and loss of borrowing
opportunities perpetuates negative effect, World Bank 2010. This has led to low profitability and
decrease in internally generated finances for reinvestment. Commercial banks lending rates are
still much higher than the deposit rate, though the interest rate spread narrowed down to 4.83 per
cent points at the end of march 2009 from 5.00 per cent points in December 2018,Chamber of
Commerce and SSNBS (2018).

Currently, the banks provide loans to large and medium scale industries at interest rate ranging
between 11 per cent and 13.25 per cent and small industries between 10 per cent and 16.50 per

3
cent. The bank lending rates on working capital to small businesses range between 10.5 per cent
and 18 per cent. These commercial banks now offer inflation ranging from 5.25 to 12.7 per cent
on fixed deposit schemes, while the rates for savings accounts varies between 10 per cent and
16.50 per cent, KCB Bank (2009).

In Uganda, the number of SBEs is increasing as more and more people are becoming jobless
through layoffs and retrenchment from both public and private sectors and others failing to get
jobs. With SBEs contributing to 70 per cent of the country’s total GPD and employing more than
2.5 million people, SSNBS (2010). There is great need to support these SBEs to ensure the
survival of this sector which up to 90 per cent is private for the country to achieve sustainable
economic growth since these enterprises support a large number of the population as there are
estimated to be over 8,000 enterprises in the country, SSNBS (2010).

Today Owino market, Kampala has attracted a big number of SBEs for instance supermarkets,
retail shops, hardwares and many more. It is one of the major trading centers in Owino market of
which in this year it is estimated to be having a population of 376,300 people. (SNBS, 2011).

1.2 Statement of the Problem

Small Business Enterprises attracts 90 per cent of the Uganda population, especially in this era of
retrenchments where there are few white and blue collar jobs, Uganda Investment Authority,
(2018). Thus many Ugandans, old and young educated and uneducated, engage in small
businesses as a means of livelihood and hence they provide sustainable for many citizens and
contribute substantially to the economy. It provides employment to over 2.5 million of
Ugandans. However, they are faced with many challenges that include lack of adequate capital to
either start or expand the already started business. This is because Uganda is said to have the
highest inflation in the region that range from 15 per cent to 25 per cent, The Citizen, (2014).
Most of their financing therefore comes from own savings, friends and relatives and community
welfare groups.

Despite the effort of the Bank Of Uganda to cut down its bank rate by 2.96 per cent points in
2015 the inflation that financial institution are charging is still very high that this, ranging from

4
15 per cent to 25 per cent hence hindering business enterprises from getting access to credit for
their genesis or expansion. This issue of inflation in Uganda continues to occupy policy makers
in government and Bank of Uganda as well as bankers, borrowers and just about anyone who has
interest in the economic structure of the country. The concern is that inflation are too high given
the inflation rate in the country on one hand and low inflation on deposit on the other hand.

1.4. Objectives of the study

1.4.1 General objective
To assess the influence of inflation on the performance of Small business Enterprises in Owino
market, Kampala City Uganda

1.4.2 Specific objectives

1. To assess the impact of high inflation on the growth of SBES at Owino market, Kampala
2. To assess how high inflation have affected the financial performance of SBEs at Owino
market, Kampala
3. To highlight the suggested ways through which SBEs can deal with the high inflation in
Uganda at Owino market, Kampala

1.5. Research questions

1. What is the impact of high inflation on the growth of SBES at Owino market, Kampala?
2. What is the impact high inflation have affected the financial performance of SBEs at Owino
market, Kampala?
3. What are the ways through which SBEs can deal with the high inflation in Uganda at Owino
market, Kampala?
1.6. Scope of the Study
1.6.1. Geographical Scope
This study was limited to Owino market, Kampala, Uganda. The researcher chose this case study
because of its proximity and access to information
1.6.2. Subject Scope
The study was concerned with the influence of inflation on the performance of Small business
Enterprises in Owino market, Kampala City Uganda.

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1.6.3 Time Scope
The study was linked to literature from 2011-2014 because within this period there was a
significant increase in inflation.

1.4 Significance of the study

The study shall help the policy makers to recognize the importance of Small Scale Businesses
and industries in the provision of employment to the labor force for economic development. This
shall further guide them to make trade policies to enhance the performance of S&MSEs as
regards to their activities to accommodate the mushrooming population that is attributed to high
birth and fertility rates as well as rural urban migration within the country.
To students and other scholars who intend to widen their knowledge in the study of the role of
Small Scale Businesses, this study shall be a basis of reference since it focuses on the causes of
the establishments, how the unique characteristics of the Businesses have facilitated their role in
the provision of employment, challenges they face and the solutions that are being undertaken to
harness their activities.
To the researcher, it will act as a par fulfillment for the award of a bachelor degree in Business
Administration (GENERICs) from Cavendish University.

6
1.8 Conceptual framework

Influence of inflation

 Increased price of Performance of SMEs

goods
 High interest rates on
credit
 High credit risk
 Low parching power
Intervening factors  Startup Capital
Financial discipline  Population growth
 Financial auditing
 Trade liberalization
 Book keeping
 Financial statement policy
analysis

CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction
In Uganda, as in many parts of Africa, a burgeoning informal sector has been the response of a
stagnating employment growth in the formal economy and the downsizing of Parastatals and of
private companies as they reduce their costs in a liberalizing environment, Kampala, (2018).

7
Despite its perceived importance in generating employment and production, the SBEs in Uganda
have very inadequate access to credit. This is because of the high inflation charged on amounts
borrowed from banks and Financial Institutions. Most of their financing therefore comes from
own savings and informal credit markets controlled by NGOs and community welfare groups. A
few SBEs have also been able to obtain credit from some micro financing institutions and
government initiated projects for poverty eradication, Cooperative Societies
( 2009)

Pandey defines inflation as “a price for a loan capital’’ it is the price that a borrower pays in order
to be able to consume resources now at a point in time future. On the other hand inflation are a
price that lenders receive for foregoing current consumption in order to take advantage of
resources at some point in future Apps (2011).
According to Julian (2015) inflation are ‘a price lenders expect to receive for exchanging current
claims for greater future claims. It is also a price that borrowers pay for the goods and services
extended to them by the lenders’
Babihuga (2013) defines inflation as a price charged to a borrower for the loan (of money).She
goes on to distinguish interest rate from an ordinary price. She writes that “this price is unique
because it is really a ratio of two quantities; the total required fee a borrower must pay to a lender
to obtain the use of credit for a stipulated period and the amount of credit actually made available
to the borrower.

2.2 Theories on inflation.

Thirwal (2014) defines inflation as a rise in the general price level due to increased demand or
due to increased import prices or cost push. He adds that there are various mixed causations that
may bring about inflation. Thirwal (2014) identifies five major categories as models of inflation
and these include monetarists, pure cost models, hybrid models which contain demand and cost
elements, structural models and expectation models. He asserts that it is very difficult to
discriminate between these models in analysing a particular inflation experience as it becomes as
a result of several forces interacting with one another. It is indeed difficult to isolate one
phenomenon and conclude it is the one causing inflation.

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2.2.1 Monetarism
This theory was put forward by Cagan (2016) who viewed inflation as being caused by monetary
growth and focussed on the demand for money during hyperinflation and asserted that
expectations of future inflation rates depended on past inflation rates.

The theory on monetarism was brought forward by Friedman (1982) and in his theory he looks at
the quantity theory of money and linked spending to the total amount of money in the economy.
His theory asserts that inflation was as a result of an increase in the supply of money in the
economy. He concludes that inflation occurs if the growth of money supply in the economy
supersedes the economic growth.

The monetarist theory explains demand pull inflation as being caused by excess demand for
goods and services which causes a positive output gap, whereby businesses respond by raising
prices to increase their profit margin. This is attributed to increases in the money supply in the
economy, depreciation of the exchange rate and reduction in the tax rates in an economy.

Monetarism maintains the view that inflation is as a result of higher rate of growth of money
supply from the rate of growth in the economy, aimed at regulating the quantity, cost and
allocation of money and credit in the whole economy. Moreover it aims at achieving a set of
objectives to maintain growth and stability in the economy. Therefore any monetary policy seeks
to stabilize both the exchange rates and prices, raise the level of employment, stable economic
growth and interest rate smoothing.

2.2.2 Structural Perception of Inflation

This holds the view that inflation is brought about by structural rigidities in the economy as a
natural consequence. According to Ndebbio (2013) these rigidities results mainly from
imbalances in public finance where the government is unable to raise enough revenue to match
with the expenditures increasing.An increase in food demand with a low growth of agricultural
production and rigidity in foreign trade where exports do not raise revenues to match the
increasing import demand also contributes to these rigidities.They insist that as long as these
rigidities remain in place, inflation will be hard to reduce as these rigidities affect the relative
price structure and hence the absolute or general price level.

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2.2.3 Cost Push View
This came into being mainly in the 1950‟s and 1960‟s and asserts that pressure in wages and
monopoly pricing policies cause inflation. They argue that with strong trade unions nominal
wages keep going up once the price level goes up. The adjustment in wages should match up the
price index so as to check inflation levels; however the commodity shortages and crop failures
coupled with high oil prices also cause inflation.

Cost push inflation is brought about by factors that make costs to go up, which include wages,
exchange rates and costs of inputs that activate inflation through the supply side by causing costs
of production and hence lower output. These costs are hence passed on to the consumers through
higher prices. This is also referred to as wage push inflation since wages take the largest part of
the total production cost (Zahoo & Shama, 2010) Supply shocks lead to a sudden change in the
price of a commodity and this may be due to the shortage of a particular good. A good example
of this would be oil prices and when used as an input the price further goes up due to the high
exchange rate in the international market.

2.2.4 Phillips Curve Model

It shows the short-run relationship between inflation and unemployment. Phillips showed that the
nominal wage growth was negatively correlated with unemployment and later in 1960
Samuelson and Solow found a negative correlation between inflation and unemployment and
further referred it to the Phillips Curve. (Romer and Chow, 2016)

The model asserts that the rate of money wages has an inverse relationship with the rate of
unemployment. This means that as wages go up the rate of unemployment goes down, the model
suggests that the policy makers could choose between different unemployment and inflation
rates. (Friedman, 2018)

Phillips observed that in the short run there was no trade-off between inflation and
unemployment but in the long run inflationary policies would not increase or decrease
unemployment. In the long run the Phillips curve is vertical at the natural rate of unemployment
where the rate of inflation has no effect on unemployment. A similar pattern were found in other
countries and therefore this means that fiscal and monetary policies could be used to stimulate
the economy, raise the gap and lower unemployment. However this view was disputed since in

10
the 2010‟s countries experienced both high inflation and unemployment (stagflation) and
Friedman was of the view that it was a short run phenomenon.

There is usually a trade-off between unemployment and inflation and monetary policy together
with fiscal policy could be used as a variable to bring down the unemployment at certain
inflation levels. The relationship was found to be unstable, however as people would anticipate
inflation then policies were not able to lower unemployment and therefore leading to an outward
shift on the Phillips curve due to high levels of unemployment and high inflation(Friedman,
2016).

Friedman together with Phelps argued that the Phillips curve would shift up when inflationary
expectations rise and came up with the expectations augmented Phillips curve. However in the
long run, monetary policy cannot affect unemployment and therefore adjusts back to its natural
rate called the non-accelerating inflation rate of unemployment also known as the long run
Philips curve.

Friedman therefore provided an explanation for the shift and concluded that in the long run
unemployment rate could not be affected by monetary policy because there was no trade-off
between the wage rate and unemployment. This gave rise to the natural rate of unemployment
and concluded that inflation had no impact on unemployment rate once individuals had
expectations on the level of inflation. The authorities can influence unemployment through the
supply side by providing information to the labour market. (Friedman, 2018)

With expectations the faster the prices are expected to rise, the faster money wages demand will
rise for a given level of unemployment. It asserts that in the long run the wage earners will
anticipate inflation and this leads to the Phillips curve being a straight line this gave rise to the
augmented Phillips curve (Friedman, 2016)

The rational expectations on the other hand, imply that the short run Phillips curve is vertical and
that systematic, fiscal and monetary policies have no impact on unemployment. Only
unanticipated policies affect the real side of the economy and agent can forecast then there is no
impact. It assumes that people make expectations on inflation depending on all information
economically available about the given variable. This led to the long run Phillips curve
collapsing in the short run and in this case any inflation brought about by a government policy

11
are anticipated and therefore influence unemployment when they first appear. Under adaptive
expectations, people form expectations about the future and are adaptive since they look at the
previous behaviour of inflation and the expected inflation is a weighted average of current and
past inflation rates. (Friedman, 2016)

2.3 Causes of high inflation

The simplest definition of inflation is that inflation is "too much money chasing too few goods",
a more thorough definition however would be that inflation is “A persistent increase in the level
of consumer prices or a persistent decline in the purchasing power of money, caused by an
increase in available currency and credit beyond the proportion of available goods and services”
(Kohn 2013).

Whatever the definition however the results are the same, inflation means that over time a
consumer or company can purchase less with their money. Over time the cost of a good or
service will raise meaning that the purchase power of the consumer or company will be
decreased. For example if the rate of $ 1.0 is 5.50SSP in the black market rate in Uganda.

The interest rate charges on a loan will depend, to some extent on the risk of default. Borrowers
that look equally risky to the bank suffer rising inflation. This is due to the fact that banks tend to
incorporate the risk factor in the loan portfolio that normally carries a higher interest rate (Kohn
2013). Banks have experienced numerous frustrations in attempting to recover non-performing
loans through the judicial process, this makes the banks incur additional costs in lengthy
litigation processes. These costs are reflected in inflation.

Julian (2015) provides that a large increase in government borrowing to finance current
spending will push up inflation if there is no parallel increase in private sector saving. This will
occur even with stationary inflation rate.

Real inflation in one country will be influenced by external factors such as inflation in other
countries and expectations about exchange rate movements. When inflation in oversees countries
are high, inflation on domestic currency investments may need to be comparably high to avoid

12
capital transfers abroad and a fall in the exchange rate of the domestic currency against other
currencies (Cox 2011).In the Ugandan scenario for instance, Juma Kisaane, the DFCU bank
managing director says, the bank sources funds from other financial institutions abroad which
price their money at the prevailing market rates “Therefore the loans we advance that we
advance cannot be priced below the rate at which we access the funds”.
Weston (2011) attributes changes in the level of inflation to supply and availability of funds to
borrowers. He argues that, within a framework of general and financial patterns, short-term
inflation patterns and forecasts can be analyzed through the use of flow of funds accounts. These
accounts depict the behavior of major kinds of suppliers and demanders of funds. They helped to
determine the direction of pressure on inflation. He added that, a period of high inflation reflects
tight money, which in turn is associated with tight reserve positions at commercial banks. At
such times inflation rise.

Bankers argue that the prevailing macro economic environment influences the cost of funds for
instance, the Annual Headline Inflation rate for the year ending February 2011 rose to 6.0 per
cent from 5.0 per cent recorded for the year ended January 2011. (SNBS, 2011).When there is
inflation for instance, the monetary authorities tend to rise the statutory inflation and reserves as
a way of reducing money supply in the economy. This automatically will force the other
financial institutions to raise their inflation.

The poor repaying culture among some customers increases the lending risks for bank. Risky
customers are charged high inflation while less risky customers can negotiate for good rates on
the loan. Poor lending particularly by government owned banks due to political influence in
approval of non viable loans as well as insider lending and fraudulent activities by directors in
indigenous and Asian owned banks.
Understanding the interaction between growth and inflation is one of the macroeconomic
problems. The problem of whether the inflation has an effect on growth or not have been
discussed frequently in the economic literature. The content of these discussions has changed
with respect to the development stage of the world economy. After the Second World War, in
both developed and developing countries, Keynesian policies were on the agenda, and as a result
of these policies the increase aggregate demand caused both the inflation and production to rise.

13
During this period the inflation was not considered as a problem, besides, the thesis about
inflation s positive effect on growth was on the agenda. During 1970 s while high inflation was
continuing in most countries, the thesis of high inflation with high growth was disputed with the
falling growth rates. In 1980 s hyperinflation problems, especially in Latin American countries
increased the instability in those economies and affected the development of those countries in a
negative way. Those developments strengthen the thesis about the negative effects of inflation on
growth.

The most important approach that claims the existence of a positive relationship between
inflation and the growth is the Phillips Curve approach. This approach assumes that the high
inflation causes low rates of unemployment therefore effects growth positively (Grimes, 1991).
The empirical studies made afterwards showed that the relationship between inflation and the
unemployment rate is valid in the short-term in case of unanticipated inflation. According to
another approach, rising inflation results in contraction of the individuals wealth. In this context,
individuals increase their savings to reach their pre-inflation wealth level and therefore interest
rates fall with rising investments (Mundell 1991). On the other hand, in the countries with
insufficient financial system, the government obtains income through inflation tax with using
central bank s resources. It is argued that, if the government uses these revenues for financing
investment spending; the process of inflation would increase growth. Besides, the slow
adaptation of nominal wages to sudden changes in inflation, time lags in wage bargaining or the
governments willingness to improve the real wages result in the fall of real income of the people
whose propensity to save is low and the rise in the real income of the parties whose propensity to
save is high. It is argued that such a condition would contribute to the growth. In general, views
that claim the existence of positive effects of inflation on growth are based on the assumption
that inflation increases compulsory savings (Bruno and Easterly, 1995). However, this result is
based on empirical analysis using the data for the period in which the growth rates are high and
the inflation rate is relatively low.

There are several empirical studies claiming that inflation affect economic growth negatively.
These studies originated from the analyses that have micro and macroeconomic foundations. One
of the most important elements that makes the market mechanism efficient is that economic

14
agents use informative aspects of market prices to determine their investment and production
decisions. Unhealthy structure of the markets in which the prices are formed and non-market
factors in price formation lead to the distortions in the signals that are extracted from prices by
the economic agents. This situation affects resource allocation negatively and causes changes in
relative prices through preventing the efficient market. Moreover, this decreases the productivity
of the economy. The decisions about future are directly related to price expectations. High and
volatile inflation rates would create uncertainties about the formation of economic agents future
spending and income decisions.

It is certain that in an economy that has high and volatile inflation rates, real return of each
investment whose real return is not fixed would be uncertain. This uncertainty would make it
difficult for individuals and firms to realize long-term contracts and causes the investment
expenditures to decline. In an environment where the investments are financed by debt, the risk
premium revealed from volatility of inflation rates would increase the cost of investment. When
firms that decide to invest by considering Net Present Value encounter interest rate volatility
originating from inflation volatility, they would postpone their investment decisions (Pyndick
and Solimano, 1993).

Another channel, through which the inflation impedes efficient resource allocation and
investments, is the relative price changes. In an economy with the imperfect information and
price rigidities, it is difficult to designate whether the increase in general price level stems from
nominal or real factors (Fischer, 1981). In this situation, the impossibility of the determination of
the source of any price movement and the lack of suitable reaction for it would cause serious
price volatility and distortion of resource allocation in the economy. Besides, according to
Andres and Hernando s (1997), as a result of the high inflation that impede the prices to be
informative, the cost of firms increases due to gathering information to protect themselves from
price volatility. As a result, resource allocation would be affected negatively.

In an environment where the inflation rate is high and volatile, the disappearance of the
information-transmitting feature of relative prices would decrease the economic efficiency and
thus growth rate (Friedman, 1977). In an economy where the general level of prices is stable, any

15
change in price level of group of commodities give important signal about the scarcity of those
goods. However, in the environment of chronic and high inflation, the signals of rising prices of
certain commodities would disappear. In such an environment, an increase in the price of certain
group of commodities would not be perceived as the scarcity of those commodities but an
increase in general price level, and inflationary expectations.

Another fact that indicates the negative effect of inflation on growth comes from the higher
return of financial services relative to other sectors return in an inflationary environment. In an
economy where the return of financial services is higher, it is possible that there can be shifts of
significant amount of resources and labor power from the R&D and the industrial sectors to
financial sector. This situation would limit the long-term growth potential (Frenkel and Mehrez,
1998).

The claim that the high and unstable inflation would affect growth negatively is supported by
empirical studies using both time series and cross-section data (De Gregorio, Fisher, 1993;
Barro, 1995; Barro 1996). Barro (1996) concluded that the unexpected inflation would affect
growth negatively through decreasing the performance of households and firms. This study
follows the exogenous growth approach and empirical tests have been made with sample of 100
countries for 1960-1990 period. In this study besides inflation rate, variables like schooling rate,
life expectancy, legal structure, birth rate, school attendance rates and the ratio of public
spending to national income have been used to explain growth.

Levine and Zervos (1993) concluded that the moderate inflation would not affect the growth
negatively. In this study, it is argued that if the inflation rate is above 80 percent, the growth rate
is affected negatively. On the other hand, Ghosh and Phillips (1998) put forward that even the
moderate rates of inflation would affect growth negatively. Furthermore, for the sample that is
consisted of the OECD countries other than Turkey, similar results have been reached by Andres
and Hernando(1997). In another way, De Grogorio (1992) argued that high inflation has negative
effects on growth through decreasing total factor productivity. In another words, in that study it is
claimed that inflation causes the behavior of rent seeking

16
2.4 Small and Medium Enterprises
SBEs are arbitrary and vary significantly according to different stages of economic development
and economic structures, Castel-Branco, (2013).Some analyses define them in terms of total
revenue, while others use the number of employees as an indicator (world business council for
sustainable development, 2017).Although SBEs definition is individual country specific and is
based on size and level of economic development, there is not yet an agreed definition for SBEs
in Uganda. Attempts have been made to define SBEs in developing countries, for instance Elaina
(as cited by Albaladejo, 2012) defines Small enterprises are firms that employ between 5 and 19
workers while medium enterprises are firms that employ between 20 and 29 workers therefore an
SME is a business with a head count ranging from 5 employees to 99 employees.

According to Kasekende and Opondo, (2013) medium enterprises in Uganda employ 50 to 99

workers while small enterprises have a minimum number of 5 and a maximum of 50 workers
with a value of assets including land, building and an annual income turnover of between Ugx 10
million to Ugx 50 million.

2.4.1 Performance of Small and Medium Enterprises

Firm performance is a multi-dimensional concept; it may be financial or non financial. Firm’s
performance can be measured by sales growth and development of new markets and products,
Tadlianvini etal, (2012).
A sale is the pinnacle activity, involved in selling products or services in return for money or
other compensation. It’s an act of completion of a commercial activity. Sales growth is often
used as a measure of performance. The assumption is often made that if sales increase, profits
will eventually follow, Thomas and Mason, (2017).A key determinant of success in a firm’s
growth is sales provided of course, that the profits and cash flows generated from sales are
adequate to cover the costs incurred in generation of the revenue.

Sales growth can only be achieved by a business enterprise that has adequate capital to carry out
activities like sales promotion. To get this capital firms need sources of funds of which
borrowing is one of the most common sources of fund. When one borrows he or she has to pay

17
back with an interest of which these inflation as per now are high leading to low performance of
SBEs. That is, reduced sales growth (poor performance) due to high inflation.

New markets development do not emerge nor do they appear but they are made by the activities
of the firm, Anderson and Gatignon, (2013).New markets are created when firms correctly sense
a latent need to communicate their solution to that need. AS new market can be created by
carrying out marketing activities like product design, branding, promotion, pricing, sales and
distribution of established products or innovating new products, Pawakapan, (2010)
Innovation increases public welfare and as such new markets are thought to rise because buyers
recognize the will be better off, Anderson and Gatignon, (2013).For most firms, successful new
products are engines of growth, Cohen, Eliashberg and Ho, (2017).New products generate future
profitability and prevent obsolescence of the firm’s product line, Pauwels, Silva-Risso, Srinivasn
and Hanssens, (2014).Indeed aggregate evidence suggests that profitable firms do innovate,
Pauwels etal, (2014).

Development of new markets and products can only be achieved by an SME that has adequate
capital to carry out activities like advertising so as to capture new customers and maintain the
existing ones. To achieve this, firms need funds of which borrowing is one of the most common
sources of fund. When one borrows he or she has to pay back with an interest of which these
inflation as per now are high leading to low performance of SBEs. That is, minimal development
of new markets and products.

Small and medium-sized enterprises and start-ups have almost by definition fewer resources than
larger enterprises, and the types of resources of these two groups of enterprises are different.
SMEs possess such capabilities as niche filling, speed and flexibility that allow them to exploit
certain opportunities faster and more effectively than established firms (Kraus and Kaurane,
2009).

Uganda has an extensive small and medium enterprise sector. There are estimated 1,069,848
SMEs in urban and rural arrears which account for 90% of the private sector. They contribute
75% of Uganda’s Gross Domestic Product (GDP) and employ some 2.5 million people (Hatega,

18
2007). Employment growth has been estimated at around 25% per annum. SMEs are the prime
source of new jobs and play a crucial role in income generation, especially for the poor.

The SME sector in Uganda, like other developing economies, is highly diversified by ownership,
type of enterprise and stage of development. According to the Uganda’s 35 Small Scale
Industries Association, SMEs are spread across all sub-sectors of the economy with the majority
operating in the informal sector (Randall, 2008).

In Uganda’s most SMEs are largely concentrated in urban areas, mainly in Kampala and the
central region. They are predominantly engaged in hospitality and entertainment, education,
wholesale and retail trade, manufacturing, finance and insurance, health, social work, furniture,
agriculture, professional services, and Information and Communication Technology (ICT).
Ownership of the enterprises is almost equally distributed between the male and female genders
at 47.4% and 52.6% respectively, with more females engaged in micro enterprises.

Uganda’s SMEs are predominantly informal and young enterprises, majority of which are aged
between 1 and 5 years, suggesting a high enterprise mortality rate. Generally, less than 10% of
the enterprises have operated for more than 20 years. Even at the top end of the spectrum, only a
handful of indigenous enterprises have been able to survive the demise of their founders
(MFPED, 2011). MFPED, (2011) further asserts that most of the SMEs are sole proprietorships,
which constitute 43% and private limited liability companies that comprise 33%. Others include
partnerships (18%), associations (2%), cooperatives (3%) and NGOs (1%).

Effects of high inflation on SBEs

The issue of high inflation being charged on borrowers of funds has posed a great problem to
owners who can only borrow in small amounts. This has led to either closure or stagnation of
their business and those who have not began the business end up not starting one because of lack
of lack of capital.

SBEs in Uganda have been given low priority. Despite recent attempts to rectify the situation,
our knowledge of SBEs is still rudimentary and incomplete. SBEs suffer from loss of

19
profitability and lack of investments, which promote growth, due to poor credit offered to them
and non access to bank loans. This is due to high costs of borrowing from commercial banks and
other FIs.

Until the 1960's many economists attributed the relatively small size businesses in the less
developed countries to the scarcity of capital and administrative experience. It was often argued
that with economic growth modern forms of large-scale production would in one sector after
another supersede the small-enterprises. In order to ensure orderly transition small-enterprises
were seen to deserve support. Small-enterprises as quasi-sponge for urban employment and
provider of inexpensive consumer goods with little or no import contest serving an important
pressure releasing and welfare-augmenting function, Kilby, (2009).

Small-enterprises also contribute to long-run industrial growth by producing an increasing

number of businesses that prow up and out of the small sector. Thus the emergence of wholly
modern small-enterprises Uganda industries is likely to be a presequite for any enduring
industrialization in that country.

Credit markets are partly shaped by lenders' strategies for screening potential borrowers and for
addressing opportunistic behavior encouraged by the inter-temporal nature of loan contracts.
These problems are acute in the developing countries where information asymmetries are more
pervasive especially among the resource base poor. Financial markets in such countries tend to
be highly dualistic and fragmented with weak linkages between the formal and informal
components. The formal segment of the markets tends to be characterized by the market
imperfections demonstrated by high concentration ratios with only a small number of financial
institutions exerting considerable market power. Attempts to protect depositors against corporate
excesses often lead to share capital requirements that work against the need to encourage
competition. On the demand side, firms choose between external and internal financial sources in
consideration of the need to maximize profits, Dercon and Fafchamps, (2010).

Credit markets are peculiar as their transactions involve heterogeneous goods since the qualities
of credit contracts vary due to differences in the creditworthiness of borrowers. Rather than being

20
contemporaneous, debit transactions are also inter-temporal since credit is exchanged for a
promise to repay later. Lending activities also tend to be transactions intensive and the
information available to contract parties not always symmetric. The parties often posses different
information on risks and profitability of projects. Intermediaries tend to have only subjective
assessments of projects for which funds are sought. High transactions costs come on the way of
attempts by intermediaries to procure adequate information from borrowers. These and other
conditions mean that changes in the price of credit affect the quality of the debt contract and the
intermediary's expected returns, Jennings (2014).

An important consequence of these peculiarities is that the outcomes of credit market

equilibrium often embody some rationing, so that among seemingly homogeneous borrowers,
some receive credit while others do not, even when they are willing to borrow on existing credit
terms. Suppose lenders consider borrowers as homogeneous group even when they are unable to
adequately determine the relative quality and risks of each borrower due to the cost of acquiring
such information. Suppose further that borrowers are deficit spenders who borrow to finance
expenditures in excess of initial resources schedules. Expected returns by intermediaries decline
due to adverse selection and adverse incentive effects of high credit costs. One adverse selection
increases loan portfolio risks. Aware of this, lenders tend to raise the price of credit to a level
where expected returns are maximized. This level often excludes small, risky and costly
borrowers who would have been drawn in had the price of credit been higher. To shield
themselves against these effects, lenders insist on credit prices to maximize expected returns and
then ration available credit accordingly, Maddalla, (2013).

In developing countries, informal credit arrangements enjoy less transaction costs and loan losses
because they are restricted to close networks’ that derive from kinship, neighborhoods,
professions, workplaces, economic activities and other mechanisms that encourage regular
interactions. They therefore offer solutions to the information and enforcement problems that
formal arrangements often face. However, the volume of credit available through these informal
arrangements ends to be highly limited, Mookherjee, (2009).

21
On the other hand, the consumption of credit tends to be inversely related not only to inflation
but also to collateral requirements. Micro businesses tend to have a poor collateral base and
therefore get excluded from the credit market. Even when their asset base is rich, property rights
problems reduce the collateral value of such assets. Where entrepreneurs can successfully seek
out credit from formal sources, they may not bother to borrow because of limited ability to
comprehend debt management and costs of borrowings, fear related to potential hidden costs,
previously disastrous experiences with financial services, presence surrogates such as savings
and credit associations, and cultural norms that discourage borrowing. The mere presence of
financial services even within very close proximity does not therefore guarantee the demand for
and use of credit. The credit seeking decision is a three-stage process, in the sense that
enterprises have first to decide on whether or not they need credit. Once the decision at this level
is in the affirmative an entrepreneur then decides on an appropriate source of approach. A
decision has also to be made about the level of credit to seek out, Kimuyu and Omiti, (2010).

2.5 Factors that commercial banks consider when Giving Credit to Small and Medium
Enterprises
Unlike formal finance, informal lenders often attach more importance to loan screening than to
monitoring the use of credit. Screening practices often include group observation of individual
habits, personal knowledge by individual moneylenders and recommendations by others, and
creditworthiness. In-group lending programmers, members are made jointly liable for the loans
given. The joint liability plus the threat of losing access to future loans motivates members to
perform functions of screening loan applicants, monitoring borrowers and enforcing repayment.
Investigations of the effect of intra-group pooling of risky assets show that groups exploit scope
and scale economies of risk by pooling risks and entering into informal insurance contracts. This
confirms the role of social cohesion in-group repayment, Zeller, (2018)

In-group lending; the financial intermediary reduces the recurrent transaction costs by replacing
multiple small loans to individuals by a large loan to a group. This enables financial
intermediaries to bank with poor loan applicants who would not receive any loans under
individual loan contracts due to excessive unit transaction costs. One of the most important

22
rationales for a group lending is the information and monitoring advantages that member based
financial institutions have compared with individual contracts between bank and borrower. The
main argument in the rationale is that in comparison with distant bank agents, group members
obtain information about the reputation, indebtedness and wealth of the applicant. They are also
able to use social sanctions to compel repayment. However, it has been shown that a number of
factors may undermine repayment performance of group lending under join liability. These
include reduced repayment incentives for individual borrowers where other members default,
and the incentive to borrow for riskier projects under group based contracts.. There are strong
incentives for individuals with similar risk characteristics to form credit groups while other
scholars have indicated that group lending schemes work well with groups that are homogeneous
and jointly liable for defaults, Huppi and Feder, (2010).

A study Obamuyi (2007) examined the exploratory insights into the level of loan delinquency
among the small and medium enterprises (SMEs) in Ondo State of Nigeria, and the lending
practices of the country’s bankers towards the SMEs. The study used a sample of 9 commercial
bank managers and 115 SMEs that have been borrowers and those who had active loans from the
banks. The study findings revealed that several factors were responsible for banks’ altitude of not
expanding loan portfolio, principal of which are poor credit worthiness, lack of collateral
security and the constraint imposed on banks’ capital by regulations. The study also established
that loans delinquency rate was low among SMEs in the Ondo State, which could be attributed to
the fact that soundlending policy demands that for those small and medium enterprises that the
bankers believe they have high probabilities of default, loan applications are not approved.

In addition, Torre, Peria and Schmukler (2008) investigated the factors banks perceive as drivers
and obstacles to finance small and medium enterprises with particular attention to the role of
competition, institutions, and macroeconomic factors. The study used a survey of banks in
Argentina and Chile. The study established that despite differences in the countries’
environments, SMEs are strategic segment for most banks in both countries. Further, the study
found out that given significant competition in the corporate and retail sectors, banks have come
to perceive the SME market as highly profitable, large, and with good prospects. However, the
study revealed that although institutional and macroeconomic factors still matter, banks are

23
developing coping mechanisms to overcome the particular obstacles present in each country and
to compete for SMEs. Banks’ interest in SMEs, which is not based on government programs in
the two countries, was found to be yet policy action that might help to reduce the cost in
providing financing, especially long term lending.

Agyapong, Agyapong and Darfor (2011) investigated the criteria for assessing Small and
Medium Enterprises’ Borrowers in Ghana. The study focused on developing an insight into the
decision making process which lenders employ in granting loans to SME borrowers.
Questionnaires were used to collect data from the selected bank branch managers of
conventional banks, rural banks and savings and loans companies. The study findings indicated
that when loan managers are deciding on whether to accept or reject an SME loan application,
the intended purpose of loan, repayment of previous loan, repayment schedule, type of business
activity, size of loan relative to size of business and availability of collateral, ranked highest on
their criteria list. Conversely, the study established that Curriculum Vitae of clients, government
guarantee of loans, charges on assets and gearing ranked lowest on the criteria list in terms of
importance. The study revealed that lenders took particular interest in risk when dealing with
SMEs.

Hwarire (2012) analyzed loan repayment and credit management of Small, micro and medium
enterprise in a South African financial institution. Factors such as age, bank balance,
relationships (personal, business and new customer), interest rate, loan size, loan term, product
type, gender and race were analyzed to determine their relationship and impact on default. The
dichotomous nature of the dependent variable (default) led the researcher to use the binary Logit
model to assess the relationship and impact of the determinant factors affecting loan repayment.
The study analyzed 169 loans granted to small businesses by a South African commercial bank.
The study findings established that 39 per cent of loan repayments by SMMEs were not made on
time, while 28 per cent actually defaulted. In addition, the study established that race, gender and
negative bank balance were found to be statistically significant in relation to defaults in loan
repayment and credit management.

24
Nguyen (2014) explored the use of soft and hard information for bank lending decisions to small
and medium enterprises (SMEs) in Vietnam. The study aimed at investigating to what extent
different types of information were used for loan approval, whether the two types of information
were used in a complementary manner, and what factors determined the banks’ lending
decisions. Descriptive statistics for was used for overall assessment, principal component
analysis and confirmatory factor analysis to establish and test the scales, and logistic regression
to examine determinants of lending decisions. The study findings indicated that although
collateral based lending was the most widespread method and could substitute for other lending
technologies, usually a combination of lending information types were utilized in the decision
making process. This suggests that both complementarity and substitutability were found in the
use of the various information types by Vietnamese banks for such decision-making.

Abdesamed and Wahab (2014) examined financing of small and medium enterprises. The study
aimed at determining which factors influence SMEs to apply for a bank loan and to develop a
bank loan model based on applicability. The model was developed using quantitative methods
coupled with a hypothetical – deductive testing approach applied on primary data on loan
applications gathered from questionnaires. Logistic regression tests indicated that business
experience of the firm’s owner has no significant relation with the firm’s tendency to apply for a
bank loan. However, the study found that educational background of the owner; firm size;
collaterals and loans with interest were negatively related to its tendency to apply for bank loans.

Gondwe et al (2014) investigates empirically if social capital affects access to formal finance for
small and medium enterprises using the case of Malawi. The study used a sample of 115 micro,
small and medium enterprises in the cities of Blantyre and Lilongwe, an ordered probit model
was used to analyze factors affecting the likelihood of getting credit from a bank when a person
is known personally by the bank personnel. The study findings indicated that both entrepreneurs
and bank officers perceive that when a person is known personally the likelihood of getting a
loan changes positively. In addition, firm characteristics and social capital were found to affect
perceptions of SMEs.

25
2.6 Conclusion
From the above literature, for the success of these SBEs their capital base needs to expand of
which credit from financial institutions is one of the major sources of financing. This source of
financing attracts interest of which the level of interest may encourage or discourage potential
investors from borrowing that is, high inflation reduces the level of borrowing hence lowering
the performance of SBEs and low inflation increase the level of borrowing which in turn
improves the performance of SBEs. This means that the government needs to do more that will
encourage reduction of inflation to enable SBEs access finances easily. With this kind of
government intervention the Uganda economy growth rate will automatically increase as it is
clear that SBEs contribute a lot in the economy especially as the main source of employment.

26
 CHAPTER THREE

METHODOLOGY

3.1 Introduction
In order to obtain the information required to meet the objectives of the study it will be necessary
to obtain data from different sources, including review of previous studies, interviews and
questionnaires. The rest of this section details the approaches to be used to obtain the required
information and how the data will be analyzed.

3.2 Research Design

The Researcher employed cross sectional research design to gather data due to the time limit of
the research. Both descriptive and analytical research designs which involve qualitative and
quantitative approach when collecting data were used so as to describe observations and examine
the findings.

3.3 Survey Population

The population constituted the small and medium business operations such as operations of
metal works, garages, shops, salons, grain millers, secretarial bureaus, hardwares, supermarkets,
bookshops, schools, hotels and restaurants from Owino market, Kampala which made a
population of 75 business operators.

3.4 Data sources

The researcher used both primary and secondary sources of data. Primary data were obtained
from the respondents of Owino market, Kampala by use of self administered questionnaires and
interview and the secondary data.

27
3.5 Sampling techniques
The researcher used a sample size of 50 respondents from Kampala in Owino market, which
included restaurants, salons, supermarkets, schools and Hardwares.

The researcher selected all the respondents from the mentioned enterprises using simple random
to draw representative a sample from each category of business since it gives everyone an equal
chance of participation.

3.6 Data Collection

The research instruments used by the researcher to collect data were research questionnaires and
interviewing.

The researcher selected at random all businesses that were fit in the category of small and
medium business enterprises and gave them questionnaires to fill in. Once the respondent agreed
to assist in the research, the interviewer either;

a) Ask the respondent questions contained in the questionnaire and filled it himself.
b) Gave the respondents the questionnaire to fill out at the moment.
c) Left the questionnaire with the respondent to be collected later;

During interviewing, the researcher asked questions and the respondents gave responses
immediately which were documented and later on analyzed and conclusions made. This method
increased response rate and was less costly in terms of money.

3.7 Measurement of variables

Variables were measured to the hypothesis. The study used both nominal scale which measured
the education level, age and how long the respondents had worked in the ministry and the ordinal
scale that ranked questions by a five likers scale ranging between five to one were 5 strongly
agree,4agree,3not certain,2disagree,and 1strongly disagree.

28
3.8 Validity and Reliability
3.8.1 Validity
Prior to commencement of the data collection exercise, the data collection instruments were
subjected to a pre-test with three members of staff at different levels within the market to check
for validity of the instruments. The purpose of the pre-test was to ensure the final questionnaire
and check list would generate the adequate and relevant information required.

3.82 Reliability
This was done through a test retest method. This ensured that the data collected was accurate and
reliable and free of bias. Internal consistency technique was used, where the researcher
administered a single test to a sample of objects and the score obtained in one item was
correlated with scores obtained from other items in the instrument.

3.9 Data Analysis

All responses from questionnaires were edited for accuracy in data. The data was then manually
coded, organized and analyzed using the frequencies and percentages and there after interpreted
it.

29
 CHAPTER FOUR

PRESENTATION AND ANALYSIS OF FINDINGS

4.0 Introduction
This chapter contains the findings of the study and their analysis, which was carried out as a
view of exploring the effects of high inflation on the performance of small and medium
enterprises. A case study of SBEs in Owino market, Kampala. The total number of people who
responded to the questionnaires / interview was 50 which represented a 100 per cent response of
the sample size.

4.1 Findings on the demographic characteristics of the respondents and SBEs

4.1.1 Gender and age of respondents

In order to avoid biased responses, the researcher obtained a sample size of 50 businessmen and
business women as indicated in the table;

Table 4. 1: Showing gender and age of the respondents

Age Gender Percentage (%)

Male Female Male Female

18-30 6 5 12 10
31-40 13 11 26 22
41 and above 9 6 18 12
Total 28 22 56 44
Source: primary data

Table 4.1 indicates that more male respondents participated in the study than females. This is
shown by the biggest percentage of 56 per cent compared to 44 per cent for females. It therefore
implies that during the research most businesses are operated by males and it is so because in
most cases women are left at home while men are looking for money to sustain their families.

30
Results in table 4.1 reveal that majority of the respondents who participated were in the 31-40
years bracket and above 41 years respectively. This is so because at this age most people need
more to sustain their families for instance if they have children who are studying they tend to be
at high schools, colleges and universities which forces people to work harder. This scenario
forces even those people who are employed to open up businesses so as to have extra sources of
income. Also it is at the category of 41 years and above that you will find those people who have
retired from their jobs and they opt to invest.

4.1.2 Respondents’ level of education attained

The researcher had an interest in the academic qualifications of the respondents as part of their
bio data and the responses were given as shown in the table below;

Table 4. 2: Showing education level of respondents

Level of education Frequency Percentage (%)

Bachelor 12 24
Diploma 17 34
A-level 9 18
O-level 7 14
Others 5 10
Totals 50 100
Source: primary data

The high percentages of Diploma holders and Degree holders as shown in Table 4.3 means that
most investors in Owino market, Kampala are educated which means that even though they
might be employed they are not in a position to earn enough hence they are forced to invest so as
to get an extra income .The category of ‘others’ has the lowest percentage of respondents of 10
per cent. These were respondents considered to be uneducated which makes most of them not to
be in a position to invest in SBEs due to lack of enough capital.
4.2 Sources of finance and their proportionate financing

31
The researcher wanted to analyze the source or mixture of sources that the business people
around Owino market, Kampala get their funding for their businesses from and got the
information shown in the table below

Table 4. 3: Showing Sources of finance and their proportionate financing

Sources of Fund Frequency Percentage (%)

Friends and relatives 14 28
MFIs 8 16
Own savings 18 36
Commercial Banks 6 12
Other sources 4 8
Totals 50 100
Source: primary data

Own saving had the highest percentage of 36 as a source of starting or additional capital.
According to the respondents, they preferred raising funds through this means because it was
cheap and reliable and no repayment was required. 28 per cent of the respondents raised funds
from friends because very low or no interest was charged, the procedures of obtaining the money
were simple and short, no collateral was required, repayment was on condition that the business
made profits and the repayment period was considerable.

Sixteen per cent of study sample got their finances from Micro-finance institutions because; the
inflation were lower compared to commercial banks, most businesses met requirements to
borrow from MFIs and most MFIs offered financial management guidance.12 per cent borrowed
from CBs because; funds were readily available from the bank, the interest charged was not
fluctuating and availability of information concerning commercial banks. 8 per cent of the
respondents got funds from other sources for instance, sale of property because they were at
reach.
Own savings and family sources form the most important sources of initial capital forming 36
per cent and 28 per cent respectively. Also according to further research they form important
sources of additional capital. This is because their conditions are lenient as compared to the
others. Though other sources of financing are also lenient from the research we found out that

32
some people do not have those extra sources of funds like a property to sell and if it is available
they are not willing to make it the opportunity cost of investing hence the low percentage.
Considering the low incomes and savings rate in the country, SBEs fall back on these sources out
of desperation. The small proportion of SBEs that receives some credit receives very modest
amounts reflecting low activity levels.

4.2.1 Problems encountered in financing the business through borrowing

Raising funds through Friends and relatives according to the respondents had some challenges
hence the 28 percentage. The main problems were lack of trust and confidence in relation to
repaying the money, funds from the latter were not sufficient, there was lack of specified
duration for repayment of the funds. It was unsafe to involve friends and relatives to avoid their
influence in the management and running of the business, it was strenuous to the family
members and friends and also issues concerning the families internally were another problem.

According to the respondents borrowing from commercial banks had its problems like Inflation
were high, they (respondents) found it hard to obtain collateral required, other respondents said
repayment period was short and the credit worthiness evaluation process was long and strict on
them hence limited the amount they could borrow.

MFIs as a source of finance according to the respondents had the following challenges; little
information was available concerning MFIs, others said that macro-finance institutions are
bureaucratic, problem in getting the collateral needed, repayment period was short and that MFIs
were not trustworthy because most of the MFIs that are started in Uganda collapse as soon as
they are started and people end up losing their money.

Other sources of funds for instance, sale of properties according to the respondents said they did
not have the properties to sell and superstitions that selling of a property like land to invest, the
business cannot prosper.

33
Generally SBEs face difficulties in accessing credit thus undercapitalized. Of all the sources of
capital available, they are only able to apply successfully to a small proportion. This is because
entrepreneurs lacked about 80 per cent of collateral and information required.

4.2.2 Period of repayment of loans

Table 4. 4: Showing repayment period of loans

Repayment period (years) Frequency

0-2 8
2-4 2
>4 5
Total 15
Source: primary data
From table 4.4, the response was very low because most of the respondents depended on their
own savings and funds from friends and families as their start up capital or expansionary capital
of which have less or no repayment period at all on these forms of raising funds. Out of the 50
respondents 70 per cent did not respond to this question. It is only 16 per cent that said that their
repayment period was between 0 to 2 years, 4 per cent between 2 to 4 years and 10 per cent said
that they were given a period of above 4 years to repay their loans. This response represented
only 30 per cent of the sample size.

The duration of repayment depended on the amount of money borrowed as small amounts had a
short repayment period. As the amount borrowed increased, the repayment period would be long.
This is reflected on the inflation charged and how the inflation were calculated. Large amounts
borrowed lead to long repayment period and in this case interest was calculated annually. The
amount borrowed from MFIs faced the smallest interest rate charges and shortest repayment
period as compared to CBs. The monthly interests charge was the majority because of the
amounts borrowed were relatively in low amounts.

4.2.3 Inflation perception on borrowings

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Table 4. 5: Showing perception inflation in Uganda

Frequency Percentage (%)

Too high 15 30
High 34 68
Average 1 2
Low -
Too low -
Total 50 100
Source: primary data

A high percentage of the respondents believed that the interest rate in Uganda are high and too
high as shown in table 4.5.This clearly brought out the problem that the researcher was
researching about.

When trying to get the information concerning the businesses of the respondents only 12 out of
the sample of 50 which represents 24 percent were willing to disclose their initial capital and also
only 15 respondents which represents 30 per cent defined the size of their businesses using sales.
Majority used year of starting the business and the number of employees respectively.

A credit seeking decision is a three-stage process. Enterprises first decide on whether or not they
need credit once that decision is affirmed further decision has to be made regarding the
appropriate source if they will reconsider borrowing an additional decision relates to the level of
credit to seek out. But even when SBEs felt a need for external credit, they did not borrow if
their perceptions on the costs of applying for a loan out weighed the expected benefits,
sometimes they lacked enough money to meet the application costs and also had to shy off
sometimes due to a poor collateral position. Thus the decision to reconsider borrowing again
depends on the preference and its credit position status.

Generally in Uganda commercial banks lending rates remain high averaging between 18 percent
and 26 percent. This has mainly been due to lack of competition in the banking sector. This was
brought about by; few banks controlling a large market share, high operational inefficiency, high
operational costs and high risk of borrowers, BOSS (2010).

35
 CHAPTER FIVE

DISCUSSION AND INTERPRETATION OF THE FINDINGS

5.0 Introduction
This chapter discusses the summary of the findings, conclusion and recommendations of the
research study; this was explained from the analyzed and presented data in quantitative and
qualitative analysis. The summary of the findings gave an in-depth explanation found on impact
of high interests in financing on the performance of SBEs. The answers to the research questions
were discussed and the study conclusions were drawn from the findings. The study gave several
recommendations and suggestions for further studies were made to address other problems of
high inflation that were not explored by the study.

36
5.1 Discussion of findings
The research has established that high inflation charged on borrowings has greatly affected the
financial performance as well as the investment levels in SBEs. It is well established that long
term borrowings appeared to be expensive by observing the borrowing habit. This is because the
risk is perceived to be higher. For instance, a small percentage of 6 of the people interviewed
borrow long term loans with a repayment period of more than 4 years as they have a higher
interest rate compared to 18 per cent who borrow short term loans which attract lower inflation.

Short term borrowings were charged considerate interests because their risk is perceived to be
low. The main problem with short term borrowing is, repayment may be required before the
funds borrowed re-generate income to repay the initial borrowing plus interest, thus threatening
investment decisions and also the money obtained might not be enough.

Most of the times long term borrowings discouraged entrepreneurs from borrowing due to high
interest charged and also confidential information required. This had an adverse impact on
investment decisions.
Own savings and funding from relatives and friends seems to be the order the day of most
businesses in Owino market, Kampala which in total represents a high percentage of 64. Young
investors like fresh graduates are being supported by their parent and other relatives to start their
own businesses instead of moving around the streets of Kampala looking for jobs. According to
other respondents, these two sources of funds are convenient and termed as ‘stress free’.

The research has established that the inflation charged on borrowings play a vital role in
obtaining the finances of SBEs thus determine the growth, financial performance and
investments habits in SBEs.

5.1.1 Summary of findings on the impact of high inflation on the growth of SBEs
Most of the respondents explained that high inflation made them borrow funds only in small
amounts. This is due to large amounts of funds used in repayment of the loans obtained and short
repayment period, which inhibits large amounts, borrowed. This negatively affects on the growth
of the small businesses in that they cannot be expanded or even out competing their competitors.

37
This has led to an annual growth rate of the businesses to be below average and others are closed
as they become insolvent due to their inability to service their loan obligations as they become
due.
Most of the respondents said that due to high costs of borrowing from banks and MFIs the effect
is that of low or no profits because the costs are inversely proportional to the profits i.e. as the
costs increase the profits decrease and so does the returns.
De Gregorio (1993), on the other hand, shows a significant negative effectof inflation and its
variability on growth for Latin American countries. Theseeffects on growth work through the
effects of inflation on the productivity ofinvestment. If inflation rates had been half of their
levels in the 1950-85 period,the rate of growth of per capita GDP could have been 25% higher.
Barro (1995)using data for about 100 countries for the period 1960 to 1990 has estimated thatan
increase in average inflation of ten percentage points per year lowers thegrowth rate of per capita
GDP by 0.2-0.3 percentage points per year and reducesthe ratio of investment to GDP by 0.4-0.6
percentage points.Finally, Bruno and Easterly (1998) argue that the negative long-runrelationship
between inflation and growth found in the literature is only presentwith high frequency data and
with extreme inflation observations, and thatthere is no cross-sectional correlation between long-
run averages of growthand inflation. By examining discrete high inflation crises, they find that
growthfalls sharply during discrete high inflation crises, then recovers rapidly andstrongly after
inflation falls

5.2 Suggestions on how SBEs should deal with high inflation

Some respondents said that SBEs should consolidate themselves in order to be able to access
credit, others said that SBEs should take credit from informal financial institutions and shun
away from banks which charge high inflation. Others said forming their own SACCOS was a
better option. Others advocated for strengthening of personal savings. Majority of the
respondents said that increasing the size of their businesses in order to increase their chances of
getting credit even when charged high inflation as they will not erode all their profits.

38
 CHAPTER SIX

CONCLUSION AND RECOMMENDATION

6.0 Introduction
This Chapter presents conclusion, recommendations and areas of further research

6.1 Conclusion
It was established that high inflation charged on borrowings greatly affect the growth, financial
performance and the investment levels of SBEs. This is because it becomes hard for an investor
to expand his or her businesses to match up or even out compete the competitors. Some potential
investors end up not making their dreams come true due to funds shortage and others start
businesses which do not even celebrate their first birthday.

39
We established that Small Business entrepreneurs who borrow from Commercial Banks and
other financial institutions borrow in small amounts and not large amounts. This is associated to
large amounts of funds required in repayment of the loans obtained and short repayment period,
which inhibits large amounts borrowed.

We also established that there were a number of problems faced by SBEs in funding their
businesses. The problem faced by most respondents was the high inflation charged on borrowing
loans from CBs, lack of collateral, lack of access to credit, lack of enough cash to meet the
application costs, lack of knowledge of available loans and short repayment period.

In order to combat the above difficulties, educational opportunities should be expanded to

improve on the literacy and numeracy of the entrepreneurs in order to improve access to credit
by SBEs and collateral levels should be lowered.

After carrying out the research it was established that majority of investors preferred using own
savings and funds from their friends and relatives to finance their businesses main reasons being
convenience and less costly.

In conclusion, the research has established that the inflation charged on borrowing play a vital
role in obtaining the finances of SBEs thus determine the growth, financial performance and
investments in the SBEs.

6.2 Recommendations

From the observations and findings enumerated herein, the researcher recommends as follows:
80 per cent of the respondents said that the inflation are too high and should be lowered to enable
availability of funds to SBEs. High inflation discourage borrowing, deters investments, retard
economic performance of business in the country and hinders growth in domestic investments
hence the BOSS should control government borrowing which raises the inflation and should

40
place a Treasury Bills benchmark on government debt to reduce market imperfections or it can
also reduce the bank rate.

Most SB entrepreneurs are ignorant about MFIs. MFIs should create more awareness to the
public so that those who need assistance may seek their services. This awareness can be created
through the mass and electronic media such as television, radio and internet. Other methods
include seminars, workshops, leaflet distribution and public rallies. They should expand their
activities in order to reach out and assist more SBEs to foster growth in this young and important
industry and restructure their loan programs from group-based loan schemes to individual based
loans schemes, which are easier to access. This is because with the current economic hardships,
it is difficult to get groups to guarantee loans for individuals.

Since the age of an enterprise is important in accessing credit, short life expectancy of SBEs
especially informal ones is an impediment to credit access. High mortality rates mean lost
opportunities not only of accumulating business experience but also for building credibility and
reputation necessary for accessing credit from financial institutions and suppliers of inputs and
products. It is therefore necessary to put in place business ‘clinics’ for extending managerial and
financial ‘First Aid’.

To be able to confront competition, collaboration between SMEs can be considered. By entering

into joint ventures, the opportunity to combine strengths, information and technological
capabilities to increase sales or to enhance their customer base.

SMEs need to continuously evaluate the environment that they operate in, understanding their
competitors and their offerings/service. SME competitiveness depends largely on the speed with
which new products can be brought to the market place.

SMEs in Kampala to be able to confront competition from local and foreign competitors, from
developed and emerging economies, need to look into the opportunities these economies will
provide.

41
Future researches could perform an in-depth study on the external factor competition, addressing
the impact on the performance of SMEs.

6.3 Suggestions for further studies

Because of the limited time and funds, it was not possible to cover effectively all the areas of
interest in the study and therefore more research is needed on the following area; the effect of
high cost of living on the expansion of businesses, the impact of market forces on inflation and
the effect of financial institutions profitability motive on interest rate levels.

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Appendix I

QUESTIONNAIRE

The researcher is conducting purely an academic research as a partial requirement for award of a
bachelor’s degree Cavendish University.
The study is to find out the relationship between inflation and performance of SBEs in this
Owino market, Kampala. I am requesting you to humbly respond to the questions.
Please be assured that your response will be treated with strict confidentiality.
PART A: PERSONAL DATA
Please fill or tick the right response that describes you for each of the following items. (Please
tick in the box where applicable)

1. Gender Male Female

2. Age 18-30 years 31-40 years 41 years and above

45
 1. Highest level of education attained

Bachelor Diploma A-level O-level others………..

Part B: BUSINESS INFORMATION

1. When did you start the business and with how much capital?........................................
2. What is the size of your business in terms of : (Optional)
Sales ………………… Employees…………………….. Assets…………………..

Part C: IMPACT OF HIGH INFLATION ON THE GROWTH OF SMALL & MEDIUM

SIZE ENTERPRISES
1. What are the sources of funding for your business
Friends and relatives Own saving
Micro Finance Institutions
Commercial banks Other sources (Specify) ________
2. Which of these institutions have you ever borrowed from? (Tick were applicable)
a. Commercial bank?
b. Micro finance?
c. Friends /Relatives
d. Other sources (Specify) ………………………………………..

3. What was the repayment period of the loan or the borrowed money?
0-2 years 2-4years 4 years and above
4. What are the inflation charged …………………………………………………….
5. What are the reasons that make you fund your business with funds from the above
sources and not any other? ..............................................................................................
6. What problems did you experience in borrowing from
a. Friend and relatives………………………………………………………………

46
 …………………………………………………………………….
b. Commercial

banks ....................................................................................................................................
............................................................................................................
c. Micro-finance institutions ………………………………………………………..
……………………………………………………………………..
d. Other sources …………………………………........................................................

11 Do the interest charged on your loan discourage you from borrowing again from these sources
Yes No
12 What is your perception on the loan interest charged?

Too high High Average Low Too low

Part D: HOW HIGH INFLATION AFFECT THE FINANCIAL PERFORMANCE OF

SMALL & MEDIUM SIZES ENTERPRISES

13. Do you think that high inflation have affected your financial performance?
Yes No
14. If yes, please rate the extent to which the financial performance has been affected in (13)
above:
Positively Negatively Averagely Adversely

15. Do you intend to expand your business Yes No

16. How do you intend to raise your funds? .........................................................................

……………………………………………………………………………………….

47
Part D: WAYS THROUGH WHICH SMALL & MEDIUM SIZE ENTERPRISES CAN
DEAL WITH THE HIGH INFLATION IN UGANDA

17. What suggested ways do you think that small & medium size enterprises can use to shield
their businesses from high inflation in
Uganda? ............................................................................................................................................
…………………………………………………………………………………………….
18. Do you think small & medium size enterprises like yours can still borrow from banks?
………………………………………………………………………………………………………
…………………………………………………………………………….
19 How do you perceive inflation in Uganda?
Too High High Average Low Too low

48