Definition of SME

SME stands for Small to Medium Enterprise.

MEDA SME Definition

Small & Medium Enterprises are defined as follows, as approved in SME Policy 2007

Enterprise Category Employment Size (a) Paid Up Capital (b) Annual Sales (c)
Small & Medium Enterprise (SME) Up to 250 Up to Rs. 25 Million Up to Rs. 250 Million

SME Definitions used by various institutions in Pakistan

Institution Small Medium

SME Bank Total Assets of Rs. 20 million Total Assets of Rs. 100 million
Federal Bureau of Statistics Less than 10 employees N/A
Punjab Small Industries Fixed investment. up to Rs. 20 million excluding land and
N/A
Corporation building
Punjab Industries Department Fixed assets with Rs. 10 million excluding cost of land
Entity engaged in handicrafts or manufacturing of consumer or producer goods with fixed capital
Sindh Industries Department
investment up to Rs.10 million including land & building
State Bank of Pakistan (SME An entity , ideally not being a public limited company, which does not employee more than 250
Prudential Regulations) persons ( manufacturing) and 50 persons (trade / services) and also fulfills one of the following
criteria:
(i) A trade / services concern with total assets at cost excluding land and buildings up to Rs 50
million.
(ii) A manufacturing concern with total assets at cost excluding land and building up to Rs 100
million.
(iii) Any concern (trade, services or manufacturing) with net sales not exceeding Rs 300 million
as per latest financial statements.

SME Definitions in selected Asia Pacific Economic Cooperation (APEC) member countries
Enterprises exporting up to US$2.5 Million a year are considered Small by the State Bank of
Pakistan

Country Sector Employment Other Measures

Manufacturing Less than 100 employees
Australia
Services Less than 20 employees
Manufacturing Less than 500 employees
Canada
Services Less than 50 employees
China Varies with Industry Usually less than 100 Employees
Indonesia Less than 100 employees
Manufacturing Less than 300 employees ¥100 million assets
Japan* Wholesaling Less than 100 employees ¥30 million assets
Retailing-Services Less than 50 employees ¥10 million assets
Manufacturing Less than 300 employees
Korea
Services Less than 20 employees
Less than 75 employees (Different for Bumiputra
Malaysia Varies (for SMI) Less than RM 2.5 million
Enterprises)
Philippines Less than 200 employees P 40 million assets
Singapore Manufacturing less than S$12 million fixed assets
 Services Less than 100 employees
USA Less than 500 employees

In the given scenario Small and Medium Enterprises (SMEs) are considered to be one of
the principle driving forces in the economic development of Pakistan. Anecdotal
evidence suggests that despite the decline in the large sector growth rate, SME sector has
managed to grow at an average above 8% since they are relatively flexible and can adapt
quickly to changing market demand and supply situations. Their ability to generate
employment and to diversify economic activity can make a significant contribution to
exports and trade, create employment as well as alleviate poverty in Pakistan.

Why SME important for economic growth

Small and medium-sized entities are contributing the lion share to economic growth also in any
country They produce 68% of all exports are from sme. Which is much more than in other
countries.

IMP L I C A T I ONS O F MONE TA RY P O L I C Y FO R SMES

The monetary transmission mechanism is a process through which monetary policy
actions affect the ultimate policy goals i.e. output and inflation. Due to considerable lags
between monetary policy shocks and their effects on policy variables, it becomes crucial
to forecast the possible impact and extent of monetary policy actions on the real
variables. Interest rate channel is the most extensively discussed and recognized
monetary policy transmission channel. The fundamental nature of this channel makes it
not only relevant to the economy at large but also serves as an important medium of
transition in SME sector. Transmission through this channel hinges on the relationship
between changes in the policy rate and short term nominal interest rate and subsequently
long term real interest rates. Shifts in long term real interest rates affect aggregate
consumption, business investment and other components of aggregate demand.

Tightened monetary policy over the last few years kept on increasing the policy rate
which caused upward shifts in the yield curve. Cost of financing has gone up due to
higher long term interest rates which constrains investment in SME sector.

Credit channel transmits those changes in monetary policy that affect firms’ tendency to
borrow money as well as banks’ capacity to lend money. Such policy changes are
controlled by the structure of financial system and its regulation. SBP, in consultation
with relevant stakeholders, is undertaking a detailed review of existing Prudential
Regulations for SME Financing. This review is an attempt to facilitate SMEs’ access to
credit by proposing separate definition and regulations for them. Exchange rate channel
involves policy-induced changes in domestic interest rate, their impact on exchange rate
which subsequently affects the aggregate demand through foreign financial flows and net
exports.

The efficacy of this channel is highly dependent on sensitivity of exchange rates to

monetary policy shocks, the extent of economy’s openness and responsiveness of foreign
inflows and net exports (including exports of SME sector) to the changes in exchange
rates. Furthermore, changes in exchange rate have an impact on the domestic price of
imported production inputs (raw material etc.) and in turn affects the cost of production
of SMEs which are mainly dependent on imported raw material.

Developments in Monetary Indicators

Government’s record borrowing of Rs. 216 billion from The State Bank in the first 70
days of the current fiscal year raised Net Domestic Assets (NDA) of the banking system
which, being one of the components of money supply , consequently increased M2.

Increased government borrowing restricts the scope of SME sector in particular and
private sector in general to gain from the available credit. This link can also be
substantiated by the above mentioned trends of monetary indicators. Furthermore, rising
SME sector’s nonperforming loans (NPLs) also encourage risk averse banks to prefer
government borrowing requirements over SME sector’s investment.

Inflation Trend

Already fragile macroeconomic outlook has further been hit by devastating floods
causing serious implications for macroeconomic growth and stability. The rise in MoM
Food Inflation to 5.1 percent and MoM Consumer Price Index (CPI) Inflation to 2.5
percent in August 2010was predominantly due to floods as it caused disruption in the
supply chain of food items and was above the average MoM growth (during Ramadan in
previous five years) in Food and CPI Inflation which are 1.6 percent and 1.1 percent
respectively. In October 2010, MoM food and CPI inflation fell down to 0.1 and 0.6
percent respectively. Raw materials, fuel and electricity are the major production inputs
used by SME sector. These production inputs are mainly covered under the non food
bracket of CPI inflation and Wholesale Price Index (WPI) inflation, which in contrast to
falling CPI food inflation increased to 1.1 and 4.2 percent respectively in October 2010,
which increases SMEs cost of production. According to SBP the average YoY CPI
Inflation for FY11 is projected to come down between 13.5 and 14.5 percent. On the
other hand, likely increases in electricity prices and increasing government borrowings
from SBP together with introduction of reformed GST make expected inflation even
more uncertain.

IMP L I C A T I ONS O F FI S C A L POL I CY FO R SMES

Stabilization policies (monetary and fiscal) have a significant role in combating the
challenges of economic growth and price stability. Monetary policy represents the
decisions regarding the optimal level of money supply and interest rates while fiscal
policy is associated to taxation and spending decisions of the government. Although the
scope of this document is by design exclusive to the monitoring of fiscal policy changes
and their impact on SME sector,
Over the last five years, slow revenue growth and higher expenditure led to higher fiscal
deficit. Consequently, fiscal policy had been shifting largely at the cost of development
expenditure. Revenue balance is the difference between the total revenue and current
expenditure and corresponds to government’s savings or dis-savings behavior. There
should be sufficient amount of total revenue to at least finance the current expenditures In
order to reduce the fiscal deficit, the government needs to generate higher revenues
predominantly through an efficient tax system rather than curtailing development
expenditure.

SME Sector related Fiscal Policy Shocks

There are two broad categories of fiscal policy shocks, Taxation and Government
Spending. In order to monitor SME Sector related policy shocks, relevant changes under
each category need to be examined.

Taxation
Following are the relief measures announced in the Federal Budget 2010-11 that can help
SMEs reduce their cost of production inputs to some extent:

• Reduction of customs duty on crude palm oil from Rs.9, 000/MT to Rs.8, 000/MT to
decrease cost of vegetable ghee and oil.
• Reduction of duty on raw materials for laundry soap and detergent to provide relief to
general public.
• Exemption of customs duty on import of fully dedicated LPG buses and dispensing
equipment to encourage use of cheaper environment friendly fuel.
• Exemption of customs duty on import of raw materials/ components for energy saving
lamps to support its local manufacturers.
• Exemption of customs duty and sales tax on rice processing machinery to boost value
addition and export of rice.
• Reduction of duty on raw materials of leather industry to encourage leather exports.
• Reduction of duty on raw materials of glass industry to make them more competitive.
• Reduction of duty on secondary quality tin mill black plate for manufacturers of tin
plate to reduce their manufacturing cost.
• Exemption of duty on milk filters to support dairy industry.
• Withdrawal of restriction on adjustment of FED paid on beverage concentrate is aimed
at attracting new investment in beverage industry and reducing the prices of aerated
waters in the country.
• Reduction of advance tax on monthly industrial and commercial electricity consumption
from 10 in FY10 to 5% in FY11.

• 5% tax credit for a company in the year of its enlistment in any registered stock
exchange in Pakistan. On the other hand, some revenue measures which may have
negative impact on SME sector are as follows:
• Enhancement of tax rate for small companies from 20% in FY10 to 25% in FY11.
• Rise in withholding tax on imports from 4% in FY10 to 5% in FY11.
• Rise in the rate of sales tax from 16% in FY10 to 17% in FY11.
• Introduction of 10% FED on air conditioners and deep-freezers.
• Increase of FED on Natural Gas from Rs. 5.1 per MMBTu in FY10 to Rs. 10 per
MMBTu in FY11.
Government Spending

Government spending is another fiscal tool that is used for policy adjustment.
Government expenditure comprises of two distinct strands i.e. current expenditure and
development expenditure. Development expenditure is further divided into two strands;
Public Sector Development Programme (PSDP) and other development expenditures.
SME related development expenditure is largely covered under PSDP through
programmes/ projects undertaken by various government ministries and departments. The
changes in PSDP expenditure most relevant to SME sector are largely being focused
here. This degree of relevance has been inferred on the basis of Ministries/Departments
direct involvement in SME related PSDP projects

As evident in the table above, the overall size of Public Sector Development Programme
(PSDP) for 2010-11 is Rs 663 billion that is 30% above the revised estimates 2009-10
while the PSDP size for SME sector related divisions has decreased. The forthcoming
provincial legislation of the draft of Reformed General Sales Tax (RGST) which is an
attempt to restore original form of GST distorted by exemptions along with rehabilitation
of flood affected areas are going to influence government’s fiscal stance. Therefore,
budget 2010-11 is prone to a revision in its revenue and relief measures as well as its
allocation of government expenditure. These revised estimates may provide completely
opposite inferences. Corresponding to the available estimates, SME sector may benefit
from the proposed tax credits and reduction and exemption of duties however these relief
measures may also be outweighed by the government’s revenue measures such as
enhancement of tax rate for small companies, withholding tax on imports and sales tax
along with reduction in SME sector related development expenditure.

RE F O RME D GE N E R A L S A L E S T A X B I L L (RGS T ) 2 0 1 0 & SME

SECTOR

Stagnant Tax-to-GDP ratio has brought forth a dire need of undertaking a few revenue
measures. There is no second opinion on the subject of implementing a broad-based
modern form of sales tax on goods and services so as to increase country’s tax revenues.
The original Sales
Tax Act 1990 was designed on the basis of recognized value added taxation principles
due to which this tax regime is often phrased as “GST in VAT mode”. Unfortunately, this
Act had been distorted and restricted to a narrow base through political compromises and
revenue constraints in the shape of ever-expanding exemptions, special
regimes, multiplicity of rates and several other deviations from international best
concepts and practices. Since the introduction of Value Added Tax (VAT) triggered a
political hullabaloo and disagreement among various segments of the country, it has been
proposed to rely on the value added tax doctrines in the original act and broaden the tax
base by integrating exempted sectors and imposing a uniform sales tax rate, instead of
multiple rates. The Cabinet has approved the Draft to table the Reformed General Sales
Tax (RGST) Bill for discussion and approval of the Parliament. This bill, if approved,
will replace the present Sales Tax Act, 1990. Pakistan, SME-related tax reforms in the
bill need to be highlighted in specific and are as follows:

• A uniform sales tax rate of 15 percent has been proposed, instead of rates ranging
between 17 and 26 percent.
• GST will replace the existing regimes of sales tax and excises on services and apply on
both at import and local supply stages.
• Annual uniform exemption threshold is proposed to be enhanced from Rs. 5 million to
Rs. 7.5 million to keep small businesses including small traders / retailers / cottage
industry out of mandatory tax compliance.
• Local consumption of sectors like textile (including carpets), leather, dairy products,
surgical and sports goods has been subjected to tax that is, in one way or another, going
to affect the SME sector. Correspondingly, agricultural inputs (e.g. pesticides etc.) and
agricultural machinery have also been proposed to be taxed.
• GST will be levied only on value added component of each stage of the supply chain
and there is a provision to adjust the tax paid at preceding stages in the supply chain due
to which net tax incidence remains as a single stage levy. Automatic input tax adjustment
facility leads businesses towards voluntary registration so that they can benefit from
such adjustments and improve their cash flows. This is going to encourage
documentation and self compliance of small and medium businesses.
• Exemptions on certain goods and services have been kept intact and include basic food
items (e.g. wheat, rice, pulses, vegetables, fruits, live animals, meat and poultry) and
edible oil. Despite an enhanced uniform annual exemption threshold and automatic tax
adjustment led incentive for documentation and self compliance, the aforementioned
reforms also have some repercussions for the SME sector. RGST on inputs and services
will increase RGST on inputs and services will increase the cost of production and
services e.g. raw material, logistics, electricity, gas, communication, leasing and banking
charges etc. It will lead small and medium size manufacturers and wholesalers to increase
their prices which will affect the end consumer. Most of the sectors brought under this tax
bracket are based on SMEs and tax on their local consumption will directly increase their
prices. The sectors under discussion are textile (including carpets), leather, dairy
products, surgical and sports goods. Looming and stitching sectors of textile industry are
mainly SMEs and also vulnerable to RGST imposition. Moreover, government’s inability
to release previous tax refunds and export rebates raises concerns about the smooth
clearing of GST refunds. In case of delays in tax refunds, the exporter or entrepreneur in
value-added sectors such as textile will face shortfall in working capital. On the other
hand, cost of financing working capital is also rising as mark-up rate is continuously
increasing. These issues together with increased utility tariffs and cost of raw materials
will eventually reduce the industrial output and subsequently exports volume. Balance of
payments will also be disturbed by the ensuing export curtailment. The SME sector, by
and large, lacks the complete documentation of tax returns and therefore is unable to
avail tax adjustments right away. Although it promotes documentation, the procedural
delays in registration may lead to serious cash flow bottlenecks The imposition of RGST
is currently under debate among policy makers and major
Stakeholders. While there may be differing points of views on the issue, the inevitability
of broadening the country’s tax base and increasing tax revenues cannot be denied.

ABOUT SME OB S E RV E R
In the absence of any specific mechanism for provision of such practical information
to businesses and in particular to small and medium enterprises, the SME Observer
would serve as a handy tool. The publication includes sections on SME Trade, Price
Trends, Raw Materials and Macro Economic Policies with specific reference to SMEs.
As a business intelligence tool the publication would be useful for entrepreneurs,
providing information on business input costs and trends, export markets and key
economic indicators, such as interest rates, government expenditure and taxation.
We are hopeful that the analysis presented in SME Observer will be useful for policy
makers, academia and entrepreneurs