Micro and Small Enterprises in Ethiopia: Access to

Credit – Challenges and Solutions

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30 août 2022

The importance of MSEs to the Ethiopian economy

cannot be overstated.

In Ethiopia, Micro and Small Enterprises (MSEs) are

the second largest employment-generating sector,
after agriculture. According to the Entrepreneurship
Development Center (EDC) of Ethiopia, before the
COVID-19 pandemic, there were 1.5 million MSEs,
employing 4.5 million people and generating 40.7
billion Birr (760 million US) in monthly sales.

What are MSEs?

Micro and small enterprises (MSEs) are businesses with revenues, assets, or employee
counts that fall below a certain threshold.

While there is no universally accepted threshold for what constitutes a MSE, countries
consider, in varying proportions, the number of employees, turnover, and asset value. In
Ethiopia, a micro-enterprise is defined as an enterprise with no more than 5 employees,
including the owner, and total assets of less than or equal to $5,000 US for the industrial
sector and less than $2,500 US for the service sector. A company with 6-30 employees
and total assets of $5,001-$75,000 US in the industrial sector and $2,500-25,000 US in
the service sector is classified as a small enterprise.

The economic and social benefits of MSEs

MSEs were once thought to be marginal and unproductive, contributing little to a country’s
economic growth. However, in recent decades their importance in terms of job creation
and income generation has been widely recognized and has become the primary playing
field for policymakers.

According to the World Bank, MSEs represent about 90 percent of businesses and
provide 50 percent of worldwide employment. Additionally, MSEs contribute up to 40
percent of the gross domestic product in emerging economies.

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The economic and social benefits of MSEs include:

Creating jobs with low capital cost

Contributing to a country’s GDP (the value of goods and services generated
within the country)
Providing an opportunity to expand the entrepreneurial base
Providing flexibility to adapt to market changes
Boosting economic growth by introducing innovative technologies, products
and services
Moving into market niches that are not profitable or interesting for larger
enterprises.

 Challenges for MSEs in Ethiopia

MSEs are the engines of economic growth in Ethiopia. They face, however, many barriers
to achieving expansion and growth.

Recognizing and overcoming these challenges is an important question for the Ethiopian
government.

Policymakers must consider ways for MSEs to reduce financial barriers, improve support
systems, and empower them to realize their full potential by instilling the values of
innovation, creativity, and decent work for all.

Financial Challenges of MSEs and How to Overcome Them

Access to finance is one of the key elements that determine the development and
success of MSEs. It is crucial for helping them to set up, maintain, develop and grow their
business.

However, limited access to finance is one of the leading constraints affecting the growth
of MSEs in Ethiopia, despite the fact that 90 percent of MSEs rely on external sources of
finance, generally from investment banks, commercial banks, and other governmental
microfinance institutions (MFIs).

For example, the share of loans provided to the MSE sector is deteriorating because:

banks are not interested in providing credit to startup businesses with no credit
history (because of the lack of information on the credit-worthiness of MSEs),
the absence of capital markets, and
the weak legal framework regarding credit, collateral and other related aspects.

Overcoming Financial Challenges

Risk Sharing Guarantee Schemes

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Firstly, through appropriate policies, the government should improve the financial
environment.

For example, they should promote more risk-sharing guarantee schemes (RSGS). These
work by covering some portion of the losses experienced by lenders when firms default
on loans. These are widely used as financial instruments for supporting MSE growth and
have an advantage over other possible finance policies in that it enables MSEs to obtain
credit that is free from collateral requirements.

A five-year partial credit guarantee scheme (with 50 percent risk-sharing risk) was
implemented in Ethiopia between 2011–2016 to help smallholder coffee cooperatives
receive bank loans.

According to Negussie Efa Gurmessa, Catherine Ndinda, Charles Agwanda & Morris
Akiri (2021), “Despite some limitations, the guarantee scheme under assessment made
positive contributions in improving cooperatives’ access to bank credit.  A total of
22 cooperatives were targeted from the south and Oromia regions (representing 99
percent of Ethiopia’s coffee growing region) to benefit from the credit guarantee scheme,
out of the 22 cooperatives, 20 had submitted loan applications at least once over the first
three years of lending, and close to two-thirds (70 percent) were able to access
guaranteed bank loans.”

The government and its development partners should also consider individual coffee
farmers with high production potential who are not benefiting from guaranteed bank
loans. Furthermore, given the nature of the crop, the RSGS should be implemented for
more than five years.

Micro Finance Institutions

The five-year MSE development strategy and the policy/manual prepared by Federal
Micro and Small Enterprise Development Agency (FeMSEDA) 2011 stated that,

MSEs who wish to benefit from credit guarantee schemes were MSEs that were
organized in groups or cooperative forms of organization and those who are capable of
saving 15- 20% of the loan size were given priority to access loans from MFIs without
collateral and accessing many support services (awareness creation programs, skills
training, business development services (BDS), market linkages, working premises,
extension and mentoring). 

In this case, individuals who are interested in being self-employed but unable to save 20
percent of the loan have no access to the credit guarantee and other support services.
Additionally, according to the 2022 National Bank of Ethiopia (NBE) annual report, the
total number of people employed by MSEs has dropped to 585,119 in 2020/21 from
1,569,163 in 2019/20.

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Therefore, the government, in collaboration with its development partners, should
consider the country’s massive unemployment gap and improve existing regulations and
credit guaranty scheme policy by increasing the lending capacities of MFIs to address the
credit demand of individuals and cooperative MSEs who were previously unable to meet
the collateral requirements, savings, and credit costs of financial institutions.

Informal Credit Sources

Owners/managers of MSEs should also have a “plan B” that focuses on informal credit
sources to meet their financial needs, such as Iqub. This is a traditional savings club that
combines a lottery and a bank, based on pre-established social ties. They consist of
homogeneous groups that participate with varying capital contributions according to the
purpose of the Iqub and the economic status of its members. It also includes credit from
friends and relatives.

Attracting foreign direct investment (FDI) in the financial sector

Foreign bank entry has significant benefits for host countries, financial systems and
economies. Foreign banks may also promote domestic financial market efficiency and
development by increasing the number of financial products available to local customers
via imported technologies and know-how.

Therefore, the government should reconsider the current restrictions on foreign direct
investment (FDI).

Generally, attracting foreign investors to invest in Ethiopia’s banking sector has the
following benefits:

It promotes healthy competition, which

helps to keep capital markets efficient
and vibrant, and serves millions of
domestic customers through
commercial and retail lending.
By making loans available to individuals
and businesses, it can boost innovation,
exports, and employment, thereby
increasing Ethiopia’s economic growth.
It helps to advance fintech (financial technology), which allows for the expansion of
new investments and entrepreneurial activities.

Fintech

Fintech is any technology that delivers digital lending and credit financial services via
computer software through the use of mobile banking, mobile payments, cryptocurrency
and blockchain, insurance, trading, and banking as a service (BaaS). Instead of relying

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solely on traditional financial services, the Ethiopian government should promote financial
technology or FinTech such as digital lending and credit Fintech that can directly fund
MSEs loans and boost their competitiveness.

MSEs can use FinTech platforms to access unsecured long-term financing and release
pledged assets (collateral held by a lender in exchange for lending funds) by repaying
secured long-term bank loans. For example, a P2B platform (a method of debt financing
that enables individuals to lend money to enterprise projects of any scale) allows MSEs to
expand their pool of lenders.

By diversifying their financing sources, firms achieve greater financial flexibility and
protect themselves from the risk of lending cuts caused by liquidity shocks.

Ethiopia’s Fintech sector is currently quite

small in comparison to South Africa, Nigeria
and Kenya, hence there is room for
expansion. Startups that offer payment and
mobile money services, like Arifpay, Kifiya
and Belcash, and M-birr from EthioTelecom,
dominate the market. It’s also anticipated that
Safaricom and M-Pesa from Vodacom will
soon begin operations.

Fintech has the potential to significantly boost the nation’s economic growth and, in
particular, solve MSEs’ working capital problems if properly implemented. To reduce risks
associated with technology, such as cyber-attacks, the government should implement
strict cyber deterrence policies and regulations.

Equity Financing
MSE owners/managers should also consider equity financing (selling a portion of their
shares to investors to raise capital) as an alternative source of external financing to fund
their company’s growth and expansion.

The government should expand the capital market to allow individuals and businesses to
obtain funds. This includes company shares, bonds (investment security in which an
individual lends money to a company or government for a set period of time in exchange
for regular interest payments), debentures (marketable security that businesses can issue
to obtain long-term financing without putting up collateral, such as treasury bills and
treasury bonds), and debt insurances.

In my next article, I will look at how governments, policymakers, and the MSEs
themselves can overcome the marketing-related challenges, and thus provide greater
economic growth and employment to Ethiopia.

Sources:

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Factors influencing the growth of MSEs in Ethiopia  by Muluken Haile

National Bank of Ethiopia 2020-21 Annual Report

Negussie Efa Gurmessa, Catherine Ndinda, Charles Agwanda & Morris Akiri (2021)
Partial credit guarantee and financial additionality for smallholders coffee
cooperatives: experience from Ethiopia, Development in Practice,
DOI: 1080/09614524.2021.1958161

Further reading:

The Emerging Aviation Market in Africa by Deborah Lavanchy

Entrepreneurship opportunities between Africa and Europe by Zandonaide Dantas

Photos:

Istockphoto

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