SME’s and Africa – the ‘missing middle’ Their growth and place in genuine economic development

The missing middle  Most African economies consist of INFORMAL microenterprises ( many are very skilful) and large enterprises ( often in the extractive sector)  Most companies are small because the private sector is both new and faces some difficulties with legal and financial obstacles – though as we will note these are being reduced.  Between the microenterprises and large business is the ‘ missing middle’ – even in the most advanced African economy, namely South Africa micro and small business create the majority of jobs and somewhere approximate to 24% of GDP  SME’s have struggled against local markets, a local of regional integration, poor infrastructure, dubious legal systems, a lack of local finance and unattractive tax systems – again considerable improvements in all of these has taken place in a number of the leading economies.  Many small enterprises contain a high skills base – growth tends to be limited by technical progress and low values of fixed assets, which helps if bankruptcy looms.

The potential of SME’s  SMEs account for 70% of Ghana’s gross domestic product (GDP) and 92% of its businesses.  They also make up 91% of formalised businesses in South Africa  70% of the manufacturing sector in Nigeria – processing equals value added – tax receipts and more opportunity for government to spend on the quality of life of its citizens  They are the growing engine of innovation, the application of technology, diversification and the development of previously under performing sectors of economies  They can the nucleus for moving into other markets, cross border trade and the expansion of the under utilised intra-regional trade  They can also assist in the preparation fro moving beyond regional and looking for‘ international connections’.

The continued growth of SME’s and their role in ‘balanced’ development – the current environment  Government – variations in support  Lack of credit facilities  A belief that their business will not grow as fast as ‘western’ equivalents  If obstacles eased or removed the prospect for growth and development would increase considerably WHY?  The Global Enterprise Monitor(GEM) notes that in South Africa, Uganda,Angola, Ghana and Zambia have both growing numbers of SME’s and these are considered to be main drives of growth in their respective parts of the continent.

Africa’s population is increasing  571m sub-Saharan Africans (62%) are under 25 years of age, 386m (42%) are under 14 years of age. Only 3% of the population is over 65.  The median age is 18.6, the lowest in the world (developing world: 26.5; developed world: 39.6).  With fertility rates as well as child mortality rates declining since 2000, working-age adults have become the fastest-growing population segment.  The ratio of working-age people to dependants is consequently on the rise. Out of a 440m increase in sub-Saharan Africa’s population over the next decade, half will be below 25 (and one third below 14).

The potential is there

Some other factors that business needs to address  I nequality – back on political agenda – Republicans (US), Davos and most commentators are focusing on increase in income levels when considering rich v poor world but greater disparities within countries.  The need to be culturally aware*, so reducing business risk. It is surprising how little many business know about the country(s) they wish to operate in and trade with  The ways of achieving Corporate Social Goals and increasing your own efficiencies – building sustainable supply-chains and linking your growth with local increases in prosperity – insetting etc.  But because Africa’s population has grown so much in recent years — and because inequality remains so pronounced — the total number of people living in such extreme poverty has still increased, to an estimated 413 million in 2010 from 376 million in  * I can assist

The challenges facing SME’s in Africa  A recent World Bank report noted Chad as the most difficult African country in which to start an SME. This was partly blamed on a 65% tax rate.  Chad also has high insolvency fees, so making the fear of failure one of financial ruin for those who started the enterprise.  In Ethiopia building permits were noted as a major cause of small growth in SME’s. Land and property rights do need to be looked at in detail  Other problems, such as corruption, unreliable electricity and poor infrastructure were blamed for the sluggish nature of SME growth in the largest economy on the continent, namely Nigeria. This allowed this fast growing economy to be ranked only 133 rd in the ‘ease of doing business’ index. With its young, large and growing middle class Nigeria is an SME market waiting to be developed.

More challenges facing SME’s  Those these are known to most prospective business projects it must be noted that in recent years Mauritius, South Africa, Botswana, Ghana, Rwanda and Tanzania have made significant improvements in easing the cost of starting and doing business in their countries.  Recent World Bank data suggests that 78% of all African countries have made meaningful improvements to their ‘ease of business’ climates.’  Botswana is the top nation resolving insolvency and recovery rates.  South Africa is second in this list and notes its short processing times, high access to credit lines and the least bureaucracy in obtaining building permits.  Others – Ghana, Rwanda and Tanzania have all made significant strides towards easing regulation and creating business enabling environments for enterprise to grow.

External Debts  The exchange rate risk of sovereign bonds issued by governments in sub-Saharan Africa in 2013 and 2014 is threatening losses of $10.8 billion - a value equivalent 1.1% of the region’s Gross Domestic Product (GDP  This is because sovereign bonds are issued and repaid in US dollars but local currencies depreciated significantly in 2014  Repayments are dependent on continued strong economic growth in sub-Saharan Africa but growth is now at risk of stalling as export markets slow and commodity prices - especially oil – fall  governments be held more accountable for the responsible use of funds by national institutions, development agencies and investors so that funds are used wisely to continue sub-Saharan Africa’s economic boom.  Sovereign bonds are a popular way of financing development in emerging economies as investors lend with little conditionality compared to multilateral banks such as the International Monetary Fund (IMF) or the World Bank.

Ngozi Okonjo-Iweala,Finance Minister, Nigeria  Emerging markets have provided more than half the global growth at some point during the time of the financial crisis  With the young population that will be one of the largest in the world, Africa stands a very good chance of turning this into a demographic dividend  We would need to make sure that we provide the means for productivity to rise within the continent, basically focusing on infrastructure  You can’t afford to have a young population not gainfully employed. We all have seen what happened with the Arab Spring. And that absolutely has to be avoided so that we don’t have causes of instability within the continent. But I think that working on sectors like agriculture, for instance, which generates a lot of labour all along the value chain—changing the concept of agriculture to one of a business.

More from Nigeria  running through the whole value chain as well as creating the right infrastructure: looking for how to improve education, focusing on technology and skills—to be able to really equip our young people to work in the modern world. Communications technologies will be critical, the access to the Internet. All of these things I think are areas that the continent will need to work on to avoid these risks.  the creation of a rising middle class and the opportunities offered for a growth driven by internal consumption, a growth driven by the nonoil sector but really by services, by manufacturing, by agriculture  the type of growth, the quality of growth we’ve had in the past, needs to be radically improved because it has resulted in rising inequality. And that is not a sustainable situation for the future.  certainly true that the type of growth, the quality of growth we’ve had in the past, needs to be radically improved because it has resulted in rising inequality. And that is not a sustainable situation for the future.

A snapshot of Africa  An increasing number of African economies are growing at pleasing rates  SME’s are playing pivotal role in driving these growth rates – they assist in restructuring, industrial development and in satisfying local demand for services – this encourages domestic specialisation, many of which support larger corporations.  Too many SME’s remain in the informal sector – this restricts their ability to raise finance, enter new markets or work with the public sector.  There is a growing body of evidence that the better the business environment the more SME’s arise and greater is their influence of economic growth

The current role of SME’s in Africa  First, with so many countries and in theory SME’s accounting for 95% of Sub- Saharan registered business, we need to know exactly to what we referring.  It is not the microbusiness market, which is often measured as 1-9 employees. SME’s begin at 10 employees and can rise as far as 250 employees. At the top end of this range they are the dominant factor in all economies ( including UK), and it a rough average figure the continent records micro ( 1-9) as being about 90% of all enterprise, small records 8%, medium 1.5% and large 0.5% - though this is an average it is reasonably accurate for the majority of Sub-Saharan economies.  Despite growth, most African countries are not well integrated with international financial markets. Those countries who have recorded lower than average growth rates have ben under the burden of specific factors, including wars and international isolation.

What are the drivers? ( these do NOT apply to all countries and are ‘at best’ a trend.)  Reductions in external debt repayments, caused in part by (a) wiping-off some debts (b) lower interest rates in some developed economies and major lenders  Natural resources – first warning on NATURAL CAPITAL – lack of processing power  Agriculture – remain low in productivity but large in employment – think traditional mixed with modern – surprising yields. In some countries e.g. Zambia, how can it made 12 months of the year  Raw materials and agriculture account for around 70% of Sub-Saharan exports – different from that of Latin America and Asia  Imports, especially of foodstuffs and electrical equipment are increasing in BOTH quantity and value ( SME opportunity area)

More drivers…  An incomes rise so Foreign Direct Investment flows are rising – see earlier presentation  Returns on FDI have risen to as high as 25%, whilst Eastern Europe struggles to reach 10% - though this number does contain some volatility.  At present Africa receives approximately 2% of FDI – African Stock Exchanges are recording attractive rates of return, some as high as 35% and with risk premiums falling Africa is seen as a less risky investment than it was in first decade of this century. The majority of elections are now considered to be ‘ reasonably free and fair’ – lower risk and higher growth rates are attracting increasing amount of both paper speculation and direct FDI.  Against this we have to offset actions by groups such as Boko Harem, military coups, ethnic tensions and natural disaster (Ebola)

More drivers….  As a more settled pattern emerges across Africa so risk premiums are falling – by about 1.5% in recent years.  Lines of credit are also increasing – this is assisting private investment to expand and most economists agree that this is normally more of a stimulus to economic growth – this is another term we need to consider, as many prefer to focus on economic development, which contains many more measurements that just GDP/GNP/GNI.  Channelling FDI into the private sector investment is now agreed to normally be more growth oriented than into the public section – though infrastructure investment is normally focused on the public and is known as being complementary to growth prospects.  Private consumption and private investment are now the largest drivers of economic growth in the majority of African countries.  The informal sector in most Sub-Saharan economies represent between 40-60% of GDP. The sector mostly consists of small merchandise traders, the selling and producing of basic services, simple manufactured goods and processed food and drink. As such this sector is ready for inward investment.

More drivers…  Though SME’s are a growing market in Africa the precise number is influenced by the institutional factors already mentioned – they are not necessarily related to level of economic development and can be widely spread over a range of business areas.  Research from IMF and World Bank suggests that the wealthier the country is the more important is the role of SME’s. This research also shows a negative correlation between the proportion of employment and GDP generated by the informal sector and GDP per capita. This would point to African countries who have a large informal sector being capable of promoting more entrants in the SME market but with the proviso that GDP per capita may not grow as fast as expected.  The ‘perfect storm’ scenario for SME’s in Africa would appear to be that when a country is following a persistent path of economic growth, then as levels of income grow so does the demand for the goods and services that SME’s can provide – in the formal sector.

It’s a growing market and set to get larger!

Any questions?  You can always contact me on: – Phone – African Research Associates Thank You