SMEs Development in Nepal : Current Status and Way Forward

Introduction

Small and Medium Enterprises (SMEs) refers to all types of micro, cottage, small and medium enterprises. These are generally determined on the basis of annual turnover, fixed assets, job creation etc. SMEs play an important role in creating self-employment opportunities, mobilizing and utilizing local resources and increasing the income of rural people. Small and medium industries have contributed significantly to the creation of employment in emerging and developing countries. According to the World Trade Organization SMEs represent over 90% of the business population, 60-70% of employment and 55% of GDP in world economies.

The Industrial Enterprises Act in force in Nepal has classified the industries as micro, cottage, small, medium and large. It seems appropriate to study all the enterprises except the big ones as SMEs.

The practice of small and cottage enterprises in Nepal has existed since ancient times. Under which there was trade with India in the south and Tibet in the north. Administrative bodies like Udyog Parishad (1936) and Ilam Prachar Adda (1940), which were opened at the government level before the emergence of democracy in 1950, and the Biratnagar Jute Mill established in 1940, led Nepalese SMEs to the formal path. In the following years, industrial sector was developed under state control. After the political changes of 1990, Nepal adopted an open and liberal economy. In the following years, the private sector has been playing a leading role in the industrial development of the country.

At present, the constitution of Nepal has adopted an open and liberal economy. The Industrial Policy 2011, which provides policy guidance for the development of SMEs, is being implemented in this area. The Industrial Enterprises Act 2020 has made arrangements regarding industry registration and operation process. The Department of Industry under the Ministry of Industry, Commerce and Supplies is the agency that oversees the administration of industry at the center. There are Cottage and Small Industry Offices in all the districts under all the 7 provinces. Micro, Cottage and Small Industry Promotion Center has also been established at the central level for the promotion of small enterprises.

So far, 10 Industrial Zones have been established and 6 have been announced in Nepal. Also 5 Special Economic Zones (SEZ) and 5 Dry Ports have been announced. After the country entered the federal system, the government of Nepal has been implementing the policy of building industrial villages at every local level and industrial parks in every province with priority.

Various procedures and standards and banking channels have been arranged to provide concessional loans to entrepreneurs. A policy of cash incentives has been adopted for export promotion. Various programs are being conducted for enterprise development at the provincial and local levels as well.

In this perspective, it is necessary to study the current situation of SMEs, their contribution to the economy, the financial investment situation in SMEs, the problems faced by SMEs and the way to improve them. This study focuses on that topic.

Objective of the Study

The main objective of this study is to review the current situation of small and medium enterprises in Nepal, identify challenges and suggest ways forward. It is mentioned as follows.

•           To analyze the current situation of small and medium enterprises in Nepal,
           To find out the challenges of small and medium enterprises in Nepal,
           To find the future direction of development of small and medium industries in Nepal.

Literature Review

In Nepal, there is a trend of seeing the industry as micro, cottage and small in one part and small, medium and large in another part. Both of these parts were looked after by the Department of Cottage and Small Industry on one hand and the Department of Industry on the other, but currently small and cottage matters are under the provincial government and other matters are looked after by the Department of Industry. Due to all these reasons, it seems difficult to obtain integrated data on Nepalese SMEs.

Policy and legal arrangements related to Nepalese SMEs, surveys, calculations and studies conducted by the Nepalese Ministry of Finance, Nepal Rastra Bank, Department of Industry and Central Bureau of Statistics and Federation of Nepalese Chamber of Commerce and Industries have been presented.

The Industrial Enterprises Act, 2020 has made arrangements regarding the registration process of the industry and various concessions and facilities. In this, the industry is classified as follows (The Industrial Enterprises Act: 18).

Micro Industry: Having a fixed capital of up to 20 lakh rupees excluding real estate, the entrepreneur himself is involved in the operation and management of the industry, has a maximum of nine employees and the annual turnover is less than 10 million rupees, if the machine has an operating capacity of 20 kilowatts or less.

Cottage Industry: Based on traditional skills and technology, labor intensive and special skills or based on local raw materials, local technology, art and culture, consuming up to fifty kilowatts of electricity in case of machines, certain mentioned industries.

Small Industry: Industries with fixed capital up to fifteen crore rupees.

Medium Industry: An industry with a fixed capital of more than fifteen crore rupees to fifty crore rupees.

Large Industry: Industries with a fixed capital of more than fifty crore rupees.

Industrial Statistics (2021) published by the Department of Industry, the number of small, medium and large industries established in various sectors under the department up to that financial year, the proposed investment and employment have been presented.

Micro, Cottage and Small Industry Statistics (2021) published by the Department of Industry, the number of micro, cottage and small industries established in various sectors in 2020/21, the proposed investment and employment statistics have been presented.

Based on these two reports 604,830 SMEs have been registered in Nepal by the end of the financial year 2020/21. Detailed statistics of SMEs in the last 10 years are as follows.

Table -1 SMEs Registered in Nepal by FY 2011/12 to 2020/21

Fiscal Year	SMEs Registered in FY	Proposed Total Capital in FY (in million)	Proposed Employment	Registered SMEs Up to FY	Proposed Total Capital Up to FY (in million)	Proposed Total Employment Up to FY
Up to 2010/11				245460	260108	2108614
2011/12	18050	20169	75704	263510	280277	2184318
2012/13	19482	30912	86788	282992	311189	2271106
2013/14	16628	36337	22385	299620	347526	2293491
2014/15	26348	38557	109822	325968	386083	2403313
2015/16	24389	58011	77628	350357	444094	2480941
2016/17	32120	44173	134534	382477	488267	2615475
2017/18	37221	74204	146015	419698	562471	2761490
2018/19	52720	111684	208485	472418	674155	2969975
2019/20	48977	138762	178017	521395	812917	3147992
2020/21	83435	200647	314913	604830	1013564	3462905

(Source: Department of Industry)

Project Loan Potential (2021) published by the Federation of Nepalese Chamber of Commerce and Industries, credit flow practices in startup micro, cottage, small and medium enterprises have been studied.

SMEs Financing in Nepal (2020) published by Nepal Rastra Bank, has been studied on the mobilization of financial instruments in SMEs.

National Economic Census Report (2018) published by Central Bureau of Statistics have presented the statistics including establishments, their registration status and the manpower involved in them.

Economic Survey (2022) published by the Ministry of Finance has presented the overall economic situation of the country.

Study Methodology

In this study, the legal basis for distinguishing small and medium enterprises has been considered as a theoretical basis. It is basically based on the provisions of the Industrial Enterprises Act of Nepal. Mainly relying on secondary sources for the collection of material. The study is based on the study reports and statistics obtained from the websites of the Government of Nepal Ministry of Finance, National Bank of Nepal, Department of Industry, Central Bureau of Statistics, Planning Commission of Nepal and Federation of Nepalese Chamber of Commerce and Industries. The findings of the study have been further analyzed and presented based on the challenges and suggested suggestions in the same study reports and the articles of experts of various related subjects.

Sectoral Involvement of SMEs

Most of the small and medium enterprises in Nepal are involved in the service sector and the agro-forestry sector. In the service sector include educational and health institutions, educational consultancy, hostels, restaurants, trade and suppliers, etc. In the agro-forestry sector include rice, pulses, oil and flour mills, dairy products, conditioned soft drinks, fruit juices and processed products, tea, noodles, biscuits and snacks, chocolates and candies, mineral water, dry vegetables and other food items. They are involved in the production and processing of other consumer goods. The sector includes forest fiber based industries, wood and metal handicrafts, handmade paper and products, textiles and clothing, woolen carpets, pashmina shawls, rugs and leather.

Thirdly, in the manufacturing sector, the involvement of SMEs in the production of items such as utensils, plastics, pipes, jute goods, cement, rods, rubber tires and tubes, colored paints is high. Since investment is open to the private sector for infrastructure development, investment in small hydropower, tourism resorts and complexes has also increased in some areas.

The number of micro, cottage and small industries in different sectors is as follows.

Fig -1 Number of SMEs* Registered till FY 2020/21 (Based on Classification)

(Source: Micro, Cottage and Small Industries Statistics (2021), Department of Industry)

*Only micro, cottage and small enterprises are included

In Nepal, most of the micro and cottage enterprises that are still located in rural areas, operate seasonally and are run by family members are not registered. According to the Central Bureau of Statistics, the number of such enterprises is 49.9 percent (National Economic Census: 17). It seems difficult to assess the contribution made by such enterprises to the national economy.

Employment Created by SMEs

According to the statistics of the Department of Industry, the number of jobs offered in registered SMEs in Nepal has reached 3462905 people. The average job creation in the last ten years is 135430 people per year. While in Nepal every year the number of people entering the labor market exceeds 500,000 (Fifteenth Plan: 333). Looking at the statistics, it seems that 27 percentage of the workforce entering the labor market is employed in SMEs. The details of SME establishment and job creation in the last ten years are presented as follows.

           Fig -2 SMEs Establishment and Job Creation by FY

(Data taken from table -1)

Looking at the mentioned statistics, the growth rate of SME establishment and employment creation in other financial years is positive, but it is negative in financial years 2013/14, 2015/16 and 2019/20. In the first year, there was a prolonged transition period and in the following years, due to the earthquake in 2015 and the Covid-19 pandemic in 2019, the establishment rate of industries and the growth rate of employment decreased. In post-Covid-19 situation, it has been assessed that most of the SMEs have been negatively affected and many have lost their jobs, but it does not seem to have been sufficiently studied.

Mobilization of Financial Instruments in SMEs

As of February 2022, there are 27 commercial banks, 17 development banks, 17 finance companies, 66 microfinance financial institutions, and one infrastructure development bank in Nepal (Economic Survey: 64). Government of Nepal has adopted the policy of subsidized loans based on projects. However, there seems to be insufficient investment from financial institutions in start-up SMEs. According to a study of Nepal Rastra Bank, only 16 percent of start-up enterprises have access to banks (Project Loan Potential: 8). In startups and small and medium enterprises, the main source of investment still seems to be ancestral wealth and self-saving. It can be seen in the documentary below.

                         Fig -3 Sources of SME Financing

(Source: SME Financing in Nepal (2020), Nepal Rashtra Bank)

Contribution of SMEs to the Overall Economy

In recent years, structural changes have been taking place in Nepalese economy. The agriculture-based economy is gradually transforming into a service-based economy. It is estimated that the contribution of agriculture, industry and service sector to the Gross Domestic Product will be 23.9 percent, 14.3 percent and 61.8 percent respectively in the current financial year (Economic Survey: 64). SMEs occupy 90 percent of the total industrial sector, but the contribution of manufacturing industries is decreasing. Since most of the SMEs are involved in the agriculture and service sectors, it is estimated that the contribution of SMEs from all sectors to the Gross Domestic Product is 22 percent (SME Financing in Nepal: iii).

Nepal's export size is small. In the total international trade of 21.2 trillion, the import-export ratio is 1:9 (Department of Customs: 2021/22). However, the export growth rate has been encouragingly increasing in recent years. Agricultural products, handicrafts, carpets, textiles, oil and other major items exported from Nepal are produced by SMEs. But since there is no clear study, it is not possible to estimate the contribution of SMEs in the total export. Some previous studies have shown that SMEs account for 70 percent of total exports (Luitel: 329). But there is no updated study.

Challenges faced by Nepalese SMEs

In Nepal, it has not yet been possible to clearly identify the areas of comparative advantage and competitive advantage and invest in those areas to gain benefits. Small hydropower projects, tourism sector, herbs, forest products and final preparation of agricultural products are the challenges to be prepared and exported. Due to globalization and liberal economic policies, rather than investing in the productive sector, it seems that there is a tendency to import cheap goods from neighboring countries and sell them in Nepal to gain profit in a short period of time (Fifteenth Plan: 152).  For this reason, in the structural changes of Nepalese economy, the manufacturing sector is declining and the service sector is increasing. If this is not addressed properly, the condition of Nepalese small and medium enterprises will further deteriorate.

Lack of start-up capital seems to be another major challenge for small and medium enterprises. Even though the government of Nepal has adopted a policy of disbursing loans based on project feasibility, the industries have not been able to obtain large amounts of loans. One of the reasons for this is the lack of financial awareness among entrepreneurs and another reason is the practice of financial institutions giving loans on the basis of relationships rather than on the basis of project feasibility.

Arranging appropriate technology and equipment necessary for the development of Nepalese SMEs seems to be challenging. Problems such as lack of raw materials, lack of skilled manpower, and lack of adequate infrastructure still exist in this area (Fifteenth Plan: 153). It seems that new entrepreneurs are finding it difficult to attract new entrepreneurs in this sector due to the lack of market arrangements for the manufactured goods.

Industry administration in Nepal has not yet been made simple, easy and effective. A single point service center has been brought into operation under the Industries Department. But there is so much complexity in the existing laws that even after reading the entire law, the industrialists do not get the information about which agency to go to register the industry. Due to the multi-entity registration system, we have not yet been able to create integrated and clear statistics of the industry.

Developing entrepreneurial thinking, encouraging saving while discouraging consumerism and investing the economic and social capital obtained from foreign employment in the productive sector seems to be still challenging.

Suggestions for the future directions of SMEs Development

It is suggested to adopt the following measures for the development of Nepalese SMEs.

1.      After the country went to the federal system, various types of enterprise promotion funds established in the past, which became inactive, will be brought under the unified fund and activated and operated in a manner that provides loans to SMEs easily.

2.      Encouraging the establishment and operation of technologies that can provide loans online quickly. As in India, Fintech provides loans easily through online means.

3.      To implement more effectively the system of providing loans to start-up enterprises by keeping project mortgage and government guarantee.

4.      Establish cluster-based industrial villages in every district and local levels. Establishing suitable infrastructure such as water, electricity, transport etc. in one place.

5.      To further expand the workplace-based apprenticeship program for supplying skilled manpower to SMEs. Establish linkages between Micro, Cottage and Small Industry Promotion Center and other skill training centers and SMEs so that the related enterprises can easily supply trained manpower from these centers.

6.      Establishing outlets and exhibition places in places to easily bring the products produced by SMEs to the market. By creating an online portal for procurement from government bodies, entrepreneurs will be allowed to advertise their products with price and quality, and the related bodies will also be required to purchase sensitive goods through the same portal.

7.      The government should expand the work of providing assistance in transferring new and modern technology to SMEs with more effectiveness.

8.      By verifying the skills of people who have returned from foreign employment, they will be motivated to transfer their skills and knowledge in related SMEs in Nepal. And also they will be encouraging to invest the remittance in productive sector.

9.      Making industry administration simple, easy and effective.

10.  To strengthen SMEs, collaboration between SMEs and cooperatives will be enhance.

Conclusions

SMEs play an important role in the economic development of any country. It seems that SMEs have been formally developing in Nepal since the 1940s. At present, the government of Nepal has taken the policy of developing SMEs through policy and legal basis, institutional structure and financial system. It seems that Nepalese SMEs are creating jobs annually and contributing 22 percent to the gross domestic product. These seem to be scattered in different subject areas. Basically, their involvement in service and agroforestry sector is high. Still not all enterprises have access to banks. Looking at the financial resources, it seems that most of the investments in SMEs are made from ancestral property and self-savings.

The major challenges for Nepalese SMEs are to clearly identify areas of comparative and competitive advantage and increase investment in that area, access to financial resources and arrange appropriate technology and equipment. In addition to this, provision of raw materials, supply of skilled manpower and access to the market and provision of necessary infrastructure are also challenging. In order to face these challenges, it seems necessary to pay attention to issues such as arrangement of loan funds, encouragement of financial technology and improvement of credit delivery system, cluster development, development and supply of skilled manpower, establishment of sales room, support in new technology and improvement in industry administration. 

References

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Nepal Foreign Trade Statistics. (2021/2022). Department of Customs https://customs.gov.np/ storage/DoC/Statistics/FTS_78_79_final.xlsx accessed on 6 August 2022.

Project Loan Potential. (2021). Federation of Nepalese Chamber of Commerce and Industries doi: https://fncci.org/uploads/publication/file/ProjectFinancingNepali-final_20211020054855.pdf accessed on 4 August, 2022.

SMEs Financing in Nepal. (2020). Nepal Rastra Bank retrieved from: https://www.nrb.org.np/ category/study-reports/page/4/?department=red

The Industrial Enterprises Act. (2020). Government of Nepal doi: https://moics.gov.np/               uploads/ shares/laws/Industrial%20Enterprises%20Act%20%202020.pdf accessed on 5         August, 2022. 

Chandra Dev Joshi

Rajan Khanal