INFLATION BLEEDS SMEs WHITE

In January this year, Nepal Rastra Bank (NRB) was compelled to amend the Working Capital Guidelines enforced on October 18, 2022, reportedly, to control the rampant evergreening of loans. The amended guidelines have stopped the rescheduling or restructuring of existing loans but provided flexibility to borrowers to repay their credit as term loans. The loans issued prior to the issuance of the guidelines have to be mandatorily classified under separate categories and it requires provisioning along with the repayment deadline of mid-July 2023 to mid-July 2025 through five instalments.

Lack of fiscal and monetary incentives for SMEs has demoralised the entrepreneurial mass in the country. Though an evidential and independent study is yet to happen, it is believed that many SMEs have pulled down shutters. SMEs are the backbone of Nepal’s economy accounting for 22% of the country’s GDP and employing 1.8 million people, according to the International Finance Corporation (IFC), a member of the World Bank Group.

Nepal witnessed skyrocketing inflation following the Russia-Ukraine war that has caused price hike in fuel and essentials. Nepal Oil Corporation recently announced it will adjust the price of fuel automatically as per the price in the international market after keeping prices at a higher trajectory for more than a year.

Higher fuel price, higher interest rates of banks and financial institutions (BFIs), and higher cost of importing raw materials has significantly increased cost of production and thus the cost of doing business. The sustained increase in general prices of goods and services has eroded the purchasing power of consumers resulting in plummetting demand in the market.

Sunita Dangol, Deputy Mayor of Kathmandu Metropolitan City, recently said that the judicial committee of the metropolis is flooded with complaints for recovery of house rent as some entrepreneurs have fled or failed to pay rental tax for several months. “Such complaints have increased by two-fold as compared to the past,” she said, adding, “The situation reflects that economic activities are shrinking.”

Consistently high inflation has had manifold impacts, especially on SMEs, as a result of which many have been forced to close business. According to Nara Bahadur Thapa, former Executive Director of NRB, inflation has increased input costs such as price of raw materials, labour, interest rate and energy/fuel prices, among others. “Higher input costs directly hit their profitability, and they are unable to pass on these increased costs to their customers by raising prices as consumption has plummeted heavily due to the decline in people’s income along with deteriorating consumption and production pattern,” said Thapa.

He added, “Profit margins have reduced heavily. If small businesses are unable to adjust their prices quickly enough to keep up with inflation, their profit margins shrink. This can limit their ability to reinvest in the business, expand operations, or hire additional employees.”

Higher inflation has created uncertainty in the business environment, making it difficult for small businesses to plan for the future. Rapid or unpredictable inflation has made it challenging to forecast costs, set prices, secure financing, or negotiate contracts, thereby hindering business operations, say entrepreneurs. On the other hand, exporting firms are also facing challenges due to lack of demand n from importing countries. Swoyambhu Ratna Tuladhar, Managing Director, Yak & Yeti Enterprises, stated that the demand for handicraft goods in Europe has declined heavily following the Covid 19 pandemic and further slumped following the Russia-Ukraine tensions.

Due to the high inflation of daily essentials, consumers have had to dig deep into their pockets to meet expenses. Buying luxury items, travelling, dining out and entertainment have become least prioritsed now.

“Inflation hits discretionary spending. When the cost of essential goods and services rises, consumers may have less money available for non-essential purchases,” stated Keshav Acharya, a senior economist. “It has affected small businesses such as retail stores, restaurants and entertainment venues which rely on discretionary spending,” he added.

Meanwhile, employees are demanding an adjustment for inflation in their wages as compensation that keeps pace with rising prices. “SMEs with tight profit margins may find it challenging to meet these demands, leading to increased labour costs and potential challenges in retaining skilled employees,” Acharya reiterated.

Normally, higher inflation affects businesses of all sizes, including large corporations. However, larger businesses often have more resources and bargaining power to navigate inflationary pressures as compared to SMEs. Small businesses have been facing more significant challenges in competing with larger firms which has affected their revenue and compelled them to shut down.

A study of the IFC underlined that access to finance remains a major constraint for 44% of SMEs – deterring their growth prospects and hampering job creation – with the SME finance gap estimated to be $2.9 billion.

Central Banks often respond to inflation by raising interest rates to curb excessive spending and control inflationary pressures and NRB – the central regulatory and monetary authority – has done the same. SMEs are reluctant to avail loans despite the mandatory provision of the Central Bank that has sought mobilisation of certain loan portfolios to SMEs as interest rates have gone very high. Access to credit and their ability to invest for expansion are limited due to expensive borrowing.

NRB has urged banks to mobilise 15% of their loan portfolio in micro, small and medium enterprises (MSMEs) by mid-July 2024, however, the average lending from the banking fraternity hovers at 9.85% till mid-April 2023, according to the Central Bank. The ticket size of the MSMEs lending as defined by the Central Bank is up to Rs 10 million. Three government-owned banks have a sound exposure in SMEs, said Dr Gunakar Bhatta, Executive Director of NRB, adding, “All three government-owned banks have already surpassed the given target; however, the average lending portfolio of the remaining banks stands at around 8% which means they have room for credit expansion in the SME sector.”

SMEs must be revived for stability, inclusiveness, equitable distribution and economic development in the medium term. “The problems should be immediately diagnosed and they must be provided special care through the fiscal and monetary policy to get rid of the current economic slowdown,” opined Thapa. “Tax waiver for a certain period and cheaper credit below ticket size of Rs 10 million for SMEs should be provided by the government considering the importance of the SMEs in job creation and stability of growth,” he stressed.

Businesses too should adapt and work a bit differently. He advised business owners to monitor and manage costs efficiently saying prudence could help small businesses maintain some profitability. This may involve negotiating better deals with suppliers, optimising operations, seeking alternative suppliers, or exploring cost-saving technologies.

Small businesses may also need to adjust their pricing strategies to reflect rising costs. While increasing prices is one option, it’s essential to assess the market’s price sensitivity and competitor actions to avoid losing customers. Exploring alternative pricing models or product/service differentiation can also be considered, states Thapa. “Subsequently, diversifying the product/service offering or customer base can help small businesses mitigate the impact of inflation. By expanding into new markets or developing additional revenue streams, businesses can reduce their dependence on specific products or customer segments that may be more susceptible to inflationary pressures,” he emphasised.

He further advised that SMEs focus on financial planning, downsizing operations (part-time or outsourcing of labourers, exploiting technologies such as online selling, among others), regular cash flow projections, and financial strategies to account for changing economic conditions. “Financial planning is more crucial for forecasting to anticipate and mitigate potential inflationary impacts,” he said.

Experts say that sharing knowledge, pooling resources, and collectively addressing common challenges can help small businesses navigate the impacts of inflation more effectively.