SMEs are catalysts of economic development globally. Islamic SMEs are considered beyond a general ‘inclusion strategy’, leading to their acceptance as employment generators and producers for niche sectors. As the global economy was abruptly occluded due to COVID-19, SMEs are particularly affected due to a number of reasons. While many large companies can quickly transform their production and marketing policies from a physical route to an electronic platform, the same is onerous for SMEs due to the cost associated with this quick transformation.
In addition, the additional cost of financing due to the long delay in sales recovery during the pandemic — since February 2019 until now — has forced millions of SMEs either to completely shut their doors or to significantly reduce their scope. Since a major portion of Islamic SME financing is done through non-profit-and-loss-sharing contracts, Islamic SMEs do not expect effective risk- or loss-sharing during this difficult time. Consequently, there are puissant infrastructural, regulatory and market-based transformations that become prerequisites to help SMEs survive the post-crisis impact until at least the year 2025. This may take a long-lasting toll on the several recent country-specific visions that include Saudi Vision 2030, Malaysia Vision 2025 (or Shared Prosperity Vision 2030), Africa Vision 2025 and the Indonesia Islamic Economic Masterplan 2019–24.
Review of 2020
Islamic SMEs were impacted from the beginning of 2020, even though not solely because of the pandemic. Due to geopolitical rifts affecting SME-centric Muslim-majority countries, including Malaysia, Nigeria, Sudan, Pakistan and Saudi Arabia, SMEs have experienced a suboptimal start. Then comes the mighty COVID-19. The World Bank projected a massive reduction in the GDP growth rate by the first quarter of 2020 for most of these countries, including a staggering -3.8% in Saudi Arabia, 0% in Indonesia, 1.6% in Bangladesh, -3.1% in Malaysia and -2.6% in Pakistan.
In a cycle of events, the reduced growth forecast will block essential strategic assistance for SMEs, including financing and cross-border trading. On the other hand, some countries tried helping SMEs by completely closing borders, but at the cost of a higher inflation rate: the general point-to-point price level grew by at least 2.5%. As a result of this globally unmatched fallout of the supply chain, SMEs are expecting a dramatic closure of businesses.
McKinsey and Company has reported from a survey by SME.Africa and SASFIN that 60% of the SMEs in Africa are expected to shut down their premises by the time COVID-19 is over. Mapping the impact of COVID-19 for South Africa, where 98% of the businesses are registered as MSMEs that are responsible for 50–60% of the country’s employment, it is suggested that most countries should start a half-a-decade SME recovery plan.
The situation is often worse for Asian SMEs as the sources of supplies are more concentrated to China, India, Bangladesh, Vietnam and Taiwan. Some of these countries are heavily hit by the pandemic and may require a longer time to recover. Paul Vandenberg, a senior economist with the Asian Development Bank, envisioned that over 60% of the Asian SME workforce became vulnerable to the COVID-19 issue.
A recent survey by Monsha’at, the SME General Authority of the Kingdom of Saudi Arabia, revealed that nearly all the SMEs (99.5%) found themselves in some sort of trouble including laying off employees (15%), pessimistic business confidence affecting revenue (66%) and a continued loss for the rest of 2020 (73%). Even though only a quarter of the SMEs trained their employees on the applications of e-commerce to diversity the operation, it was unclear how the policy initiatives supported the SMEs.
Preview of 2021
Unfortunately, 2021 may not be a recovery year for the lion’s share of the surviving SMEs. Before quickly deciding on transferring all burden to the policymakers, let us relook the problems. I forward four major problems for SMEs for 2021 (Figure 1). SME businesses are profoundly pro-cyclical. Only 10% of the SMEs generally survive the first year of their life cycle. Therefore, SMEs and policymakers must initiate changes (1) to diversify small businesses to reduce their pro-cyclicality, and (2) to help SMEs survive the crucial first year.
SMEs are extremely poor in management planning, financial literacy and adaptation strategy in particular. According to the Asia Pacific MSME Trade Coalition Survey, SMEs may face a serious cash flow shortage due to limited knowledge of strategic and financial planning. As revenue falls due to COVID-19, SMEs will prefer to close their business than to proactively search for a restructuring.
In strategic terms, SMEs largely depend on regulatory incentives. During the pandemic, SMEs are left alone when the governments are busy feeding the most important economic and social urgencies. Most SMEs are limited in their use of e-commerce facilities. Most Muslim countries do not provide updated internet infrastructure and training facilities for the SMEs to effectively learn and join the electronic ecosystem. Due to limited financing for SMEs, Islamic SMEs rely heavily on personal financing. During this extreme economic downfall, potential investors in emerging countries may look into non-SME investment due to a shortage of personal finance and the unavailability of collateral.
The way forward is challenging. At the beginning of the crisis, researches pointed out the need for additional fiscal and monetary incentives for SMEs. Obviously, these are ‘desperate measures for desperate times’. Low cost of credit, subsidizing wage and materials through bonded warehousing and relaxing or deferring tax payment are some of the more common suggested initiatives. Even though none of these are particularly unique to Islamic SMEs, these initiatives have met serious opposition.
As SMEs are already an incentive-dependent sector, the overreliance on the fiscal and monetary relaxations may force additional pressure on the financial market in the form of increasing government and private sector borrowings. Consequently, increasing inflationary pressure may reduce the real economic added value.
A general recommendation is to increase cross-border collaboration among SMEs from neighboring countries, leading to temporary trade bubbles. These bubbles, however, do not solve the financing crisis. As we go across this new normal, it has been suggested that countries practicing Islamic financing should engage in Waqf-based public–private partnership, going back to profit- and loss-sharing contracts, Zakat trust funds for investment and Qard Hasan-based financing contracts.
More essential is to consider redesigning the SME business model that will enhance their capabilities to adapt to uncertainties. For instance, Waqf-based private equity companies can take over the development of innovative Islamic products. We see examples such as Kohlberg Kravis and Roberts managing US$222 billion-worth of assets of 103 portfolios across 20 cities primarily based on private equities. Similar Islamic asset management companies can be set up to nurture Islamic SMEs.
The views and opinions expressed in this article are those of the author’s independent personal opinion and should not be construed to represent any institution with whom the author is affiliated.