FINANCIAL GROWTH AND CHALLENGES FACING THE GROWTH OF SMEs IN KENYA CHAPTER ONE; INTRODUCTION 1. 1 BACKGROUND In recent years, the nurturing of SMES have become the dominant theme of development economics. This rediscovery of the importance of the spirit of free enterprise was undoubtedly prompted by the failure of centrally planned communist economies. The achievement of impressive prosperity by certain East Asian and western countries also encouraged the start up of SMES (Mwaura, 2006) A global perspective

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There is no generally accepted definition of small businesses because the clarification of businesses into large scale or small scale is a subjective and qualitative judgement. For instance, in the US, Britain and Canada, small scale business is defined in terms of annual turnover and the number of paid employees. In Britain, small scale business is defined as that industry with an annual turnover of 2 million pounds or less and with fewer than 200 paid employees. In Japan, they are defined according to the type of industry, paid up capital and number of paid employees.

Consequently, SMES are defined as; those in manufacturing with 100 million yen paid up capital and 300 employees, and those in the retail and service trades with 10 million yen paid up capital and 50 employees (Valsamakis and Sprague, 2001). There is no single, accepted definition of a small and medium enterprise (Storey, 1994, Valsamakis and Sprague, 2001). While the definition of a SME differs from country to country, the SME literature has typically used criteria such as sales volume, number of employees (for manufacturing) and fixed physical assets (Kathuria, 2000; Lefebvre et al. 1992; Valsamakis and Sprague, 2001). In Kenya, microenterprises are those with 10 or fewer workers, small enterprises have from 11 to 50 workers and medium enterprises have from 50 to a 100 workers. There are however no records to show these classifications in Kenya. Censuses indicate that micro enterprises comprise the lion`s share of enterprises in Kenya while there are a few medium enterprises (Parker and Torres, 1994). Today in Singapore SME community makes up over 90% of enterprises.

Last year (2007) SMES contributed about 42% of the country’s GDP and employed more than half the workforce (Chandaria, 2007). In Malaysia, where the government has acknowledged the growth potential of SMES, there is great collaboration with ministries and government agencies to synergize implementation programs that spur development resulting in strategic alliances with larger entities. The collaboration has provided SMES with greater access to markets, financing, technology transfer and best practices in human capital development.

Through effective partnership the Malaysian government has projected SMES contribution to GDP to increase from 32 percent in 2005 to 37 percent by 2010. This will have an impact on total employment share by which SMES contribution will be 57 percent. This is according to a speech made by Dato’ Seri Abdullah bin Haji Ahmad Badawi Perdana Menteri Malaysia on 6th June during the official launch of SMIDEX 2007 (Chandaria, 2007). The development of the private sector varies greatly throughout Africa.

SMEs are flourishing in South Africa, Mauritius and North Africa, thanks to fairly modern financial systems and clear government policies in favour of private enterprise. Elsewhere the rise of a small-business class has been hindered by political instability or strong dependence on a few raw materials. In the Democratic Republic of Congo, for example, most SMEs went bankrupt in the 1990s – as a result of looting in 1993 and 1996 or during the civil war. In Congo, Equatorial Guinea, Gabon and Chad, the dominance of oil has slowed the emergence of non-oil businesses.

Very few countries have working definitions of SMEs, except some members of UEMOA/WAEMU and Mauritius and Morocco. So data on this is hard to compare, though patterns can be seen and countries can be ranked by extent of SME activity: Nearly 80 per cent of firms in Congo have fewer than five workers. The country has 2 100 firms in the formal and 10 000 in the informal sector. A 1997 survey in Benin showed that of the 666 SMEs counted, half were in commerce and the rest were mostly in construction, or were pharmacies and restaurants. Only 17 per cent were in manufacturing.

SMEs in Kenya employed some 3. 2 million people in 2003 and accounted for 18 per cent of national GDP. SMEs in Senegal contribute about 20 per cent of national value-added. Nigerian SMEs account for some 95 per cent of formal manufacturing activity and 70 per cent of industrial jobs. In Morocco, 93 per cent of all industrial firms are SMEs and account for 38 per cent of production, 33 per cent of investment, 30 per cent of exports and 46 per cent of all jobs. Micro and very small businesses in South Africa provided more than 55 per cent of total employment and 22 percent of GDP in 2003.

Small firms accounted for 16 per cent of both jobs and production and medium and large firms 26 per cent of jobs and 62 per cent of production. (African Development Bank and OECD Development Centre, African Economic Outlook (2004-2005). 1. 2 ROLE OF SMEs IN AN ECONOMY The Kenyan informal sector has greatly grown over time and plays an important role in job creation, reducing income inequalities, conserving foreign exchange, tapping small industrial and family savings for investments and creation of industrial skill at a little cost (GOK, 1986 and Ikiara, 1991).

Nearly half of Kenya’s population made a living from small scale cash crop farming, carpentry, masonry, metal working, tailoring, shoe making, second hand clothes and matatu business (Mulaa, 1993) It is widely recognized that smes form the backbone of the private sector at all levels of development in least developed countries and make a significant contribution to economic development in general and to industrial development in particular. Over 90% of enterprises in the world are smes which account for between 50 to 60% of employment, while smes engaged in manufacturing accounted for between 40 to 80% of manufacturing employment.

Their contribution is even more important in the last developed countries of Africa, where they often offer the only realistic prospects for increases in employment and value added (World Bank, 2003). Smes also contribute to development significantly since they are more labor intensive and lend to a more equitable distribution of income than larger enterprises. They provide employment opportunities at reasonable rates of remuneration to workers from poor households and to women who have few alternative sources of sources of income (Hobolm and Kennedy, 1999).

Smes contribute to a more efficient allocation of resources in developing countries. To the extent that these enterprises operate in informal markets, the factor and product prices they face also provide a better reflection of social opportunity costs than the prices faced by large enterprises (Hobolm and Kennedy, 1999). Smes support the building of systemic productive capacities. They help absorb productive resources at all levels of the economy and contribute to the establishments of dynamic and resilient economic systems in which small and large firms are interlinked.

They also tend to be more widely dispersed geographically than big firms, support the development and diffusion of entrepreneurial spirit and skills and help reduce economic disparities between urban and rural areas (Hobolm and Kennedy, 1999). Smes contribute significantly to economy`s output of goods and services and act as a primary source of developing a pool of unskilled and semiskilled workers on entrepreneurial talent who form an important base for future industrial expansion.

In addition, smes strengthen forward and backward linkages among socially, economically and geographically in diverse sectors of the economy. The sector constitutes an important market and supply point for products of rural enterprises, which are predominantly marketed to rural areas (sessional paper on smes, 1992). 1. 3 FINANCIAL GROWTH OF SMEs IN KENYA Growth is defined as increase, expansion or development. In this context, growth will be considered to include increase in size; workforce, turnover levels, changes in asset size, profitability, revenues and expenses (Mwaka, 006). Growth of smes can be reflected in terms of graduation in the following dimensions; legal dimension a business that fulfills the requirements necessary to be a legally licensed enterprise, the social dimension which makes the personal development of the entrepreneur the focal point and financial dimension entrepreneur leaves the credit program of MFI`s to become a client of the formal financial sector (mwaka, 2006).

Other factors suggested to give an indication of growth by GOK sessional papers include increased access to credit, increased info on available market opportunities, improved production techniques for small scale manufacturing and training focused on skills development (Ronge, Ndirangu and Hezron, 2002). Constraints on growth include lack of property rights which limits their ability to access external finances, inadequate infrastructure, undeveloped business support services, inhibitive legal and regulatory environment, limited access to markets, unfavorable tax regimes among other (Ihiga, 2005). . 4 SMEs IN KENYA History of SMEs In the mid 1960`s a new approach to small to medium scale enterprise development began to emerge due to several factors. First there was growing concern over low employment elasticity of modem large scale production. It was claimed that even with more optimal policies, this form of industrial organization was unable to absorb a significant proportion of the rapidly expanding labour force.

Second, there was widespread recognition that the benefits of economic growth were not being fairly distributed, and that the use of large scale capital intensive techniques was partly to blame. Third, empirical studies revealed that the causes of poverty were not confined to unemployment, and that most of the poor were employed in a large variety of small scale production (Noormohamed, 1985). The present situation SMEs sector has in recent times assumed a position of almost universal orthodoxy. In all the successful economies of the world, they figure as a dominant force in achievement of economic growth.

The impressive economic performance of the likes of Taiwan, Korea, Malaysia, Singapore and many western countries has focused the attention of business leaders, policy makers and academicians on the prominent important role played by SMEs (Mwaura, 2006). Drawing on the experiences of the aforementioned nations and seeing what tremendous influence SMES can have on the economic growth and development of a country, some African countries also resorted to it as the engine for economic prosperity and development.

Leaders on the African countries also realized that SMES can make significant contribution to economic growth, employment generation and social progress. They refer SMES as “second economy” (Macgaffey, 1998). They are the most effective job creators, because they are generally more labour intensive than large enterprises and generate more direct and indirect jobs per unit of capital invested. They provide a seedbed for entrepreneurial talent and contribute to the competition within an economy.

They aid the promotion of free enterprise and self sufficiency by creating and spreading wealth to the grassroots level and as a result enhance economic and political stability (Macgaffey, 1998). Some numbers related to SMEs Informal sectors in Kenya are considered one of the major contributions to the economy of the country. It is reported to have created 500,000 jobs a year. However, little is done to support this vital sector to enhance its performance amid environmental and other constraints.

Kenya`s informal sector in the last few years has rightfully earned recognition as a major contributor to the growth and development of the economy, esp. with slowing down the expansion of the traditional formal sectors (New people African feature service, 1999). Although it is globally acknowledged that SMES have been duly recognized as a major source of economic growth in many emerging economies and have provided countless job opportunities to the citizens, the challenges they face have prevented them from realizing their full potential, particularly in Kenya (Mwaura, 2006).

Kenyan government’s attitude towards SMEs The business sector in Africa especially SMES frequently suffer from harassment by government officials. Demolitions in Nairobi bear testimony, where even licensed small businesses are threatened with demolition and closure. Government policy in Kenya encourages their people to establish medium and large scale businesses in commerce and industry, but some scholars argue most Kenyan Africans are not yet ready for the step.

They attribute the stagnation in the private enterprises sector to policies that impose “capitalism from above”. These policies benefit reigning politicians and high level civil servants rather than indigenous private sector businesspersons. The misunderstood colonial approach was vindicated in the 1980`s when the government began to integrate the small scale and informal sectors into its overall policy regime. Kenyan government established a strategy for small enterprise development in Kenya towards the year 2000 (GOK, 1992).

The importance of SMEs to the economy While SMES potential to narrow the income gap, generate employment, stimulate economic growth and alleviate poverty, which are part of the wider national economic goals, has been widely acknowledged by the policy makers, this sector still remains handicapped in more than one way. Failure to remove bottlenecks for SMES can be attributed to the government obsession to promote large industrial concerns, mainly foreign investments, at the expense of the struggling SMEs (Ihiga, 2005).

With time however, the government is increasingly coming to terms with the inadequacies of the large industrial concerns in addressing domestic economic problems and has been incorporating policies aimed at boosting this sector. For instance, the sessional paper no. 2 of 1992 addressed specific means of promoting the sector and how to link the big industries SMES. The same emphasis is also apparent in the development plan of 1997-2001 (GOK, 1992). Like in Malaysia and Singapore, SMES importance in the Kenyan economy cannot be downplayed.

In a labourforce of 14 million or more, it is estimated that 61% of those working outside smallholder agriculture are employed here. And in urban areas, 35% of households participate in small business, with the %age being even higher, 59% in smaller urban centres. About . 5 million jobseekers, inclusive over 10,000 university graduates, are spewed into the tight labour market annually, but given the sluggish growth of the formal sector which employs a mere 1. million people, it is becoming patently clear that only the enhancement of the informal sector can salvage the situation (World bank, 2003). If the government stated goal to achieve the status of an industrialized country by 2020 and the realization of vision 2030 are to be achieved, then more concerted efforts to improve the growth of SMEs must be exerted (Mwaura, 2006). SMES in Kenya are faced with the problem of credit availability since providers of credit prefer large scale enterprises over SMES which are considered less risky as compared to SMES considered to have a high default risk.

The current banking regulations on collateral hamper the growth of micro-finance banking and hence legislation should be enacted to facilitate setting up micro-finance banks, which will operate on modified rules (Ihiga, 2005) Donors’ efforts towards SMEs development Further, on the question of donors funding, a report by the International Centre for Economic Growth (ICEG), while proposing a widening in the range donors, says that funds should be strictly monitored to ensure at least 60% each the intended enterprises before approval by the proposed Department of Small Enterprise Development (DSDE), in the ministry of national planning and Small Enterprise Development Authority (SEDA). This would also prevent duplication of programmes by mushrooming agencies and fit within the national strategy (Mwaura, 2006). Partnerships by government and development partners to help SMEs In the past few years a number of commendable moves have been recorded on this count.

The Ministry of Planning and National Development has established an information unit called Information Management Section to provide information on available opportunities and it is working with UNDP towards establishing an accessible database. Further, K-Rep Holdings in 1993 established ARIFU Centre with the aid from DFID, which contains valuable data for the sector (GOK, 1992) SMEs also face the problem of lack of quality access to the requisite information. While there has been effort to promote information flow by the government as recommended in Sessional Paper No. , 1992 to adequately redress the situation, this remains a major barrier to the growth of the sector (GOK, 1992). All the same, for proper dissemination of information, the government and the NGOs participants in the sector will have to establish a proper channel of sharing consumable Information, preferably through the establishment of a network accessible to rural areas (Mwaura, 2006). The Kenya Bureau of statistics (KBS) in collaboration with government departments, especially those dealing with the sector, are said to be working together towards achievement of this goal.

In the past the quality and diversity of MSE products stunted growth of the sector both on the domestic market where most of it is consumed, in the export market (Mwaura, 2006). With the help of the Kenya Bureau of Statistics (KBS), the sector can boost its sale in both markets and achieve its goals, that is, if KBS customizes its standards for the sector so that it does not present an extra barrier to progress, particularly with the globalization of the economy in mind.

Quality issue is already being addressed by among others, KIRDI, who have set up the leather development centre, textile training institute and the engineering and design development centre (EDSE) (Mwaura, 2006) Of particular importance is the acquisition of modern technology and dissemination of the same to the grassroots, if they are to compete with large enterprises. The sessional paper no. 2 of 1992 mandated Kenya Industrial Research Development Institute (KIRDI) to version imported technology to local needs, but, given funding and information flow constraints, it still has not had the desired effect.

It will be important that the government makes use of extension officers to the very basic level so that adapted and available technology can percolate downward for both the service and the manufacturing sectors (GOK, 1992) Sessional paper no. 2 of 1992 says the government would promote linkages between big enterprises and small ones for the benefit of the latter. Previously similar arrangements had been achieved through ministry of industry development initiative, where General Motors and East Africa fine spinners sub-contracted SMEs, but this came a cropper when UNIDO withdrew its funding.

Collaboration of the Kenya Chamber of Commerce and Industry (KCCI) with other interested parties is required to enable both sides to enhance such linkages. In sessional paper no. 2 of 2005 the government commits itself to the promotion of an enabling environment to the growth of the sector in particular the provision of a supporting framework for SMEs (GOK, 2005). At last the Kenyan government appears to have woken up to the reality of this sector, which at its best is reported to have created 500,000 jobs a year. This will be the most viable way ahead for the economy.

This change in approach was accompanied by a shift of focus towards a “rurally oriented smallholder” (ROSH) industrialization strategy, well articulated in Kilby (1975), Child (1976) and House (1978) among others. Kenyan SMEs have expanded to an extent that they are now opening operations in the neighboring east Africa states, African Air Rescue (AAR) opened an office in Rwanda in 2005, Skipix, an information technology and media communications company opened operations in Rwanda and many other have opened operations in southern Sudan and other east African countries (Financial post, 2009).


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