Rouhani banks on small businesses to generate big growth

Even though they constitute more than 85% of businesses in the country, Iran's small- to medium-sized enterprises generate a mere 14.7% of GDP and less than 30% of employment, leading the administration to focus on boosting this crucial sector.

al-monitor An employee works at a small business in Tehran, Iran, Jan. 19, 2016. Photo by REUTERS/Raheb Homavandi.
Navid Kalhor

Navid Kalhor

@navid_kalhor

Topics covered

iranian economy, hassan rouhani, economic growth, business sector, business & finance

Jul 12, 2016

TEHRAN, Iran — To achieve its target of 5% economic growth this year, the administration of President Hassan Rouhani is seeking to revive small- and medium-sized enterprises (SMEs) by continuing to focus on attracting foreign direct investment into slumbering industrial estates. Yet, in spite of the injection of $1.8 billion worth of foreign direct investment into SMEs in the three years since Rouhani took office, the reality is that almost two-thirds of small- and medium-sized enterprises in Iran have reportedly been shuttered.

The importance of reviving SMEs should not be underestimated. In developed economies, they are among the major drivers of economic growth, greatly contributing to both gross domestic product and job creation. Indeed, in high-income countries, SMEs on average generate more than half of GDP and account for over 60% of employment.

According to a report authored by Iran's Islamic Parliament Research Center, previous Iranian administrations have never paid sufficient attention to the development of SMEs. As such, SMEs in Iran account for a mere 14.7% of GDP and less than 30% of employment  even though they constitute more than 85% of enterprises in the country. Iran has long suffered from what is termed the "missing middle" phenomenon, meaning that there is a myriad of obstacles involved in doing business.

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(Source: Vastago)

According to Ali Yazdani, CEO of the Iran Small Industries and Industrial Parks Organization, Iranian SMEs are categorized into four groups: inactive industries, those operating at less than 50% capacity, those using 50%-70% of their potential and unfinished industrial projects. Thus, moving forward, the key question is which fundamental factors have brought about this dilemma for the Iranian economy.

The primary reason for the vulnerability and underdevelopment of SMEs in Iran is the existence of a variety of policy-makers within the state who do not seem to effectively cooperate among themselves. Consequently, this has made basic tasks, such as defining what an SME even is, virtually impossible. Indeed, state organizations define the term with respect to their own requirements and agendas. The differing categorizations of SMEs are evident in the table below:

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(Source: Central Bank of Iran)

Another key factor inhibiting the growth of SMEs in Iran is the shortage of financial resources and unavailability of alternative sources of funding for entrepreneurs. Indeed, for many business owners, trying to secure funding from banks has long been a dead end, given the abnormally high interest rates set by financial and credit institutions. In a negative cycle, this rate hike is caused by lenders being stuck with a skyrocketing amount of bad assets and nonperforming loans due to the prolonged recession and sanctions.

There are other reasons why small- and medium-sized enterprises in Iran have consistently been unable to access the financing needed to expand their share of the economy. For instance, SMEs do not employ standard accounting and auditing methods to report their financial statements. Given that they are mostly family owned, they do not disclose required financial information with the same clarity and transparency that is expected from their larger peers in the same environment.

Accordingly, the lack of acceptable operational records and activity records coupled with the low-yield return of such firms have obstructed their admission by securities and exchange officials. Notably, in developed economies, SMEs largely turn to specialized financial and credit bodies rather than stock markets to raise capital.

Entrepreneurs in Iran also face issues such as a convoluted tax system, laws that make doing business excessively complicated as well as the tendency of past governments to adopt policies that have been unstable and short-lived. Altogether, the consequent reality is that conditions for SMEs are worse than ever.

The merits of creating an atmosphere where SMEs can be established — and grown — greatly outweigh related risks. Indeed, the boosting of these kinds of enterprises would help drive financial resources from the informal sector of the Iranian economy to the more formal one, leading to greater productivity as well as and transparency. In other words, support for SMEs could enhance the accumulation of savings in the economy and aid the raising of capital by entrepreneurs, thus paving the way for the kind of investments that could create new job opportunities. More importantly, in the long run, this shift would pave the way for better income distribution in society.

According to the Islamic Parliament Research Center, support for SMEs could ultimately lead to decentralization of industry, which at present is to a significant extent concentrated in the greater Tehran region. On a grander scale, this could aid the government’s objective of creating job opportunities and driving economic growth in deprived regions of the country.

In this vein, the Rouhani administration and the Central Bank of Iran’s decision to recently cut the interest rate to 18% in parallel with the raising of banks’ lending capacity to SMEs are other calculated measures to revive this important sector of the Iranian economy. This is particularly noteworthy given that 72% of bank loans have until now been extended to the top decile of companies in terms of existing company capital.

The Research Center also recommends that a market dedicated to SMEs is an appropriate measure to boost such enterprises’ access to financing. As such, the impending launch of precisely such a market by the smaller Iran Fara Bourse is an important and welcome step, as the admission requirements of the Fara Bourse are lesser than the larger Tehran Stock Exchange. Indeed, with the launch of an SME-focused market and more available and affordable financing from banks, Iran may finally see a revival among its small- and medium-sized enterprises.

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