Small and Medium Enterprises in Russia - Essay Example

There was rapid growth in the SME sector in most of the post-communist nations. Small businesses responded quickly to the opportunities. At this stage there were no preconditions set for the SMEs nor was it controlled by any institution. This freedom lasted only till the gaps were filled. Thereafter, the SME sector depended upon government regulations, protection of property rights, and access to finance. In 1993, SMEs in Russia formed 85.6% of the total establishments out of which 52.7% were small enterprises and 32.9% were medium enterprises (ACTET). From mid 1990s, the pattern of growth of the SME sector changed across nations. While in the Central and Eastern European nations, the SMEs contributed to the employment and the GDP, in Russia the SME sector started stagnating after the initial surge (Guriev & Polischuk, 2002). The number of small firms per capita in Russia was about 1/10th of Poland. Russia should have registered a more rapid growth but pre-reform distortions, institutional barriers remained the major hurdles. The Polish economy grew at an average rate of 6% between 1992 and 1998 and the inflation rate fell from 70 percent in 1991 to 11 percent by 1998 (Dabrowski et al., 2004). Macroeconomic stability and institutional reforms encouraged growth in Poland while Russia registered negative growth throughout the 1990s due to inconsistent liberalization programs. Since its economic recovery in 1998, there has been some growth in the SME sector in Russia. The total number of registered SMEs in Russia in 2000 was 891,000, according to Goskomstat, a Russian federal statistics agency, as reported by Yegorov, BISNIS Representative for Northwest Russia (2001). In Russia, only 10% of the people are employed in SMEs compared to 72% in EU and 52% in the US. Almost of half the SMEs are in and around the two largest cities. According to Alexandr Afanasiev, the Head of the St. Petersburg Governors Press Office, this city has around 5 million people in which the SMEs employ about 620,000 people (cited by Janechova et al.,). These SMEs function under what is known as the ‘shadow economy’ as most of these are unregistered; they maintain no official books and pay no taxes (RECEP). It is an unorganized sector and is often started as a part-time work or second source of income run by pensioners (CIPE, 1995). The reason for the slow pace of growth in the SME sector is attributed to various reasons. A study by Johnson et al. (2000) comparing new firms in Poland, Slovakia, Romania, Russia and Ukraine identified that apart from macroeconomic instability, inadequate finance and insecure property rights have a detrimental effect on the growth of the private enterprises. According to Radaev (2003), factors like budget restrictions imposed on state owned enterprises, limited credit access, high levels of taxation, led to the SMEs falling in arrears (cited by Aidis). This also caused reduction in production and investment. As a result many SMEs switched over to trading activities. It was suppressed by legislative and regulatory measures but when institutional reform measures were implemented, the sector felt some stability. Registration for firms theoretically is supposed to be easy, but in practice, it is marked with corruption and is time consuming (CIPE). The pace of structural reforms is very slow since its financial crisis in 1998. The average GDP is 6.5% but it needs to be about 8% a year. There has been rise in income and consumer credit but the SMEs are being crushed (Aris, 2003). The money in Russia is in the control of eight industrial groups who control the economy. These groups alone account for nearly 20% of the GDP according to Peter Boone of Brunswick Warburg, a Moscow-based investment bank (cited by Aris). They managed to get hold of the most attractive assets during the fire sale that followed the 1998 crisis. They are called the reformed oligarchs. They invest in sectors like chemical, pulp, timber or agriculture. The SMEs are unable to compete with these Big Eight, who are investing in all sectors and beating competition by their sheer size. Because of their size, they also command a political influence. The gap between the SMEs and the big giants keep increasing as the big firms exercise monopolistic and political power. Access to finance is one of the main hardships that limit the development of SMEs in Russia. In 2001, financial support to SMEs in Russia was RUB 90 million ($3 million) but this amount in insufficient for a comprehensive framework for SME development (Yegorov). While 80 million rubles ($2.7 million) were allocated under St. Petersburgs SME support program for 2001, only 33 million rubles ($1.2 million) were actually disbursed, according to Delevoy Peterburg (cited by Yegorov in The Russian Journal, 2001). Bureaucracy further crushes the SMEs. Any firm employing more than seven people comes under the purview of regulations and inspectors. The moment any firm draws up a scheme they come below the local authorities’ radar. They cannot draw workers from the restructured or downsizing state firms, which is essential for the transition. Russia is supposed to have an unstable economy and an inadequate technology infrastructure. The Russian government continues to be an impediment to growth and progress. Lane, an analyst at Aberdeen Group says the lack of overall business transparency, a complex bureaucracy and restrictive tax, customs and immigration laws influences the business culture in Russia (cited by Trombly). During the transition process, the bankruptcy laws in the exit process were also against the SMEs. Stress was laid on tax collection but the tax authorities chased the SMEs as the larger house could getaway with their political influence (Samonis & Shalimov, 2003). Currently, the main three banks that finance the SME sector are the Sberbank, KMB and Vneshtorgbank. The interest charged by them from the SMEs is very high. The average interest rate for loans to SMEs reached 25.6% per annum in 2001 but these banks offered competitive rates (RECEP). Banks favor industries with smaller production cycle, which are financially stable and are able to pay the credits faster. Sberbank confirms that credit to SMEs in the industrial and construction sector has been growing but it is still less than 20% of its entire small credit portfolio. Over the last ten years, efforts have been made to create a legal and institutional framework and to establish state programs and policies for the development of the SMEs (Yegorov). Funds are coming in from private and federal sources. SMEs that lacked in information and procedures, are being trained and consulting services are being provided to the SMEs. The federal support programs are insufficient and the SMEs feel the need for government intervention. Despite these, a research financed by the United States Agency for International Development (USAID, 2004) showed that by the end of 2003, there were 118 SMEs per thousand people. The SME sector in 2003 provided more new jobs, which implies that its social role in Russias economy has strengthened but it still lags behind when compared to the developed nations. Reforms have been brought about in taxation, customs and property rights, no reform in the judicial system has taken place nor bureaucracy reduced. Loan interest rates have to reduced and the credit period increased. About 16 to 17% of GDP is going into fixed investment and most of it goes to the fuel and energy sector. All investments are out of retained earnings. Banks cannot give loans more than 4% of the total invested capital (Aris). They cannot afford long-term credits, which is essential for the growth of any economy. The SMEs concentrate on low-tech services and retail trade but knowledge based entrepreneurship is necessary for innovation and growth. Twenty-three SME Development Agencies (SME DAs) have been set up which provide advice and support; they also train the managers. Although each SMEDA developed unique services and products to suit local markets, the majority offer standard services in marketing, Finance, Legal Advice (TACIS). The Russian government supports the development of the DAs at the national level. Government support is needed on all administrative levels – federal, regional, and local. Half of SMEs have never heard of any federal support programs and the other half found these programs to be ineffective. Cooperation between the federal and the regional SME support authorities is essential for the programs to be effective. Taxation and legal issues should be a priority. The SMEs lack information about foreign partners and financing, about terms of bank credit, about marketing and suppliers. Entrepreneurs face day-to-day difficulties, which is time consuming and consequently development suffers. Training for managers should be conducted; regular seminars, conferences help to bring about awareness of the government policies and programs. As per Kremlin’s economic agenda, reforms in the SME sector should remove the current obstacles to growth while at the same time also create investment incentives to attract domestic and foreign investment (Lavelle, 2004). According to Tennison (2005), ‘kiosk economy’ or the unorganized small sector has no contribution to growth of an economy. It is easy to start a small organization, they are offered tax breaks, but what is required is the planned middle sector with investments in major industries. Investments and training in the IT sector is very small in Russia, which needs to be stepped up. The aim should not merely be to double the GDP but to take budgetary risks for the growth of the economy. Russia should understand that SME are sources of technical innovation, employment creation. Growth of SMEs reduce the gap between measured GDP and real income movements in Russia. Hence concentrating on SME is important for the economic growth of the country. SMEs have to be efficient if they have to exist. They have to use their size to generate profit. They have to compete with the large businesses, which have monopolistic tendencies. The government and the entrepreneur have to work hand-in-hand for the growth of the nation. There have been signs of growth but sustained growth is required to be at par with the other EU nations and the developed nations. 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