Home Alternative Investments Investment in small businesses can build resilient emerging economies

Investment in small businesses can build resilient emerging economies

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Access to finance of MSMEs in emerging economies

  • Readily available SME finance is a requisite of resilient economies. Opening new pathways for small business finance requires a smart mix of international and local institutional capital.
  • Social enterprises face many of the same challenges as traditional small businesses in emerging economies.
  • Innovative and scalable financing vehicles are originating from locally-based capital providers across emerging markets.

Across the globe during the COVID-19 pandemic, governments have sought to support small businesses through credit guarantee and salary support schemes. This focus on SMEs is logical as small businesses create up to 80% of jobs and generate up to 70% of GDP in Africa alone.

The role of social enterprises and SMEs in emerging economies

Social enterprises, while being a relatively small subset of such SMEs, are a segment of increasing importance due to their role in actively developing solutions for the most pressing social challenges. The survival and growth of SMEs and social enterprises should be an ongoing priority.

However, in emerging market economies (EMC) these short-term schemes were not enough to address the existing, intractable structural barriers to raising finance that most of these businesses face. The yawning gap in financing runs into the trillions of dollars.

The pandemic has further demonstrated that local and international, public and private sector organizations can work collectively to move money at scale if the motivation is strong enough. It makes economic sense for governments and private markets to do just that in order to build resilient economies.

MSME Finance Gap as % of GDP in emerging economies.

MSME Finance Gap as % of GDP in emerging economies.

Image: SME Finance Forum

A blend of global support and local currency solutions

Despite the enormous scale and liquidity in global markets, international institutional investors currently allocate little over 1% of their total assets to alternative asset classes in developing countries. However, global funds need to be thoughtful about additionally (providing capital in quantum or on terms that are currently unavailable in the market) and sustainability because of the existing over-indebtedness in many EMCs. This is particularly true in African markets where there is limited capacity to take on more foreign debt.

Meanwhile, local pension funds in EMCs generally have both the capital and the regulatory mandate to support alternative financing assets such as SME finance but tend not to do so in any meaningful measure. For example, private Ghanaian pension funds control two-thirds of ±$5.4bn pension fund assets growing at a rate of ±30% per year. Despite an investment limit of 15% into alternative assets, there is currently only a ±0.03% exposure.

What approaches can unlock more financing for SMEs in emerging economies?

As part of its presidency of the G7 in 2021, the UK government mandated an Impact Taskforce (ITF) to support the development of scalable financial vehicles that harness private capital for public good. The ITF set forward recommendations for greater amounts of capital for progressing the SDGs, with SMEs and social enterprises being vital actors in achieving such goals.

A consortium of partners initiated through the World Economic Forum’s Global Alliance for Social Entrepreneurship, including Collaborative for Frontier Finance, Sustainable Development Investment Partnership and Global Steering Group for Impact Investing (who led the G7’s ITF), supports local actors in EMCs to design financing constructs that integrate impactful international capital with scalable domestic resources.

Access to finance of MSMEs in emerging economies

Access to finance of MSMEs in emerging economies

Image: World Bank/IFC

In the past year, this consortium has worked with critical stakeholders in the emerging economies like Ghana and Zambia where each has been developing replicable pathways to finance:

  • Private sector-led Fund of Funds (FoF): a national FoF vehicle with a target size of $85 million to connect a blend of institutional capital from domestic pension funds and global development funding – to local fund managers that finance the region’s small and growing businesses. This type of structure was one of the recommendations from the SDIP-led “Country Financing Roadmap for the SDGs” to provide an efficient capital mechanism for institutional investors to “reach down” into the underserved, missing middle-market segment, by standardizing and simplifying the process as well as diversifying risk and supporting the system.
  • Local Bank Credit Risk Guarantee Facility: a guarantee mechanism from the Zambian Central Bank to underwrite the working capital and growth finance needs of SMEs by local financial institutions and non-bank finance institutions (NBFIs). This builds on the government stimulus scheme instigated during COVID-19 that successfully distributed $590 million to 10 commercial banks and 19 NBFIs. It aims to help local banks overcome the risk that stands in the way of them providing more financing to SMEs.

The Global Response Alliance for Social Entrepreneurship is one of the largest multi-stakeholder collaborations in the social innovation sector.

The Alliance has 100+ members – corporations, investors, philanthropists, governments, researchers, media, and industry actors – who work together to build an engaged ecosystem of key public and private sector leaders in support of a social innovation movement that transforms society to be more just, sustainable and equitable.

Launched in response to the COVID-19 crisis by the Schwab Foundation together with Ashoka, Catalyst2030, Echoing Green, GHR Foundation, Skoll Foundation, and Yunus Social Business in April 2020.

In the post-pandemic context, the Alliance community will strengthen the foundations of a highly dynamic and resilient innovation ecosystem in support of social entrepreneurs. In that pursuit, the Alliance will continue to mobilise a trusted community of leaders together with core partners – Bayer Foundation, Motsepe Foundation, Porticus, Deloitte, Microsoft, SAP and Salesforce, that acts and learns together so that social entrepreneurs can flourish.

Contact us to get involved.

How can we build upon and find similar solutions?

  • Engage the broader community of pension fund managers across emerging market economies. There are multiple efforts underway to increase the allocation of pension fund assets into alternative investments including the Assets Owners Forum South Africa, the Kenya Pension Funds Investment Consortium, the Ghana Pension Industry Collaborative and the work of GSG with pension funds across the globe.
  • Tap the skills, knowledge and deep capital resources of global institutional capital holders, predominantly Development Finance Institutions, development agencies, foundations and family offices to help create the conditions that ease private investments in these assets. Global pension funds and corporates will follow development monies once a track record has been established.
  • Engage committed and motivated local stakeholders from the EMCs, such as government agencies, local banks, impact investors and providers of other services for SMEs, such as capacity-building, business development tools and access to digital services.
  • Bring together this diverse yet highly complementary community of local and international capital providers to develop and fund innovative and scalable financing vehicles that can address the existing systemic gaps in providing reliable and affordable capital for small businesses across emerging economies.

SMEs and social enterprises are essential drivers of growth, employment and livelihoods in emerging markets. Providing them with the vital financing they need necessarily requires supporting the local investors, fund managers and banks who are closest to them on the ground. That said, in addition to providing access to financing to empower SMEs in emerging economies, it is important to accompany financial solutions with other types of non-financial support such as capacity building and tools relevant to their business. Experience in Africa shows that digitally-based information and services can be effective tools for empowering farmers and local businesses.

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