The micro, small and medium enterprise (MSME) or small and medium enterprise (SME) industries are generally the most critical contributors to economic output, socio-economic development, and the creation of new jobs in both developed and developing economies. The economic catastrophe that occurred during the COVID-19 pandemic, which stemmed from the negative effect on MSMEs / SMEs, was a clear indication of the importance of this business segment. These businesses serve as the backbone of economic activity and should play a prominent role in the economic recovery in a post-COVID-19 environment. Governments throughout the world have made a concerted effort to revive this sector, and major multilaterals have shared this sentiment. It can, however, be argued that many of these efforts have had a minimal impact, as a large number of SMEs have not managed to recover and remain out of business. Nevertheless, governments continue on an unrelenting pursuit of trying to bolster this pivotal sector due to its importance to the overall economic system.

Before continuing, and due to the book’s intended international audience, it is worth pointing out that the definition of an SME varies across different jurisdictions. For example, a microenterprise in Europe or North America might be considered a small enterprise in Africa.

“If you want to transform your economy, a good starting point is improving the SME sector”

Research Team- CRA Global Development
Author

As an important reference point, the table below provides an overview of the classification of MSMEs, which is based on an average classification across different regions. As turnover varies significantly across geographies, reference is also made to the number of employees, total assets, and loan size at origination. The actual classification within countries might vary significantly; for example, some countries might have a cut-off point for medium enterprises at 100 employees and some at 500 employees.

Table 1: SME Criteria

Within the table above, an MSME would need to obtain two of the three criteria within the definition section or if the origination loan falls within the loan thresholds on the right. It should be noted that many countries might differ in their classification of the SME / MSME industry, and there might be further segregation at the industry level. For example, the agricultural sector within a particular country might have a different definition criterion relative to the manufacturing sector. We will refer to the table above as a collective classification reference point. To simplify things, we will utilize the term SME for large parts of the book when referring to SME credit ratings and will reference MSMEs where needed. However, irrespective of the classification method used, it is common knowledge that the SME sector is a major contributor to economic and socio-economic development. The World Bank estimates that SMEs make up 90% of all businesses globally, 50% of all employment, and create roughly 70% of all new jobs. This market segment is also a major contributor to overall GDP within most countries and will play a significant role in the future development of many emerging and frontier countries over the coming decades. By 2030, roughly 3.3 million new jobs will be required each month in emerging markets to absorb the growing workforce, and this sector will play an integral role in employing these job seekers.

From a socio-economic perspective, SMEs are a major source of employment within both developing and developed countries. Poor economic conditions and limited job opportunities have forced many individuals into entering the challenging world of entrepreneurship, which serves as an indirect safety net and opportunity to participate in the economy. The COVID-19 pandemic, which resulted in the closure of many businesses, also resulted in the creation of new ones due to many individuals being laid off from formal employment and taking up the entrepreneurship route out of necessity and desperation. The pandemic has allowed individuals to reassess working conditions, their personal objectives, and future ambitions, resulting in many gravitating towards the flexible nature of entrepreneurship. The economic recovery will determine how this trend plays out, as the initial operating years of SMEs are often challenging. A recent study by the World Economic Forum indicates that 67% of executives from SMEs highlight survival and expansion as their main challenges. From an employment perspective, SMEs are major contributors; however, their contributions vary by country and business size.

Apart from the broader socioeconomic benefits, the industry is a key enabler for marginalised and underrepresented groups to participate in the economy. For example, females in many developed and developing countries lack equal employment opportunities, and entrepreneurship provides a platform to emancipate themselves economically. A portion of the female-owned SME segment prefers the flexibility that is associated with the entrepreneurship route, as it allows them to simultaneously focus on family-related matters, which is difficult when employed on a full-time basis. Due to the large number of low-skilled employees the industry hires, it plays an important role in upskilling them via skill development and educational programs. Additionally, employment within the SME sector provides healthcare and other social benefits that provide a safety net to these employees and have knock-on effects on overall socioeconomic development. The SME industry also houses many social enterprises that are pivotal in addressing socioeconomic imbalances by implementing and creating solutions to alleviate these issues. Furthermore, these social enterprises have grown to contribute significantly to overall GDP and employment due to the large number of social issues which need to be addressed. The prominent emergence of the ESG theme has brought many of these social issues to the forefront, and social enterprises have been notable contributors to innovative policy development. SMEs will play a central role in the transition to green energy solutions by providing related goods and services, which, in turn, reduces their overall carbon footprint. For example, in the UK, SMEs are responsible for over 90% of clean technology businesses. These entities will then play a prominent role in the transition to green energy and should be supported to maximise their positive benefits on this front. The concept of SME ESG ratings, which is unpacked later in this book, will be integral in assisting SMEs in addressing some of these issues.