Essential for growth: Donor Support for SMEs

Small- and medium-sized enterprises (SMEs) play an important role in economic development and poverty alleviation in low- and middle-income countries. This insight analyzes funding for SME development from sovereign donors and multilateral development banks (MDBs) and finds:

  • COVID-19 sparked significant growth in funding for SME development in 2020, which totaled US$10.5 billion.
  • In 2020, MDBs overtook sovereign donors as the largest funders of SME development.
  • Interventions aimed at improving access to finance received the largest share of funding for SME development in 2020 (51%).
  • EU Institutions are the largest sovereign donors to SME development, providing US$1.6 billion in 2020.
  • Among MDBs, the Inter-American Development Bank provided the most funding for SME development in 2020 (US$2.0 billion).
  • Most large disbursements made toward SME development are channeled through national banks, which in turn provide credits or loans to SMEs.
  • Beyond private sector development and financial services, SMEs receive significant funding through projects targeting women’s economic empowerment and agriculture.

Born and raised in the Mathare slum in Nairobi, Kenya, into a family with eight children, and orphaned at the age of nine, Kevin Uduny is no stranger to the struggles of living below the poverty line. Like many in his circumstance, he longed to change his life and his community for the better. Uduny, observing the challenges those living in slums face in access to good, affordable food, started a small agricultural business, with the support of a non-profit organization in Kenya. His business now employs eleven people and feeds the most vulnerable in his community. Through this entrepreneurial endeavor, Uduny has become a community leader, training youth and women's groups, as well as supporting others in starting their own businesses.

In their book, Poor Economics, Nobel laureates Esther Duflo and Abhijit Banerjee, suggest that growth of the private sector and formalized wage employment are essential measures for tackling poverty. As Uduny’s story demonstrates small- and medium-sized enterprises (SMEs) are important creators of formalized jobs in low- and middle-income countries (LMICs), and therefore are key to growth.

Given differing economic conditions around the world, there is no universal definition of what constitutes an SME, although the most widely accepted definition — from the International Finance Cooperation — defines small enterprises as having between 10 and 49 employees and medium enterprises as between 50 and 300. Anything smaller than 10 employees is considered a micro-enterprise; these businesses also play an important role in development but are often considered distinct from SMEs.

Despite their small size, formal micro-enterprises and SMEs (those that are registered as businesses) account for up to 33% of national gross domestic product (GDP) in LMICs and create up to 45% of jobs. These figures are even higher if informal (or unregistered) businesses are included. SMEs are often highly innovative and tend to improve their productivity rapidly, hastening countries’ transformation to higher-income statuses and promoting progress toward the sustainable development goals (SDGs), including SDG 1 (poverty eradication) and SDG 8 (decent work and economic growth). Approximately one-third of all formal micro, small, and medium enterprises worldwide are women-owned, meaning gender-inclusive policies can also strengthen SMEs’ contributions to women’s economic empowerment and gender equality (and SDG 5).

By effectively investing in SME development — meaning supporting new and existing businesses to grow and improve their performance — donors can enhance the impressive potential of SMEs to contribute to sustainable development in LMIC contexts. SME development covers a range of interventions, including improving the enabling environment in which SMEs operate through better policies and regulation, SMEs’ access to finance, and business development services (BDS) through which SMEs receive non-financial support, such as technical assistance or training.

There is research published on the need for more funding for SME development, the importance of increased access to financial products, and BDS best practices; however, there is no systematic review of how sovereign donors and multilateral development banks (MDBs) are currently contributing to this crucial area of development. This Donor Tracker insight aims to provide the advocacy community with clear baselines to inform their efforts toward improving the quality and quantity of funding for SME development. Using data from the Organisation for Economic Co-operation and Development (OECD) Creditor Reporting System (CRS), it asks:

  • How much funding is channeled to SME development and which types of interventions receive the most funding?
  • Which OECD development assistance committee (DAC) donors and MDBs provide the most funding for SME development and what are their policy priorities?
  • Which sectors and themes are most relevant to SME development?

Measuring the scope of SME development

This analysis, based on the latest OECD data (from 2020), examines official development finance (including Official Development Assistance and Other Official Flows) of projects contributing to SME development. Some of this funding is for projects marked by donors in their reporting to the OECD with the purpose code for SME development (32130: ‘SME development’). However, because SME development is characterized by cross-cutting and sector-specific interventions, including both financial and non-financial support, some additional forms of SME development funding may not be captured by this purpose code. This analysis works to overcome data limitations and gain a more realistic picture of total funding for SME development by combining the SME development purpose code with a keyword search1 across all project descriptions provided by donors in the OECD CRS to determine the volume of funding flowing toward this area. The list of keywords was developed in consultation with SME development experts. Note that microenterprises were explicitly excluded from the analysis since they do not fall into the category of SMEs.

The funding flows identified through this process were then categorized according to a three-part typology of SME development interventions, namely 1) policies and regulation, 2) access to finance, and 3) BDS. This was done using an additional keyword search based on three different lists of keywords.2

The final section of the analysis takes a deeper look at the projects identified through the keyword search, meaning projects which received funding relevant to SME development that were not tagged by donors using the SME development purpose code. The funding from these projects is broken down across OECD sector codes, which are the broad areas of focus under which purpose codes are nested in the OECD CRS database.

Because of the lack of consistent terminology across donors and the varying quality of donors’ project descriptions, there is some margin of error associated with this methodology. It is likely that some projects related to SME development were inadvertently excluded from the analysis or that some projects were miscategorized because of inconsistencies in the data. It is also worth noting that once a keyword from the list was identified in a project description, the total funding for that project was counted toward the total spend for SME development, not only the portion of the project relevant to SMEs.

COVID-19 sparked significant growth in funding for SME development

Figure 1: Total funding for SME development by type of donor, 2017-2020

 

Between 2017 and 2019, funding for SME development steadily increased (+34%; see Figure 1); then, in 2020, funding skyrocketed (+91% compared to 2019) as donors ramped up their support for businesses facing lockdowns, disrupted supply chains, and economic crises due to COVID-19 by ensuring national and regional development banks provide additional financial resources to SMEs. MDBs - which promote economic growth and support the economic recovery of LMICs - played a central role in this growth. MDB's support for SME development grew by 230% in 2020 compared to 2019, increasing their overall share of funding from 30% to nearly 50% in 2020. It remains to be seen whether funding will remain at the 2020 level once COVID-19-related financial support lapses, especially with the quickly expanded role of MDBs in financing SME development.

Interventions related to improving SMEs’ access to finance received the largest share of funding in 2020 (51%; see Figure 2), suggesting that this is the largest priority among donors. This is in line with calls from development practitioners and advocates who appealed to donors to close the credit gap for formal SMEs, which is estimated to be around US$5 trillion. The economic disruptions and uncertainties caused by the COVID-19 pandemic made it more challenging for national banks to provide credits to SMEs, increasing the risk for SMEs losing access to finance and making the credit gap for formal SMEs an even more pressing challenge.

Figure 2: Funding for types of interventions as % of total funding for SME development

Funding for BDS projects and projects aimed at improving policies and regulations accounted for 13%-14% of all funding for SME development in 2020, suggesting that they are a lower priority for most donors. Some might argue that these lower shares can be explained by the fact that non-financial interventions require less capital than credits and loans; however, given their vital importance to the success and growth of SMEs, donors should not neglect funding for these programs.

Unlike the other two types of support, BDS are most often targeted in combination with other types of interventions, particularly those that focus on increasing access to finance. Projects at this intersection may provide both credits and loans to SMEs, as well as training on financial literacy or entrepreneurship to ensure SMEs can make effective use of their financial assets. This suggests that donors consider BDS less as a stand-alone intervention and more as a support function to complement other efforts.

EU Institutions and Germany lead the charge in sovereign donor funding to SME development

According to OECD data, the EU Institutions (EUI) and Germany were the largest donors to projects targeting SME development in 2020. EUI led with US$1.6 billion in funding, nearly twice as much as Germany, which disbursed US$815 million for this purpose (see Figure 3a).

In addition to being the largest donor overall, the EUI’s prioritization of SME development within the context of their broader development program is significant; they spent 8% of their official development finance on SME development in 2020, making them the second-largest donor country in relative terms after Portugal (10%; see Figure 3b). Germany’s prioritization of SME development was in line with the DAC average. Funding for this purpose accounted for just under 3% of Germany’s total flows.

Figure 3: Sovereign donor funding for SME development, 2020

Most of the funding from donor countries for SME development is channeled to the group of lower- and upper-middle income countries (according to the definition by the World Bank) (61%) while low-income countries received only 9%. The largest share of both, EUI’s and Germany’s funding for SME development goes to lower-middle income countries. Egypt is the top recipient country of EUI’s funding for SME development (41%), while the largest share of Germany’s funding benefits several recipients on the African continent without further specification (31% of Germany’s funding is provided to ‘Africa – regional’). Support for SMEs is important to the development of countries at all income levels, but especially given the effectiveness of SME development in addressing poverty, SMEs in low-income countries should receive an equal amount of support.

The EUI’s development strategy ‘New consensus on development – Our world, our dignity, our future’, names SME development, particularly improving access to finance, as essential for poverty eradication in LMICs. In line with this policy, 84% of the EUI’s funding for SME development was channeled to projects targeting access to finance for SMEs in 2020. A large share of this was provided to national banks in the form of loans. For example, the EUI provided the Bank Misr in Egypt with US$561 million, which in turn provided loans to SMEs to support them through the COVID-19 crisis. In 2020, the EUI only focused 5% of its funding for SME development on BDS and 3% on policies and regulations.

Germany addresses its support for SMEs within its ‘Special Initiative on Training and Job Creation.’ The initiative focuses on promoting sustainable economic growth and job creation in countries on the African continent. Germany’s goal is to strengthen the competitiveness of SMEs by supporting them in entering new markets, promoting cooperation with German SMEs, and linking African SMEs to international value chains. Even though Germany recognizes the importance of SMEs for economic development, it does not have a coherent strategy to guide its interventions related to SME development in other regions or other sectors (e.g., agriculture, where SMEs also play an important role according to the German Ministry for Economic Cooperation and Development). Of the US$815 million in funding provided by Germany for SME development in 2020, a large share (41%) was channeled to projects targeting access to finance for SMEs. Only 6% was focused on BDS and 2% on policies and regulations.

MDB funding influences the scope of SME development

MDBs — which promote economic growth in LMICs and are well-positioned to mobilize capital — play a particularly important role in providing funding to address the finance gap SMEs in LMIC countries face. As economies were rocked by the COVID-19 crisis, MDBs expanded their credit and lending programs to ensure sufficient support for SMEs in coping with the manifold effects of the pandemic. In line with this, most MDB funding in 2020 that could be identified to contribute to a specific type of intervention was targeted at improving the access to finance for SMEs (70% of total funding from MDBs). Like sovereign donors, MBDs channel a large share of their funding for SMEs to upper- and lower-middle income countries (80%), particularly in South and Central Asia (39%) and South America (39%), reflecting the priority regions of the two largest MDB donors (see Figure 4).

The MDBs that provided the most funding to SME development in 2020 were the Inter-American Development Bank (IADB; US$2.0 billion), the Asian Development Bank (ADB; US$1.6 billion), and the International Bank for Reconstruction and Development (IBRD; US$1.2 billion; see Figure 4a). The IADB spent 15% of its total official development flows on SME development in 2020, making it the third-largest MDB in relative terms (see Figure 4b). The Council of Europe Development Bank (CEB; 30%) and International Investment Bank (IIB; 22%) came in first and second place, respectively.

Figure 4: MDB funding for SME development, 2020

The largest share of funding from MDBs toward SME development in 2020 focused on increasing access to finance and ensuring the availability of medium- and long-term financing for SMEs. For example, the IADB provided US$750 million to the Banco Nacional de Desenvolvimento Econômico e Social (BNDES), the largest state-owned development bank in Brazil, to support the provision of financing for micro, small, and medium enterprises (MSMEs) in Brazil. Although access to finance is their primary focus, MDBs also support SME development in other ways, for example, the IADB’s ConnectAmericas Project is a business-focused social network and platform in South and Central America, which provides training for SMEs, including online courses, webinars, and business roundtables to promote trade and investment of SMEs.

It is worth noting that the quality of reporting to the OECD CRS varies across MDBs, so this analysis should be understood as only indicative of MDB’s contribution to SME development and serve as an entry point for further investigation into MDB funding practices.

Women's economic empowerment and agriculture projects serve to boost SME development

Although the OECD has a purpose code used specifically to tag funding related to SME development (as described in the methodology above), given the many sectors relevant to SME development, relying solely on this purpose code yields an incomplete picture of the funding landscape. To understand which other areas of development are most relevant to SME development, this section of the analysis explores funding identified through the keyword search that falls outside of the SME development purpose code. It breaks this funding down by sector to reveal which type of projects are currently receiving donor funding relevant to SMEs and to hint at areas with growth potential.

In line with the significant donor support for improving SMEs’ access to finance, most of the funding (54% of funding for SME development not tagged with the purpose code) falls within the ‘Banking & Financial Services’ (54%) and ‘Business & Other Services’ sectors (17%; see Figure 5).

Figure 5: Funding for SME development by sector (excluding funding reported under the purpose code 32130 ‘SME development’), 2020

The two largest sectors not directly related to promoting business growth that donors appear to consider important to SME development are ‘Other Social Infrastructure & Services’ (7%) and ‘Government & Civil Society’ (6%). Projects in both these sectors often have a focus on supporting women’s economic empowerment (WEE), youth employment, and the economic participation of people living with disabilities.

WEE is an important issue for many OECD DAC donors, which fund this issue in part through projects related to SME development. For example, the Women Entrepreneur Finance Initiative (We-Fi) was launched in 2017 by 14 donor countries, eight MDBs, and other public and private sector stakeholders, and is hosted by the World Bank. It aims to address the financial and other constraints that women-led SMEs face; improve their access to finance, markets, training, networks, and mentoring; and foster an enabling environment for women entrepreneurs. As this example illustrates, projects with a focus on gender tend to favor BDS and improving conditions for women-led businesses rather than providing access to finance exclusively.

Agriculture received the fifth-largest share of funding for SME development that was not tagged with the specific purpose code (4%). Agriculture plays a key role in LMIC’s economies and agricultural SMEs are important for fostering not only economic growth but also more inclusive and sustainable food systems. One of the most well-known initiatives within agricultural SME development is the Smallholder and Agri-SME Finance and Investment Network (SAFIN), hosted by the International Fund for Agricultural Development (IFAD). SAFIN is a network of actors that operate in the ecosystem for agri-food and rural SME investment to improve the financial ecosystem for SMEs in food and agriculture. The network includes financial service providers, impact investors, farmers’ organizations, technical assistance providers, specialized agencies, industry platforms, donors, and multilateral financial institutions.

Donors can drive development in LMICs through funding to SME development

With the economic downturn, rising global debt, climate change, a global food crisis, and humanitarian disasters unfolding around the world, progress toward the SDGs is more precarious than ever. This makes it essential that donors leverage every tool at their disposal to alleviate poverty and bolster development in LMICs. Given their role as drivers of economic growth and job creation, and with the potential to enhance gender equality and more sustainable food systems, donors should continue to leverage SMEs as an important part of their development strategies. Based on this analysis of current funding for SME development, donors should consider the following recommendations:

  1. Most current donor funding is channeled to interventions targeting better access to finance for SMEs, while BDS and interventions improving the enabling environment receive smaller attention. To ensure their funding is most effective, donors should establish greater balance in their funding across all three types of SME development interventions, and specifically look to existing evidence on the most impactful BDS practices for SMEs’ growth. Practitioners in the field are well-positioned to provide additional insights and knowledge on the effectiveness of standalone and combined interventions and donors should ensure their expertise is leveraged in the design of projects and initiatives.
  2. Although much of the world has begun to open up again after COVID-19, threats to the success and prosperity of SMEs remain. Especially getting access to finance has been among the top challenges faced by SMEs and the situation is tightening even more with economic uncertainties induced by the COVID-19 pandemic and global inflation. In years ahead, donors should continue to fund SME development at the high level achieved in 2020 to ensure continuity beyond COVID-19-related financial support for businesses. To ensure high funding levels towards financial support for SMEs help close the credit gap SMEs face, more evidence is needed if and where donors’ efforts are currently falling short and how funding and services can be improved.
  3. While support for SMEs in middle-income countries (which currently receive the largest share of this funding) is important, given their poverty alleviation potential, donors should work together to ensure SMEs in low-income countries are not left behind. All donor countries should meet their commitment to spend 0.15%-0.2% of their GNI on ODA to low-income countries, including their ODA for SME development.
  4. Even donors like Germany which recognize the relevance of SMEs for economic development and eliminating poverty in their strategies and initiatives, often lack policies specific to SME development. To ensure a more coherent approach to SME development, donors should follow the lead of SME development champions, like the EUI, and develop explicit strategies for SME development that are not only applied within their private sector development departments and initiatives, but also across other sectoral and regional departments.
  5. Donors should continue to leverage SMEs’ potential for making progress in all SDGs and fund SME development through projects in other sectors. WEE and agriculture provide good examples of areas in which SME development is already contributing to gender equality and sustainable food systems, and where there is potential for greater growth and benefit.

SME development often starts at the local level, serving as a building block for state, regional, and global economic growth. Kevin Uduny’s story is a good reminder of the human impact of funding for SME development and the very real ways that, with adequate funding and the right support, SMEs can be an effective tool for the uplifting of not only individuals but entire communities. Donors should not let this potential go to waste.

 


 

1The list of keywords includes: SME, small and medium enterprise, small- and medium-sized enterprise, MSE, micro and small enterprises, MSME, micro, small, and medium enterprise, SGB, small and growing business, small and growing enterprise, small and medium firm, early-stage venture, high-growth venture, niche venture, dynamic enterprise, formalizing venture, small-scale business, small-scale firm, small-scale venture, small-scale enterprise, small-sized business, small-sized firm, small-sized venture, small-sized enterprise, small business, small firm, small venture, small enterprise, start-up, agri-SME, informal firm, entrepreneur (plurals and other word variations were included in the keyword search).

2Keywords related to policies and regulation: Policy, regulation, institutional environment, institutional structure, innovative ecosystem, enabling environment, business environment, entrepreneurial ecosystem, entrepreneurial environment, regulatory environment, standards, policy change, start-up act, investment climate, law, legal (plurals and other word variations were included in the keyword search). Keywords related to access to finance: access to finance, financial assistance, financial infrastructure, finance, investment readiness, lending, credit, financial inclusion, loan, missing middle, concessional, asset-backed finance, impact fund, credit-guarantee scheme, venture capital, guarantee, grant, mezzanine, private equity, impact investment, seed capital, investment fund (plurals and other word variations were included in the keyword search).
Keywords related to BDS: BDS, business development service, business support service, enterprise support service, enterprise support organization, service provider, intermediary service, innovation hub, building businesses, incubator, accelerator, technical assistance, TA, non-financial services, capacity building, capacity development, training, coaching, advise, consulting, counseling, knowledge sharing, business management, management training, access to talent, human capital, market linkage, market access, network (plurals and other word variations were included in the keyword search).