Five ways to connect Sri Lanka’s small businesses to global value chains

Small businesses are key to Sri Lanka’s economy – Pic courtesy ADB

Sri Lanka’s small and medium-sized enterprises can play an important role in economic recovery. By re-engaging with value chains, they can reinvigorate their own businesses and help to create opportunity and economic growth.

Sri Lanka is at a critical juncture of its development. The unfolding economic crisis is reaching almost every corner of the country in the last several months: aggravating shortages in food and medicines, day-long line-ups at petrol stations, and interruptions of education and health services. Among all challenges, an imminent one is to mitigate the impacts on small and medium-sized enterprises (SMEs), which provide essential livelihoods to many.

In Sri Lanka, SMEs comprise more than 75% of enterprises and account for more than 20% of exports, 45% of employment, and 52% of GDP.

Since their businesses are more vulnerable to demand downturn, disrupted fund flow, shrinking financing, high inflation, shortage of raw materials and fuel, as well as talent migration, SMEs will likely suffer disproportionally in the crisis.

However, through strategies and reforms to nourish their participation in global value chains, SMEs can not only prosper but—due to the size and economic importance of the sector—make a meaningful contribution to the country’s recovery and reduce the human toll of the crisis. Global and regional production chains have been a key driver of economic progress in Asia and the Pacific over the past two decades.

Sri Lanka’s strategic location makes it geographically attractive to many global value chains. In the past, it invested heavily in infrastructure, but its global value chain participation is limited. In 2020, 73.8% of Sri Lanka’s exports were direct, behind the average of 66.9% direct exports in South Asia and 53.5% in Southeast Asia.

Action is needed to connect or reconnect Sri Lanka to global value chains. Successes in this process will generate more local employment opportunities and sustainable foreign currency inflows. The positive spillover effects will eventually contribute to competitiveness of the whole economy.

Here are five measures that will help to expedite that process:

First, make Sri Lanka creditworthy in global value chains. Most, if not all, foreign financial institutions consider Sri Lanka-related transactions riskier than ever. Ensuring macroeconomic and social stability will be crucial to rebuild their confidence as investors, both foreign and domestic, need a predictable environment.

The interim responses should include policy measures, such as trade finance arrangements, to continue the business of SMEs involved in GVCs, particularly for domestic value-added exports.

Only in a predictable macro environment can Sri Lanka rebuild its attractiveness in global value chains. Moving forward, it needs to systematically reform trade policies, continuously improve trade facilitation, and more actively participate in regional cooperation and integration initiatives.

Second, upgrade business models. Sri Lanka’s SMEs should continue to align with new trends around global value chains, such as expanding from manufacturing to the service sector, adopting environmentally and socially responsible practices, and introducing quality accounting and auditing standards for transparency. While these transitions will also expose Sri Lanka’s SMEs to more fierce international competition, the ensuing level playing field in global markets will reward those with responsive business models.

The emergence of digital platforms has reduced barriers for emerging and developing countries to enter global value chains. Even small companies may participate in global value chains through increased modularisation and reductions in communication costs.

Entrepreneurship education, technology management, and research and development models could be further enhanced through collaboration between education and research institutes with local companies. Ultimately, developing competitive industrial clusters that integrate SMEs and large firms will put local companies in an even more favourable position.

Third, close the skills and talent gap. New business models will demand more skills and talent. The public sector can play a significant role in addressing this gap. Since the 1990s, Sri Lanka has developed a framework for Technical and Vocational Education and Training (TVET) which sets the benchmark for South Asia.

The TVET sector nevertheless needs a new round of drastic reforms, such as aligning the curriculum with global value chain-related industry demand, keeping up with technological innovation, modernising management practices, and establishing partnerships between the public and private sectors.

In the medium term, the focus should be on equipping the young generation with skills that employers need in priority sectors of economic growth, especially among girls.

In the long run, the rapidly changing nature of job demand, driven by fast-paced technological advances, must be included in these reforms. Job placement support for graduates can bridge the information gap between employers and education and skills agencies. These measures will eventually help the country to target the higher end of global value chains.

Fourth, promote women’s entrepreneurship. While there is gender parity in access to education, women’s economic participation is well below potential. Female participation in the labour force was 34% in 2018, significantly lower than for men. Women-owned enterprises are estimated to account for less than 10% of formal enterprises.

This is a missed opportunity for Sri Lanka to boost growth. At the household level, women’s empowerment brings financial independence and higher status. In the context of a steadily aging population and a transformation of industrial structure, women can fill in future shortages of business leadership and be a source of innovation.

Fifth, improve the business environment: To compete in international markets, the business environment should be dynamic and open to new entrants. Setting up a new business should be encouraged through conducive policies. Reducing the time and cost of obtaining utility service and export and import permits will also support the growth of export-oriented SMEs.

Access of SMEs to finance—a significant barrier to market entry—should be further enhanced. Compared to other Asian economies at a similar income level, more Sri Lankan SMEs consider themselves financially constrained.

Commercial banks in Sri Lanka rely heavily on collateral-based lending, which excludes potential entrepreneurs without sufficient physical assets. Moreover, financial avenues for SMEs, such as credit guarantee facilities, venture capital funds, trade finance, and digital financial platforms remain underdeveloped.

Sri Lanka’s SMEs can play an important role in economic recovery. By re-engaging with value chains, they can reinvigorate their own businesses and help to create a future of opportunity and growth for all Sri Lankans.

(Chen Chen is the Country Director, Sri Lanka Resident Mission, South Asia Department, ADB. Sabyasachi Mitra is Director of Public Management, Financial Sector and Trade Division, South Asia Department, ADB.)