Press Clippings

31 October 2007SME Business in Russia: Gaining Importance, —  Natalya Orlova, Chief Economist

The growth of small- and medium-sized enterprises (SMEs) is traditionally viewed as a measure of economic diversification, though such developments are difficult to assess accurately in Russia. The country’s last official evaluation of SME business was in 2004, and at the time, SMEs contributed 12 percent of GDP as opposed to 60 to 70 percent in EU countries. They absorbed just 12 percent of the labor force versus 50 to 60 percent in the EU. The latest estimates put the SMEs sector at 25 percent of the labor force, while keeping its modest 12 to 15 percent contribution to GDP.

Because official statistics do not fully reflect reality, an alternative approach calls for using an international methodology when evaluating SMEs. While according to international practices SMEs are enterprises with less than 250 employees, the Russian definition includes only enterprises with less than 100 employees. Using the international methodology, the Association of Small and Medium Business (OPORA) has assessed SMEs in Russia as absorbing 51 percent of the labor force and accounting for around 46 percent of total corporate sales. However, it could be that these figures are artificially high because of the political need to increase the importance of the association.

The number of Russian SMEs exceeds 1.5 million, according to our estimates, of which the majority are small companies with annual turnover below $2.5 million. Additionally, we believe some 10,000 companies are estimated to have turnover of $12–50 million per year, while another 40,000 companies have a turnover of $2.5–12 million per year.

A Slow Start for the SME Sector

The past lack of focus on the Russian SME sector was the result of several factors. First, the deregulation reform implemented in 2001–2003 was soon offset by an increase in the state’s penetration of the economy. As a result, positive results from the new laws were observed in 2002–2004, but were marginal thereafter. Consequent administrative barriers cost Russian SMEs around 9.6 percent of the sector’s consolidated sales in 2006 versus 8.5 percent in 2005. As a result, these high costs discouraged companies from switching from shadow operations to transparent accounting.

Second, Russian SMEs have only a local focus. While in the Czech Republic SMEs account for 34 percent of exports, and in China 60 percent, Russian SMEs account for less than two percent of total exports. While around 15 percent of SME production worldwide goes for export, only five percent of SME output in Russia ends up in international trade. Approximately two-thirds of SMEs are involved in the domestic trade and services sectors.

Third, Russian SMEs are important in the largest cities only, ones such as Moscow, St. Petersburg, and Kaliningrad, where the contribution of SMEs to employment exceeds the official Russian average by two or three times. In a number of poorer regions, the contribution of SMEs to job creation remains at just five percent.

And the final reason the SME sector has not benefited from greater general interest is the modest exposure to SMEs by Russian banks. In years past, Russian banks actively launched penetration efforts into the retail-lending market, but did not have significant interest in SMEs due to the low level of transparency of the latter. Indeed, a majority of banks named the lack of reliable clients in the SME sector as the main obstacle to increasing SME lending.

Bank attitudes, however, are now gradually changing, with two factors at last pushing banks toward the SME market. First, the retail market has delivered a high level of bad loans, which has negatively affected a number of second-tier banks; and their disappointment with retail banking has meant branching out into the SME sector. Second, increasing competition in the banking community because of the recent IPOs of two state-owned banks has likewise changed the attitude and focus of banks.

Even though slightly more than half of Russia’s banks had SME-lending programs in 2006, the total size of the SME lending is estimated to have been around $35 billion, or less than half of the retail lending market. This market is still concentrated on very short maturity loans (three to nine months), and 72 percent of the loans are used to finance working capital. Over 60 percent of the SME lending market is controlled by Sberbank, which runs a massive network of 20,000 outlets and has not suffered a significant increase in costs due to SME lending. Vozrozhdenie, which also enjoys a strong regional presence, was the second largest SME loan issuer in 2006 according to RBC ratings. Despite a number of obstacles such as low transparency, the penetration of the SME lending market has one undoubted advantage: these clients are ready to accept high interest rates, guaranteeing stable net interest margins for their creditors.