Nepal’s economic landscape is dominated by micro, small and medium enterprises (MSMEs), which are crucial contributors to the nation’s economy. As per the National Economic Census, 2018, of the 923,356 establishments in 2018, 95.5 percent were micro enterprises, 4.2 percent were small enterprises, and the remaining were medium and large-sized enterprises, with only half of them registered. Further, this sector provides employment opportunities to 84.7 percent of Nepal’s labour force. However, it exhibits a gender imbalance, with a male-female ratio of 62:38 in employment and an even greater disparity of around 73:27 in ownership and managerial roles.

The contribution of MSMEs to the national Gross Domestic Product (GDP) is substantial, accounting for nearly 90 percent of the industrial sector’s input, which itself constitutes about 5.6 percent of the total GDP. However, post-Covid, from mid-October 2022-23 to mid-October 2023-24, Nepal’s MSMEs faced challenges, marked by high inflation and borrowing costs. Such challenges must be addressed to fully realise their potential and contribute effectively to Nepal’s economic development.

High inflation and borrowing costs

As per the current Nepal Rastra Bank Macroeconomic and Financial Situation study, the consumer price index (CPI) averaged around 8 percent, with the food CPI increasing from 8.05 percent to 8.38 percent, escalating raw material costs and squeezing profit margins for food-related businesses. Conversely, the non-food CPI decreased from 8.85 percent to 6.81 percent, offering some relief to MSMEs in other sectors. This complex inflationary trend significantly impacted MSMEs, influencing their pricing strategies and operational costs. Concurrently, higher interest rate trends in 2023 added to their woes. The weighted average lending rate for commercial banks consistently stayed above 12 percent, while rates for development banks and finance companies were even higher, hovering above 13 percent and 14 percent, respectively. This situation suggests a more expensive borrowing environment for MSMEs dependent on these financial institutions, critically affecting their financial planning and cost management strategies.

Financing gap

Compounding the financial challenges is a $3.56 billion financing gap in the MSME sector, as revealed by a United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP) study. This gap, divided between micro enterprises (MEs) and small and medium enterprises (SMEs), underscores the acute need for increased financial access and support. However, the current portfolios of SMEs in commercial banks and MEs in microfinance institutions (MFIs) suggest significant untapped potential for financing within the existing regulatory framework.

Recent concessional loan trends in Nepal reflect changing dynamics in entrepreneurship. From mid-July 2022 to mid-October 2023, women entrepreneur loans decreased, both in number (from 84,001 to 81,121) and amount (from Rs70,996.1 million to Rs54,028.3 million), signalling concerns about gender inclusivity. Meanwhile, Youth Self-employment Loans increased (from 28 to 47 borrowers), indicating a growing interest among young entrepreneurs. However, loan amounts for educated youth self-employment slightly declined, pointing to more educated individuals engaging in smaller-scale self-employment. These trends necessitate tailored support and policies to nurture diverse entrepreneurial groups.

Other challenges

The procedural complexity can be challenging for entrepreneurs unfamiliar with formal ways of doing business, discouraging many from seeking assistance from banks and other financial institutions. Even those who seek financial aid have to deal with unnecessary hurdles. The government allows loans of up to Rs2.5 million for eligible startups. Despite the government’s directive to provide loans without collateral for small startups, banks favour established and well-off businesses rather than those with high potential requiring immediate financial assistance.

The registration process of new businesses involves multiple venues and departments, each with its own separate process. Apart from that, businesses have to be registered with their respective wards. This process becomes cumbersome for aspirants with limited resources and can be discouraging for those contemplating starting a small enterprise.

Furthermore, the tax regime disproportionately impacts small businesses with its high rental taxes and yearly registration fees. Once registered, a business must regularly shell out cash for tax, irrespective of its operational status or profitability. This burden is particularly heavy for small businesses during their formative phase.

The recent ban on TikTok, a platform that had significantly boosted self-employment and the growth of new businesses, has impacted many entrepreneurs. It had become an indispensable tool for small business owners as it influences market demand for products and services through quick marketing.

Addressing challenges

In Nepal, creating a robust MSME ecosystem at the macro level involves integrating key elements like streamlining processes through initiatives such as the one-stop service centre for domestic businesses, expanding loan quotas and implementing nationwide financial literacy programmes that empower more entrepreneurs to seek credit. Tax reforms are crucial to alleviate financial pressures on small businesses, and strategies to connect SMEs directly with consumers promote more affordable consumption. To support the growth of MSMEs, it’s important to consider lower taxes for these businesses than larger companies or offer tax breaks for sectors deemed priorities.

Moreover, a provision for flexible repayment instalments over a certain period could encourage struggling businesses to sustain themselves. Additionally, harnessing financial technologies and implementing demand-side initiatives, such as financial literacy, to encourage digital technology can provide targeted support for MSMEs.

As Nepal prepares to transition from the Least Developed Countries category by 2026, it must confront challenges such as losing preferential market access to the European Union. We should actively pursue new trade agreements with the EU and other countries, particularly those with growing economies and high demand for Nepali products, and, if possible, gain access to preferential tariffs.

Robust development and support of MSMEs are essential for Nepal's economic and social advancement. Addressing challenges such as high inflation, substantial financing gap, procedural complexities, and impending loss of preferential market access requires a multifaceted approach. This includes streamlining business processes, expanding loan access, tax reforms, and creating a supportive financing ecosystem. Embracing these strategies is key to transforming MSMEs into thriving contributors to Nepal's economy, fostering innovation and inclusive growth.