Mumbai: Government subsidies actually harm the development of small and medium enterprises (SMEs) in India, says Laurence Carter, director, small and medium enterprise department, International Finance Corporation (IFC), a member of the World Bank Group.

“It is not just about money. The government should develop its business environment; simplify rules and regulations to help develop SMEs," he says in an exclusive interview with Mint. Edited excerpts:

How do you see SME growth in India?

Let me tell you a story. Each year, we survey all the banks to whom we lend money and ask them about their SME clients. We have about 180 such banks in 70 or 80 different countries. The size of the total SME portfolio in these banks is about $56 billion (Rs2.2 trillion) and the client base is about nine million. The interesting fact is that the exposure of each bank to its SME clients has risen by about 30% every year. This is an exciting figure. In emerging markets, banks are going after SMEs. This is encouraging as 10 or 15 years ago banks were not interested in SMEs. My expectation is that, in India, the growth will be even more.

Do you mean more than 30%?

I am not saying that SMEs are growing by 30% per year. I am saying that the financial institutions’ exposure to the sector is growing at 30% per year. And in the case of India, it should be even faster. As a whole, SMEs in India should grow faster than the economy. My observation is that SMEs in India are highly dynamic. But there are still many activities in the informal sector. As we see the regulations getting simpler, it’s more likely that SMEs will shift from the informal to the formal sector. We see this trend happening.

How much is IFC’s contribution in developing SMEs in India?

IFC is not financing SMEs directly. In each case, we are working through local partners. If we provide financing, we provide it to local financial institutions. But in India, we are focusing more on instruments like the toolkit, which is to provide advice. In India, the local financial institutions are strong and do not need IFC financing. So, we are providing help in the area as advisers.

Advisory role: Laurence Carter, director, small and medium enterprise department, IFC .

What is an SME toolkit?

The SME toolkit is a set of tools and techniques available on the Internet for free, which helps SMEs manage their cash flow, prepare feasibility studies, etc. These are general tools that have been customized for India by our partner ICICI Bank Ltd here in India. It’s a set of tools to make life easier for owners of small businesses, who generally have very little time for such things.

What’s your exposure to India?

I don’t know how much our current exposure is, but we expect to increase the private investment in infrastructure significantly. In our last fiscal year ended June 2007, IFC’s total financing in India was more than $1 billion. This year, I think we are targeting about $2.5 billion.

Will the subprime crisis impact India’s SMEs?

I doubt it. At least, not directly. I think the bigger risk is if the subprime crisis boils down to recession in major markets such as in the US. This will affect India, but I don’t think India is much exposed to subprime lendings. But there is somewhat of a risk as we see big global imbalances at the moment. We have a very high oil price and it is impossible to completely insulate yourself from this. India is part of the global market. It benefits from the global market, but there are some risks involved, too. I would say the short-time risk to India is relatively low.

All banks and financial institutions are aggressive in targeting SMEs in India. In the process, the volume and value of their distressed assets is rising. How you think we should strike a balance?

I think that in the end, it’s up to each bank to develop its own scoring system. In a sense, it’s good that banks are competing for the space. That would be good for SMEs and yes, it is an area where there is some problem in terms of sharing information.

Yes, individual banks will face (the issue of) NPAs (non-performing assets)... But I think that’s how people test the scoring models. The main thing with (lending to) SMEs is that they (banks) have to keep the transaction cost down. From our past studies, we have concluded that this market is relatively young. No one method applies for different SMEs and it needs tailoring for different markets. Some people have lost money in the past. But banks are aggressively going after this sector and making money. It is possible to make money on SMEs.

You must have experimented with different models in different countries to check NPAs. Which one works best?

No model here. In the end, it’s risk and reward. I don’t think one needs to interfere with regulatory solutions. We should let competition take care of this. Also, I would like to add that subsidized financing by the government does not serve the SME cause, as it tends to serve a small group that has access to that financing. So, it becomes difficult for others left outside the circle.

So, what is the ideal way of tackling this sector?

A successful environment should have much more than financing. The government always tends to think: “Ah, we need more financing for SMEs." Our experience tells something different. It is important to improve the whole business environment for SMEs. This means simplifying the process of entry, registration, licensing norms, and so on, so that SMEs are not subjected to different tax authorities, or to different inspectors. Once we simplify the tax system, SMEs won’t have to spend 20 days a year filing their returns. Once the forms are put up online, SMEs won’t have to go and pay a bribe to someone. These things are more important than just financing because all SMEs do not need direct financial help. My advice would be to concentrate on the business environment. It’s not just about money.