Small and medium-sized enterprises (SMEs) exhibit higher optimism levels compared to the past couple of years, last seen in 2021.

Unbridled Optimism Among SMEs: A Dissonance with Investment Readiness

Small and medium-sized enterprises (SMEs) exhibit higher optimism levels compared to the past couple of years, last seen in 2021.

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Despite a surging wave of optimism among Small and Medium Enterprises (SMEs) unseen since autumn 2021, these businesses are hesitant to increase their investments, as indicated in a study released on Wednesday by DZ Bank and the German Association of Public Banks (BVR). The study, which surveyed over a thousand SMEs, shows that 30% of them, a ten percentage point hike since autumn 2024, anticipate their business situation to enhance in the next six months.

However, this optimistic outlook for the future clashes with the current sentiment. The number of respondents who are dissatisfied with their present business situation has ascended to 40%, marking the fourth consecutive increase. This increase also highlights the enduring low investment readiness, as shown by the figure dropping by one percentage point to a level last seen during the financial crisis, barring the financial crisis era itself. At present, only slightly over two-thirds of these businesses are planning to allocate funds for the expansion of their businesses within the next six months. The reluctance to invest arises partly due to the low capacity utilization in the manufacturing sector, which is significantly below the long-term average. Investments are mainly limited to maintenance or replacement facilities. In contrast, companies operating in the services and agricultural sectors intend to expand their investments and activities more aggressively.

This diffidence to invest is not solely tied to the economic climate or public opinion. A myriad of factors, including labor market constraints, high costs, limited international engagement, regulatory hurdles, informality, and productivity gaps, are contributing to the subdued investment readiness.

• Labour Market Constraints and Skill Shortages: SMEs struggle to find and retain ideal candidates due to competition from larger multinationals with better compensation packages and benefits, thus limiting their capacity to invest and expand.
• High Business and Credit Costs: In regions such as Ireland, SMEs bear higher credit and energy costs compared to EU averages, creating substantial obstacles for investments even when there's optimism about the future.
• Limited International Engagement and Market Access: A majority of SMEs remain domestically oriented, with only a third participating in exporting activities. This restricts their opportunity to venture into larger markets like the EU single market and hinders their growth potential, curbing investment incentives even during positive outlooks.
• Structural and Regulatory Challenges: Administrative burdens and regulations have a heavier impact on SMEs, diminishing their investment readiness. While steps such as the introduction of an 'SME test' have been made to evaluate potential regulatory burdens, further improvement in public consultation and regulatory evaluation processes is crucial to support SMEs more effectively.
• Informality and Social Security Coverage: In economies like Viet Nam, a high percentage of workers in SMEs are informal with minimal social security coverage. This limits the advantage SMEs can derive from social security benefits, decreasing their incentives to invest in growth.
• Need for Improved Productivity and Innovation Capacity: The need to enhance productivity and innovation constrains investment readiness. Commitments to boost education outcomes, foster competition, and expand access to finance, including venture debt and innovation grants, are ongoing but have yet to adequately tackle these barriers.

Policy reforms and tailored support measures targeting these issues are critical to transforming optimism into increased investment activity. By addressing the underlying causes of inhibited investment readiness, SMEs can strengthen their positions and drive economic growth.

1. The Commission has acknowledged the importance of addressing the factors contributing to the low investment readiness among small-businesses, such as labor market constraints, high finance costs, limited international engagement, and regulatory hurdles, in order to transform unbridled optimism into increased investment activity for these businesses.
2. Despite the finance sector's crucial role in supporting small-business expansion, the Commission is exploring alternative means of funding, like venture debt and innovation grants, to help small-businesses overcome their productivity gaps and innovation capacity needs, thereby boosting investment readiness.

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