As economies push to turn the page on the coronavirus disease (COVID-19) crisis, the cumulative effects of lockdowns and quarantine measures on businesses continue to weigh heavily on informal micro, small, and medium-sized enterprises (MSMEs). In Indonesia, the government imposed several large-scale social restrictions to contain the virus, Pembatasan Sosial Berskala Besar (PSBB) in April–May 2020 and a second PSBB in September–November 2020, which included temporary business closures and mobility restrictions. Due to the surging delta coronavirus variant, the government again introduced a partial mobility restriction, Pemberlakuan Pembatasan Kegiatan Masyarakat (PPKM, or Emergency Community Activity Restrictions), during July–August 2021, and private businesses cut back on production and services delivery.
Most MSMEs operate informally and contribute less to economic growth
According to the International Finance Corporation (IFC 2013), unregistered informal firms are estimated to make up 77% of all MSMEs in developing economies, and the Asia and Pacific region hosts the most worldwide. In developing Asia, the majority of MSMEs operate informally, with many engaged in domestic trade or low-technology services. This is also true for Indonesia, where MSMEs involved in traditional wholesale and retail trade dominate (63.5% of non-agriculture MSMEs in 2016). Most are unregistered family-run businesses or sole proprietorships, which implies informality.
But how have these informal MSMEs survived the pandemic despite their limited access to government support and formal financial services? A recent study by Shinozaki (2022) indicates that informal MSMEs in Indonesia were hit hardest by COVID-19 and have been more seriously affected than formal MSMEs. Many businesses were forced to close, and domestic demand for their products and services dropped sharply. By May 2021, one year into the pandemic, the situation had improved, but domestic demand had yet to recover. Meanwhile, two types of business clusters were forming and growing: (i) contracting firms hurt badly by the pandemic and (ii) groups of firms that benefited from the pandemic. These were most prominent among services firms.
A critical challenge in achieving inclusive growth is to formalize (register) informal firms and non-contract-based employees. Several studies have shown that large numbers of informal firms coincide with lower economic development (Loayza and Rigolini 2006; ILO 2011; IFC 2013). A well-designed national policy framework to formalize informal MSMEs is needed to boost productivity and create quality jobs efficiently in the aftermath of the pandemic. To this end, it is critical to understand informal MSMEs, their challenges, and latent growth opportunities through solid data analysis using granular firm-level data.
Informal MSMEs are more volatile to the pandemic’s impacts than formal firms
Shinozaki (2022) highlights key findings in a study on the impact of COVID-19 on informal MSMEs in Indonesia based on a year-long survey from March 2020 to May 2021. The regression analysis finds that revenue from construction, administrative services, education, and entertainment services was initially the hardest hit, given the PSBB social restrictions. Information and communications, financial services, and health and social services were less affected as they remained essential services.
Local firms felt the impact on revenue more than Jakarta-based firms a year after the first outbreak. As the pandemic wore on, the impact became more serious for young firms aged up to 5 years. Women-led firms also faced serious impacts on revenue, employment, and finance. Internationalized firms had a mixed impact in terms of revenue and employment, being affected by social restrictions but balanced by global market openness, while private businesses began reopening as the economy started to recover in 2021. However, small distributive trade and services—typically in the informal sectors—reacted quickly to the surging delta variant 1 month before the second wave struck in mid-June 2021 and temporarily shut down or faced revenue losses again. Informal firms were more sensitive to the pandemic’s impact than formal firms, while business remained highly fragile given the uncertainty in the infection rates of the virus.
The pandemic pushed informal MSMEs to go digital, but their business performance varied, and many remained outside of formal financial services and government support
The pandemic and mobility restrictions drove private businesses to go digitalization, and informal MSMEs joined this accelerating process. Digitally operated informal firms—those using the internet for business or using e-commerce—were less affected by the pandemic in terms of revenue compared to non-digital informal firms, but many fell into profitable or non-profitable clusters, especially those in services.
The pandemic and social restrictions also hurt the finances of informal MSMEs. Working capital shortages were more serious than for formal firms and more evident among Jakarta-based firms. As the pandemic continued, however, two groups emerged: those facing serious working capital shortages and those with sufficient cash or savings. These were closely associated with two business clusters—those who were severely hit by the pandemic and those who benefited by supplying essential goods or services. Young firms had more cash/savings problems than longer-established firms, while digitally operated firms had fewer financial issues than non-digital firms. But even digitally operated informal MSMEs had to contend with volatile working capital conditions.
Informal MSMEs relied heavily on their own funds and borrowings from close relatives at the start of the pandemic. One year later, they borrowed less from close relatives as access to formal financial services increased, largely due to the available government financial assistance. However, the number of informal MSMEs that could obtain credit from banks was still limited, causing them to rely more on internal funds to keep their businesses operating. This suggests that many remained ineligible for government financial assistance. The use of digital financial services was also not viable for them, with an average uptake of only 1% among the informal MSMEs surveyed in 2020–2021.
Informal MSMEs need more support for business development and skills upgrading besides working capital support
The top concern of most informal MSMEs at the start of the pandemic was a lack of working capital. One year later, their top concern shifted to the decline in domestic demand as the pandemic continued with the emerging new variants, although working capital shortages remained high as the second-ranked issue. Concerns over tax payments and a decline in foreign demand were ranked lowest, as the firms operate informally, with many evading tax payments, and they also focus on limited domestic markets.
These concerns surfaced in firms’ choices of their desired policy measures. Concessional and quick loans, along with subsidies and cash transfers for business recovery and worker retention, were the top policy measures desired a year into the pandemic. For more real-time assistance, they initially asked the government to set up a comprehensive information platform on available support programs. In parallel, they wanted support for training and business literacy programs. As the pandemic continued, they increasingly looked to the government more in terms of business development and skills upgrading for workers aside from a desire for continuous working capital support.
Post-pandemic policies should address formalizing MSMEs with proportionate measures
While the Indonesian government imposed social restrictions to contain the pandemic, national policies focused more on economic recovery through massive government spending. As of 15 November 2021, support packages totaled $115.3 billion, or 11.4% of 2020 gross domestic product (ADB 2021). The government launched several economic stimulus packages in 2020: (i) an economic stimulus focusing on tourism in February, (ii) a fiscal stimulus for tax relief in March, and (iii) the National Economic Recovery (PEN) program, covering financial (credit guarantees) and nonfinancial (corporate income tax exemptions) support for MSMEs. With the uncertainty over how long it will take to contain the COVID-19 pandemic—given existing and potential new variant outbreaks—there are increasing risks of further bloating national budgets and deteriorating bank balance sheets over the long term. This suggests the need for ways to better control budget expenditures with support for focused groups. One important aspect is how best to encourage informal MSMEs and workers to become formalized (or register) to ensure a smooth and stable economic recovery.
Shinozaki (2022) suggests a policy framework for formalizing informal MSMEs that is designed proportionately to focus on firms’ varying abilities to cope with the pandemic, and that provides incentives for informal business owners to concentrate on growth under the “new normal.” The policy implications include strengthening business competitiveness and entrepreneurship development for firms to survive and grow during the recovery period, with digital transformation as a part of the strategy. Changing the mindsets of informal business owners from being stability-oriented to growth-oriented is key.
In Indonesia, the growth forecast was for a robust 2022 at 5.0%, an increase from 3.7% growth in 2021 and a rebound from a 2.1% contraction in 2020 (ADB 2022). However, new COVID-19 variants, such as the omicron variant, have increased uncertainty over economic growth and raised the risk of business failures and bankruptcies, especially for MSMEs. Formalizing informal MSMEs is now more critical to the policy agenda for ensuring resilient economic recovery and sustainable, inclusive post-pandemic growth.
Asian Development Bank (ADB). 2021. COVID-19 Policy Database. https://covid19policy.adb.org/ (accessed 30 November 2021).
ADB. 2022. Asian Development Outlook 2022. Manila: ADB.
International Finance Corporation (IFC). 2013. Closing the Credit Gap for Formal and Informal Micro, Small, and Medium Enterprises. Washington, DC: IFC.
International Labor Organization (ILO). 2011. Statistical Update on Employment in the Informal Economy. ILP Department of Statistics, unpublished note.
Loayza, N., and J. Rigolini. 2006. Informality Trends and Cycles. Policy Research Working Paper 4078. Washington, DC: World Bank.
Shinozaki, S. 2022. Informal Micro, Small, and Medium-Sized Enterprises and Digitalization: Evidence from Surveys in Indonesia. ADBI Working Paper Series No. 1310. Tokyo: ADBI.