This paper discusses the relationship between the informal economy and the development of SMEs in Kosovo. The purpose of this paper is to analyze the informal economy, its causes, effects and its impact on business, as well as government policies to combat the informal economy which is a barrier to business development in Kosovo. During the period of transition, the number of small and medium businesses increased significantly, but their existence depends on external factors, such as informality. The informal economy is present in countries that are structurally and economically fragile, a structure which enables businesses to leave out the formal way of doing business. To meet the objective of this paper we usedthe observation method to analyze the data from different authors and reports about the informal economy and the development of SMEs. Among the key factors for the growth of informality are high taxes which are seen as an obstacle to business growth. According to the outcomes of this paper, we conclude that the informal economy is an obstacle to SME development in Kosovo. This study makes a significant contribution to the scientific and academic value, to the informal economy in the development of SMEs in Kosovo, in the region and beyond.