Thursday, August 10, 2017

We need microcredit to develop the rural economy

01 Wednesday, 9 August 2017
In the rural economy and the SME sector there is a dire shortage of capital. Without capital the rural economy will not move from stagnation to growth. A very large part of the population, estimated at around 75%, lives in the rural areas. To get inclusive growth in our economy we must provide them with access to capital.

Microcredit has been used in many parts of the world. Now there are 211 million microcredit customers. Sometimes it has been very successful in alleviating poverty, and at other times it has failed. There are many questions that need to be probed. Is microcredit the best conduit for capital to the rural economy? Should the Government take on the role of provider of microcredit?

There is also be the questions of trade-offs to be considered. Less infrastructure to help the big private sector and more resources like microcredit to develop the rural economy.

The development equation

To address these issues, one must get the whole development equation into some sort of clear perspective.

Sri Lanka is a private sector economy. Growth must come from the two segments of the private sector. Both the big company sector and the rural people’s private sector (which is the many component parts of the rural economy including the SME sector), must grow in tandem and grow our GDP.

The big business sector

02The big business sector contributes little towards inclusive growth. It has large private companies like Maliban, Munchee (Ceylon Biscuits) MAS, Brandix, etc. All their profits go to the owners. We also have large public quoted companies. Most of them are cosmetic public companies. Cosmetic because the bulk of the shares are held by a family and perhaps a measly 20% is available to the public. The earnings go primarily to these major shareholders. The general public have little access to the fruits of their growth.

As there is a lack of liquidity we do not have a plethora of funds in which the small man can invest his modest savings and savour the benefits of growth in the big business sector.

Growth but no inclusive growth

If these companies grow, say by 25% a year, they will grow GDP, and probably increase foreign reserves through exports. All good things certainly. But, they will not put more food on the table of farmers or fisherman or small traders or small industrialists.

Except for tourism there is no strong link between their growth and the wellbeing of the rural economy.

This bring us back to square one. To improve the wellbeing of our people we must get growth in the wider rural economy. To achieve this we must provide them with access to capital. Hence the question, is microcredit the answer?

The problem

Appuhamy has a boutique. He wants to expand his business by stocking a larger range of products. There is no one who will lend him the money that will enable him to do so.

Sunil is a talented potter. He makes creative pieces of ceramics. A shop in Colombo buys his whole small monthly output, and exports it. They tell him that they can sell 10 times what they sell now. Every night he falls sleep thinking of how his life will change if he can make more pieces of pottery. Every morning he yearns for a way to find the money to buy a larger kiln.

The dilemma

No capital, no growth, no collateral, no loans from the bank. That’s the grim scenario that confronts the Appuhamys and Sunils in the rural economy.

To get a loan from a bank one must provide collateral. You have to be able to mortgage to the bank some asset of equal value. If you are unable to repay the loan, the bank must have a hold on an asset they can sell and recover their money.

Microcredit is the answer to the poor man’s prayer

Microcredit is lending to people without asking them to mortgage any asset. Micro credit is lending without seeking any collateral. It is lending to those who have no assets to mortgage.

The evolution of microcredit

The pioneer of the concept of microcredit was Muhammad Yunus in Bangladesh. In 1976 he started lending money, seeking no collateral, to help poor people to develop their business or to start a new business. He only lent money to women. I met him in the early days of his Grameen Bank project at a presentation. Yunus said the women always repaid the loans. He said defaults were virtually zero. This was a unique innovative approach to help the poor. A lot was written about Yunus and his Bangladesh project. There was a lot of excitement about this new concept.

Then some donors who wanted to do good funded NGOs to set up micro credit projects. In the early days most of these were in Africa. The good projects ran with a default rate well below 10%. Now defaults of 10% are viewed as the red light warning of an impending crisis. In the business of lending money there will always be some defaults. The best of banks have nonperforming loans.

From donors to financial institutions

Financial institutions got interested when they found that the poor repaid their loans. On the face of it, this was an unrealistic proposition. To give money with no collateral and no guarantees. But the financial institutions got a sniff of money in the air, and researched it, and found that this seemingly absurd concept was working well and it was possible to make money. They also realised that it could be a very large market. The latest available figures say that there are 211 million microcredit customers in the world.

The motivation of the microfinance institutions was to make money. If there was any motivation at all to help the poor, it was only a very teeny weeny part of their motivation.

The micro credit experience 

A lot of research, and a lot has been written, because this has been an intriguing concept of lending money to the poor, and making money, instead of losing money.

Microfinance institutions need a good organisation with staff living in the area who can get to know potential customers. It is their call whether to give or not to give a loan. If they are very cautious, they make no money. If reckless they lose money.

The key learning in the early days was to avoid giving money to the poor that will be used for consumption. If the borrowers are late in paying, they have to be coaxed. If they are harshly bullied, people will stop borrowing. If they stop borrowing, the institution stops making money. Some projects failed as the number of customers declined rapidly as there were no more opportunities for investment in the area.

Money alone does not create a successful business. If a fisherman gets a loan, gets new equipment and doubles his catch but he cannot sell it, other fisherman will not get a loan and buy equipment as they know that the fish cannot be sold.

The conflict between making money and sponsoring economic growth

The money into microfinance institutions has come from many sources. It started with donors who wanted to do good. Very little of that now. Money comes from investment banks, private equity and even commercial banks are creating their own microfinance firms.

Sadly this has created a shift in focus. Less and less money is given to the poor and more to the relatively well-off for consumption (daughter’s wedding, pilgrimage, etc.). The dominant criteria is no longer development. It is whether they will pay back the loan. What they use it for is irrelevant to the organisation.

Sri Lanka scenario 

Except in a few pockets, we don’t have very poor people. What we do have in the rural economy is a large population all gainfully engaged in some activity or the other. That is why they will not come and work on urban building projects.

To get inclusive growth in our country, the most important need is to provide access to capital to finance the development of the mass of varied economic activities that comprise the rural economy.

Our future in incremental exports will also come from there, as the opportunity is in niche sectors like organic fruits, spices and vegetables, handcrafted ceramics, designer tiles and bricks and specialised products from the SME sector.

Banks will not lend unless the borrower can provide collateral. The rural economy has no collateral to offer. The vast majority for historical reasons do not have proper title deeds to the property they occupy. Most of the villages would be on encroachments on crown land that took place a long time ago.

The irony is that a man in the rural economy can buy a motorcycle on hire purchase as the finance companies are happy to lend with the motorcycle as collateral. The same man cannot get a loan from anyone to buy a ton of fertiliser.


Microcredit is the answer to provide capital to those in the rural economy who want to develop their business. Microfinance institutions must be structured to encompass the learnings from microcredit projects around the world.

The unwavering mission has to be to support development of existing and new income generating activities. It should not deviate in search of soft targets and lend money to those who are relatively well off to finance consumption. They should keep interest rates low and not indulge in practices like charging punitive rates if there are delays in repayment. There has to be sympathetic mindset when people are unable sometimes to comply with the repayment schedules, due to unexpected problems.

Will private microfinance institutions behave in this manner? Will it be possible for them to shed their ingrained motive of making as much money as possible? Probably not. Then the only way forward to meet the objective of providing access to capital to the rural economy is for the State to step in and create microfinance institutions. The two State banks could be used to create these, as not-for-profit institutions.

Capital is not a magic bullet that always gets the growth target. It is only a tool and to deliver results it needs the supporting infrastructure and services. The State banks as microfinance institutions must also take on the role of fostering all of that, so that capital can indeed become a magic bullet.

A new paradigm

We need a fundamental shift in our economic thinking. We need to move from urban centric, big business centric and great aspirations to a model of developing the total economy with priority to the rural economy that contains 75% of the population.

There will be tension. The Government does not have unlimited funds. The major area of expenditure is infrastructure. To fund micro credit it will have to defer some infrastructure.

It must of course pursue getting the macroeconomic fundamentals right. But it may have to go a little slower to accommodate what is necessary to stimulate the rural economy.

We need new minds, fresh thinking, emotional aspirations and the steely determination to find new solutions. I was delighted to read that Deshal de Mel (no relative) has been appointed an adviser to the Ministry of Finance. Hopefully a new initiative to bring in youth. Deshal has two important attributes, a fine mind and the refreshing insolence of youth. He says it as he sees it. We need more like him to structure a new paradigm.

(The writer has done this that and the other including the Tripos in Economics at Cambridge University.)