Demonetisation has hit microfinance hard (and no one's talking about it)

We must not forget the caution: 'Microcredit is microdebt'.

 |  6-minute read |   24-11-2016
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One sector which has been impacted hard by demonetisation but finds no space in the overall discourse is the microfinance sector . Microfinancers operate on a weekly cycle and their operations have dropped to a trickle. The recent months have seen a sudden boom in microfinance operations and much of the credit was being used by poor borrowers for consumption or white goods.

Government lens has still not turned on these desi capitalists who are daily bleeding millions of poor and driving them into greater despair.

The institutions have deferred the repayment schedule of their borrowers for the next few days. In the last four-five days, repayment collections of about Rs 500 crore to Rs 600 crore ($74-89 million) have been deferred and, with the lack of currency supply, micro-finance institutions' (MFI) disbursement was also down by around Rs 600 crore.

Microfinance operators target vulnerable low-income households with highly flexible loans but tag them with very high rates of interest. Increased microloans without a corresponding increase or non-existent income gives rise to this problem. This is accentuated by the fact that the interest costs for MFs have remained stable over a period and the recent rate cuts have had almost no impact in this sector. '

Various studies on the impact of microfinance have found that there is no transformative change in income and poverty levels despite the availability of credit. Expecting a change as huge as pulling the poor out of poverty is turning a blind eye to the limitations of market-based solutions - such as microfinance.

One may ask why the use of microfinance is still so popular despite lackluster results. One plausible reason for this lingering faith in the power of microfinance is that it provides a convenient strategy for lenders to demonstrate that they care for the poor while making a substantial amount of money from them.

In fact, it turns out that microfinance usually ends up making poverty worse. The reasons for this are fairly simple. Most microfinance loans are not even used to set up businesses but instead are used by borrowers to fund household consumption - to help people buy the basic necessities they need to survive, or to pay for unavoidable expenses such as getting their children married.

In South Africa, for example, an estimated 94 per cent of microfinance loans are used for consumption purposes. As a result, borrowers don’t generate any new income that they can use to repay their loans so they end up taking out new loans to repay the old ones, wrapping themselves in layers of debt.

rupee-embed_112416021420.jpg Microfinance usually ends up making poverty worse.

When micro-loans are used to fund new businesses, poor entrepreneurs often face a lack of consumer demand since most of their potential customers are also from poor households, struggling to make ends meet. When micro-loans are used to fund new businesses, budding entrepreneurs tend to encounter a lack of consumer demand.

After all, their potential customers are poor and low on cash, and what little money they do have gets spent on basic goods that tend already to be available Given this lack of demand, even the most assertive of micro-finance entrepreneurs will at best displace an already-existing venture within their community, yielding no net increase in employment and incomes instead of setting up businesses, which can make enough profit to pay off the high interest charging micro-finance loans, and have some money left to improve the borrower’s household income. And that’s the best of the likely outcomes.

The worst - and much more likely – is that the new micro-businesses fluster and then fail, leading micro-finance recipients to become increasingly indebted. Impoverished defendants have nothing to give, and the result is a system that disproportionately punishes the poor, leaving them with an overhang of debt from which they can never escape. In practice those safeguards are chimerical.

The biggest problem with microfinance is that people who get these small loans usually start or expand a very simple business. The most common business for microfinance is simple retail - selling groceries - where there are often too many people, fierce competition, and where they don’t really earn enough money to get out of poverty.

We need to create more jobs, and microfinance does not help do that yet. The debt trap is an under-reported problem. Quite a few people invest money, their business does not make money and goes under, and they are stuck with the debt. The interest rate on this debt, even with a microfinance loan, is quite high, so some are never able to repay it.

Another reason why they get into a debt trap is that, in theory, you should take a microloan to invest in the business. But in practice a lot of people use microloans for a wedding, festival, or to buy something. A lot of these people don’t know how to use debt.

Even people in rich countries often don’t know how to use debt. They think that once you have a credit card, you can buy anything. If you get microloans, it doesn’t necessarily mean you can buy things you couldn’t afford before. Many people get into debt stress at some points in their lives. They scrimp on groceries for a couple of weeks to have the cash for next month’s loan payment.

Or they miss loan payments because a lingering illness keeps them away from their business. That’s acute over-indebtedness. While acute debt stress can be serious, some temporary over-indebtedness is a normal part of the ups and downs of life and might not mean that a person has borrowed too much.

But we should be aware of the flip side of microfinance .Microfinance - including microcredits - is often considered to be an instrument that promotes empowerment. Whilst it can stabilise livelihoods, broaden choices, provide start-up funds for productive investment, help poor people to smooth consumption flows and send children to school, it can also lead to indebtedness and increased exclusion unless programmes are well designed.

We must not forget the caution: “Microcredit is microdebt.” When a woman fails to make her installments on time, she experiences humiliation through verbal aggression from fellow members and loan recovery officials. Such humiliation of women in a public place gives males in the household and in the lineage a bad reputation.

In an extreme case, peers may take the defaulter to the police station. For a man, if he is locked inside the police stations for several days, it would mean almost nothing to other people in the village. But if this happens to a woman then it will bring shame to her household, lineage and village. 

The failure of microfinance is recognised at even the highest levels, and yet for some reason it retains its staying power, like a zombie that refuses to die. Why is microfinance such a resilient idea? Because it promises an elegant, win-win solution to the problem of poverty.

It assures us that we - the rich world - can eradicate poverty in the global South without any cost to us, and without any threat to existing arrangements of political and economic power. In other words, it promises revolution without the messiness of class struggle. And, what is more, it promises that we can help save the poor while making money from it. It’s an irresistible tale.

Also read: Using Jan Dhan accounts to launder black money must end

Writer

Moin Qazi Moin Qazi @moinqazi123

The writer is a researcher and development professional who has spent four decades in the development sector. He holds doctorates in economics and english, and has authored books on religion, rural finance, culture and handicrafts.

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