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Tuesday, March 25, 2008

Micro-loans and Macro-expectations

By Nitin Rao

accion conferenceVia NextBillion ally Reuben Abraham, I was pointed to James Surowiecki's recent article, What Microloans Miss in The New Yorker.

Surowiecki points out that while microfinance does a tremendous amount of good, there are also real limits to what it can accomplish. With over $25 billions of loans and websites to lend to the poor, microloans are increasingly being viewed as a panacea for all issues of poverty.

An excerpt:

The idealized view of microfinance is that budding entrepreneurs use the loans to start and grow businesses?expanding operations, boosting inventory, and so on. The reality is more complicated. Microloans are often used to ?smooth consumption??tiding a borrower over in times of crisis. They?re also, as Karol Boudreaux and Tyler Cowen point out in a recent paper, often used for non-business expenses, such as a child?s education. It?s less common to find them used to fund major business expansions or to hire new employees. In part, this is because the loans can be very small?frequently as little as fifty or a hundred dollars?and generally come with very high interest rates, often above thirty or forty per cent. But it?s also because most microbusinesses aren?t looking to take on more workers. The vast majority have only one paid employee: the owner.

He argues that developing countries do not need more funds towards micro lending, but as capital for small and medium enterprises that generate employment.

I agree with James Surowiecki that not everybody is cut out to be an entrepreneur. Indeed, economies function and thrive because different people play different roles.

Perhaps, the distinction to be drawn here is between access to capital and poverty alleviation. The decision to be an entrepreneur is often a function of one's choices -- and access to capital is a key element in that decision. Additionally, when parents use microfinance to invest in their children's education, traditional and short-term metrics of poverty alleviation can be misleading.

According to a study by SIDBI (Small Industries Development Bank of India), loans from MFIs/group funds are used mostly for productive purposes (as high as 80% in the Grameen and Individual model and 60% for SHG members). With over 90% MFIs serving less than 10,000 clients, it appears likely that larger microfinance institutions will lend for productive purposes - and smaller SHGs will be relatively flexible about the use of capital. When I wrote to SKS, they insisted that the MFI only lends for income generation and by the loan utilization check verifies it too.

As Acumen Fund's Jacqueline Novogratz writes:

Acumen Fund's investments typically range from $300,000 to $2 million, or the ?missing middle? as Surowiecki calls it. These investments have helped create more than 20,000 jobs while also bringing tens of millions of people products they?ve never before been able to access. A to Z Textile Mills in Tanzania, for instance, now employs 5,000 individuals, mostly uneducated women, and produces eight million bednets per year, providing protection against malaria to more than 16 million Africans. Change is possible through a combination of smart, patient capital as well as supporting enterprises with talent and knowledge of what works elsewhere.

It is heartening to see interest in SMEs - and it might take sustained availability of capital (and realistic expectations) before the poor can benefit from the choice of successful markets.

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