For the past seven years, I have been writing about the working of microfinance, and pointing out, contrary to claims by micro-lenders and the general perception on the part of donors, that such lending has not been benefitting the poor (see my previous blogs herein, my articles in professional journals, and my book, India Untouched: The Forgotten Face of Rural Poverty). Let me further answer the central question as follows.
Proponents of microfinance have been claiming that micro-lending is helping the poor get out of poverty. Who are the recipients of microloans, and are they truly benefitting?
According to the World Bank narrow definition for poverty, those earning less than $1.20 per day are considered poor. For a family of 4, this implies a family income of $4.80 per day, or $144 per month. This works out to Rs. 6,400 per month in India. Once again, interpolating World Bank statistics for 2008, there are no less than 60% of the families (around 700 million people in India alone) living below this income level. Most of them are either illiterate, or with very little education or skills to start and run a business. Great majorities of the poor people live and work in rural areas and rural towns as laborers and unskilled employees in farms, factories and small businesses. At best, some of them can be expected to engage in family-run activities such as maintaining one or two cows, few hen or goats, provided they receive sufficient capital to start such activity.
Take the case of a poor family trying to maintain 50 hens to support themselves. It would require no less than Rs. 25,000 ($550) in initial capital to build the necessary infrastructure to keep the hens safely from predators and thieves, and to feed the chicks during the initial 6 months until they are mature enough to lay eggs. This size of capital, if borrowed, would place substantial financial burden on the borrower, especially if the interest is 24-36% annual rate as commonly charged by micro-lenders in India (note: usually microloans are for much smaller amounts).
What would this small poultry farm bring in financial return? At today’s price for eggs, and assuming that the hen are of good breed laying 200 eggs a year, the average annual revenue would be Rs. 40,000 (around $850). After deducting the cost of feed and vaccinations to prevent diseases, the annual profit could be around Rs. 28,000 ($600), not including the wages forgone by the family. This works out to Rs. 2,300 ($50) per month. At monthly interest of 2.5% on Rs. 25,000 initial loan, interest payment alone would be Rs. 625 ($14) per month. 12 monthly repayment of principal would be Rs. 2,083 ($46). These financing costs leave the family with negative cash-flow. This business is not financially feasible as structured.
By engaging in such businesses with no personal capital and high interest loans, and by losing income from gainful employment elsewhere, the borrower gets into deeper financial trouble. I have pointed out in earlier articles of this situation for practically every poor family that ventures into business. Unless the starting capital and some initial months of financial support are provided free, the family cannot engage in even small businesses.
Recognizing the above reality, micro-lenders prefer to lend to those with incomes above the poverty level and those already engaged in businesses. These people are not poor as claimed by microfinance firms.
Small businesses run by lower income people cannot usually obtain conventional loans, and they could be helped with micro-loans. However, even they would find it very hard to repay loans at the high interest rates currently charged by microfinance firms. The concept of micro-lending might be meaningful to small businesses if the cost of borrowing can be brought down substantially. But it is no poverty alleviation activity.
The author of this blog runs several social projects in South India.
Abraham M. George