Microloans May Work, but There Is Dispute in India Over Who Will Make Them

Aug 2006
New York , August, 10 2006 - Presentation of the Spandana project in India and the political crisis the private microfinance industry is facing in this country.


MICROFINANCE is based on a simple idea: banks, finance companies, and charities lend small sums — often no more than a few hundred dollars — to poor third world entrepreneurs. The loan recipients open businesses like tailoring shops or small grocery stores, thereby bolstering local economies.But does microfinance, in fact, help the poor?

But does microfinance, in fact, help the poor?

To help answer this question, I visited Hyderabad, India, in June. The Poverty Action Lab at the Massachusetts Institute of Technology, run by Abhijit Banerjee and Esther Duflo, economics professors at M.I.T., and Sendhil Mullainathan, an economics professor at Harvard, has begun a study of microfinance in Hyderabad. The lab is monitoring thousands of borrowers from Spandana, one of the largest microlenders in India. At the end of a two-year trial period, the study will compare microfinance recipients to peers without comparable opportunities. The lab looks for the real-world equivalent of controlled experiments to study which programs actually alleviate poverty; this work is one of the hottest trends in the economics profession today.

My visit suggested that microfinance is working, but it is often more corporate, more commercial and under more attack than I had expected.

Microfinance is not actually “micro” in scale. It is far more organized than the individual moneylenders in poor communities, the traditional source of finance. Spandana borrows from banks, has about 2,000 employees and deals with about 800,000 loan recipients. The resulting economies of scale make possible lower interest rates. Spandana has been lending at interest rates of 10 to 15 percent a year, while other Indian microlenders may have rates ranging up to about 30 percent a year. Traditional moneylenders receive 5 or 10 percent a month or more. It is no wonder that Spandana has grown.

Spandana seeks to earn a profit through higher repayment rates. Unlike the moneylenders, Spandana lends to small groups of 5 to 10 people rather than to individuals; each member is liable if other group borrowers do not repay. The carrot is that good borrowers become eligible to receive higher sums.

Contrary to some exaggerated claims made on its behalf, microfinance does not generally allow women to establish financial independence from their husbands. Women are the ones who show up to borrow and repay the money. But I polled three groups of Spandana borrowers and found that usually the money went to a business of the husband, not the wife.

Spandana insists on payments every week, if only to ensure that the borrowing family is fiscally responsible. But microlending does not always feed into a new business. No matter how the loan is described on paper, many families use the money to finance the purchase of a new motorbike or pay the family doctor. These loans will increase as more Indians come within reach of modern consumer society; Spandana realizes that such uses are no less important than creating businesses. In some cases, microfinance allows people to refinance loans with private moneylenders and thus go deeper into debt. But more often I heard stories of how Spandana let Indian families break free from the expensive private lenders.

Near Hyderabad, in the state of Andhra Pradesh, political opposition to microfinance has begun. State officials have fed negative stories to the media. They charge that microfinance debts have driven some people to ruin or perhaps suicide. They call Spandana’s programs “coercive” and “barbaric.” They question whether the “community pressure” behind repayment is sometimes too severe.

The motives behind this campaign are twofold. The state is not a neutral umpire but rather has its own “self-help group” banking model, which lends at the micro level. Spandana and some of the other private microfinance groups are unwelcome competition. More generally, opposition to money lending has been frequent in the history of both India and the West. Not every loan will have a positive outcome, and it is easy to focus on the victims. Not all Indians have accepted the future of their country as an open commercial society with winners and losers.

The government has abruptly shut down the branch offices of some microlenders, including Spandana, without respect for due process. There is talk of legally capping microfinance interest rates at levels — 10 to 15 percent a year — that would put many microlenders out of business. Such regulations would drive the poor back to the far more expensive private moneylenders and also to the state government.

Some microlenders have responded by raising their interest rates to reflect the new political risks. Spandana has moved in the opposite direction and is now issuing many loans at the much lower rate of 7.5 percent a year. This may forestall political attacks, but can the company make money in this new environment? The real problem with microfinance is suddenly clear: the lenders are now large enough and public enough that they become political targets.

The Indian political authorities must decide whether they will allow new businesses to spread, even when commercialization leads to some disappointments or competes with a state interest. The stipulation that no one can be harmed by progress is a sure recipe for stagnation.

Despite these troubles, Padmaja Reddy, the founder and chief executive of Spandana, says she believes her business will grow. I asked Ms. Reddy if she was afraid of having her loans scrutinized by outside academics. She said she expected Spandana programs to pass the test, but she also did not expect every good result of microlending to appear in the numbers. Sometimes access to credit simply gives families a stronger sense of security. For Ms. Reddy, the final proof of the effectiveness of her programs is that “the women keep returning, three, four times in a row.”

Tyler Cowen is a professor of economics at George Mason University. He is co-author of a blog at www.marginalrevolution.com. He can be reached at tcowen@gmu.edu.

Source : New York Times

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