Microfinance falls on hard times

LAHORE: Slow economic growth, double digit inflation, high unemployment rate and the high cost of production is not only hampering the growth of industry but also hitting the microfinance sector hard.
Official figures show that Pakistan’s real GDP growth rate plummeted from six percent in the financial year (FY) 2005 to 2.7 percent (estimated) in FY10, productivity fell sharply and average annual inflation rose from 4.8 percent in FY05 to 14.2 percent in FY10. Economists believe that for an average Pakistani, this means a decline in real income owing to a decrease in the household productivity and the purchasing power of rupee.
A recent research report released by the Pakistan Microfinance Network (PMN) entitled “Microcredit Utilisation: Shifting from Production to Consumption?” indicates that during the previous five years, microfinance outreach in the country has expanded 26 fold. Figures show that active microfinance borrowers were approximately 76,000 at year-end 2000, a figure which touched 1.98 million in June 2010. The research also infers that in real terms, the average outstanding loan balance declined by more than 25 percent during the same time.
The study points out that the microfinance sector’s failure to maintain its average loan balance has raised fears the actual viability of the average microcredit provided to meet the borrower’s business needs. It underlines that this inadequacy of the average microcredit program may spur clients to borrow from multiple microfinance providers, patching loans to meet their cash flow needs. Coupled with declining productivity and a fall in the disposal income of households, this inadequacy may lead to the diversion of the standard group-based lending (GBL) enterprise funding to unplanned/non-enterprise-related use, the report warns.
Field surveys reveal that the majority of loans diverted to unplanned consumption were utilised for household needs ranging from daily expenses to house floor repairs. Figures show that on average, up to 52 percent of loan amounts are diverted to consumption. Another major problem is unexpected medical expenses. A major chunk of the 40 percent of loans is spent to cover medical expenses.
The survey indicates that microcreditors consider small loans an easy option to meet their financial needs and become trapped in a vicious circle. Apparently, borrowers with multiple parallel loans are more likely to use them for non-commercial purposes, than borrowers accessing single loans are.
Borrowers estimated that, on average, approximately two in every five microfinance borrowers had taken multiple loans. The estimated incidence was considerably higher for district Lahore, the most concentrated microfinance market in Pakistan. However, a larger percentage of multiple-borrowers had also declared losses and/or no profits after investing their loans in their businesses, compared to borrowers without multiple loans, data suggests.
Research also indicates that the microfinance is often insufficient in the face of the sheer magnitude of inflation. Although average loan sizes of the first loan cycle increased, an average first loan from a microfinance provider (MFP) in 2010 had only 68 percent of the purchasing power of an average first loan from an MFP in 2004.
Research states that the cost of living for an average household in Pakistan has been on the rise for the last two to three years. Microfinance borrowers are under greater pressure to increase their cash flow/income sources to meet their business and household needs.
At the same time, the survey states that microcredit is adding to households’ income-earning capacity. More than four in every five borrowers declared using their loans for enterprise purposes. In addition, more than 70 percent of borrowers attributed an increase in household income to microcredit. However, an increase in income-earning capacity may not match the pace at which the cost of living rises.
Approximately one in every three borrowers felt they were left with no savings after meeting household and business expenses despite the increase in incomes due to investing microcredit in business, the survey points out.
The report underlines that while the cost of goods and the cost of living has increased and continues to increase at a double-digit rate, incomes and income-earning opportunities may not be increasing equally for all borrowers. Thus, the majority of borrowers feel that they do not have the capacity to incur large debts and still meet larger repayment obligations. These borrowers are not inclined larger loan or multiple borrowing.
The research concludes with some recommendations for the MFPs, regulators and donor agencies to strengthen the microfinance sector. These recommendations include product and market diversification, strengthening of MFPs, internal controls and underwriting practices.