Rapid economic growth, while lifting all boats and reducing poverty, is widely believed to have had an unequal fallout on income distribution. Much of this can be attributed to the anemic income and productivity growth in the agricultural sector, on which about 60% of the population depends for a living. It is not surprising that even as ?poverty rates? have declined, both the World Bank and the National Commission for Enterprises in the Unorganised Sector estimate that some 80% of the population lives on less than $2 PPP per day. There is understandably a growing concern about inclusive growth.
Since access to credit is a necessary concomitant of growth, there is a related concern over what is commonly termed ?financial exclusion?. A recent survey by Invest India Market Solutions estimates that about 75% of the credit requirements of those with an annual income of Rs 50,000 per annum, comprising some 60% of the population, is from informal sources such as friends, family or moneylenders at usurious rates of interest.
Microfinance or micro-credit through self-help groups (SHGs) is the new buzzword to achieve financial inclusion. This is largely based on the putative success of Grameen Bank in Bangladesh, for which Mohammed Yunus was awarded the Nobel Prize in 2006. The rate of interest charged by micro-credit institutions is high on account of higher transaction costs since they do not have the scale advantages of bank finance. It is, however, no higher than what is charged by the local moneylender, the proverbial lender of last resort.
The aggressive promotion and proliferation of SHGs is reminiscent of the small scale sector a few decades ago. Since SHGs have been mostly able to roll over their capital, there is a common perception that such high interest rates are eminently serviceable and the underlying economic activity sustainable. The intriguing question that remains unanswered is how the least productive sector of the economy can sustain economic activity funded by credit more than twice as costly as that available to the far more productive organised sector.
The prospect of petty production, which microcredit mostly finances, can be gauged from the fate of small scale industries which were simply not productive enough to compete with the organised sector, except in select niches and as part of highly productive global value chains. Productivity improvement and access to modern technology, including economies of scale, are critical to competitiveness in the emerging open economy. Globalisation has made the tradable goods sector extremely cost-conscious and competitive, particularly with the integration of China into the global economy. Of course, returns could actually be very high where lack of roads and other infrastructural constraints act like tariff barriers, preventing outside products and services from coming in. On balance, however, avenues for investment in activities and assets that yield returns higher than the cost of credit are extremely limited and can only be serviced by squeezing consumption. If interest rates are high, then wage rates must be low. The question, then, is whether microcredit could be used for enhancing labour productivity on a sustainable basis. High interest rates, however, make microcredit an unsuitable source for financing expensive long-gestation investments in capital and technology.
How are SHGs able to service high cost credit? There are three possible explanations. First, social pressure possibly converts SHG credit into ?senior? loans with the first charge on current income, any consequential deficit being funded by new credit or defaults on other commitments. Second, it might be possible to service SHG loans and suppress deficits initially through generous subsidies. Third, SHG loans could well be serviced by contracting fresh debt. There are reports of multiple memberships of SHGs, where credit taken from one SHG is eventually repaid through membership of other SHGs in a ?Ponzi-like? manner.
Undeniably, there are several benefits of SHGs, in particular women?s empowerment that has a knock-on effect on female literacy and family planning. Like the National Rural Employment Guarantee Scheme and other anti-poverty schemes, microfinance can also be seen as a social security net in a period of transition to modernity.
A sustainable ticket out of poverty, however, would be access to high-productivity jobs rather than high-cost credit. Since microfinance is funded through a predominantly market mechanism, any deficits that pile up under these schemes may eventually have to be recouped from taxpayer revenues.
There are uncanny parallels with subprime lending in the US, which escaped scrutiny for far too long, and for exactly the same reason: it was seen to be helping poor people. There is now a realisation that these people have actually been burdened with debts they cannot repay. These are the perils of blindly promoting financial inclusion as an end in itself, rather than as a means of enhancing income through productivity growth.
The writer is a civil servant. These are his personal views