Poverty's new saviour

Poverty has become big business in India. So much so that a slew of storied venture capital outfits and wealthy techies—such as Sequoia Capital, eBay Founder Pierre Omidyar and Michael Dell—who are more at home analysing enterprise software or semiconductor makers’ business models, have now decided to park some of their capital with some of India’s poorest people using microfinance institutions as intermediaries. These investors—and their MFI outfits— hope that handing out small loans that average 5,000 rupees at a 28 per cent interest rate to India’s impoverished, will not just help their for-profit microfinance portfolio companies such as SKS turn a tidy profit, but will also help reduce poverty in the country.

Billions of dollars have poured into poverty alleviation in India over the past decades—but with little effect. State sponsored initiatives in delivering social inputs like health care and education have proven to be profoundly inefficient. Today, literacy levels and health conditions in rural India are appalling. Infant mortality rates are high and malnutrition is rife. Consequently, average incomes in rural India have lagged severely behind urban ones during India’s last seven years of galloping growth, adding to increasing inequity between both segments of the population.

Microfinance institutions say they want to fix this problem and are in a heated race to scarf up poor clients. Industry veterans, like David Gibbons, Chariman of MFI Cashpor and Nancy Barry, ex-Head of Women’s World Banking, are aghast at the nature of their activities. Microfinance institutions come in all sorts of shapes and sizes, but the main ones plying their trade in rural India are Self-Help Groups (SHGs) and for-profit MFIs. SHGs—numbering 3.4 million and servicing 45 million poor—are groups of up to 20 women who borrow directly from banks at a 12 per cent rate and then lend the money internally to members with additional percentage points tacked on. Interest income earned on each loan goes into a savings pool. In about five years, each individual from the group has a nice little nest egg of around Rs 25,000 to spend as they like. Forprofit MFIs like SKS and Spandana—only 25 of which serve 14 million people, but are the fastest growing outfits today in microfinance—have a different approach. They loan out money using the Grameen model, within groups of five women or so—but the loans are to individuals. The group exists as a collective guarantee for the loan and if someone defaults, the rest of the members have to come up with the cash.

A staggering 800 million of India’s poor are starved of formal credit and MFIs can be a godsend to their poor clients who use this cash injection to try and transform themselves into successful minientrepreneurs by rearing buffalos or selling vegetables and thereby improving the hold of a fellow, put Rs 5,000 in his pocket and moved on,” wonders Srinivasan.

It makes sense that reasonably priced credit can be a lifesaver for the desperately poor, especially women. With the purchase of an inexpensive buffalo, a poor mother can generate a little more cash income and send her children to school. However, is everyone borrowing for entrepreneurial purposes? “An increase in lending to people to pump numbers up has resulted in many borrowing to pay for marriages,”says Jayshree Vyas, Managing Director of SEWA, an organisation of poor, self-employed women workers in Gujarat. Pigeonholing the poor as wise, frugal spenders, who are impervious to consumerism is naive. “I’ve even seen people spending huge amounts on DJ parties in remote villages,” says Vyas. Also, many industry observers point out that often a poor person takes out one loan to pay for another, and, in effect climbs on to a “debt treadmill”. In fact, double counting clients is a widespread if under-reported phenomena amongst MFIs.

AY Caramba Mexico’s MFIs have made a killing off its poor, using shady tactics, say many. India should learn from this experience. Mexican microcredit institutions seem to be experts at profiting off the poor and have raised the hackles of industry veterans, like Grameen Founder Muhammad Yunus. Yunus feels that a bank like Compartamos is a blot on the industry and likens them to a loan shark thinly disguised as a microfinance firm. Compartamos, which has around a million clients and ironically apes the Grameen model of fund disbursement, made a shocking $80 million (Rs 400 crore) in profits last year. Moreover, when the bank sold 30 per cent of its shares in an IPO in 2007, it raked in a cool $458 million (Rs 2,290 crore), $150 million (Rs 750 crore) of which went into investors and senior management’s pockets. In Mexico, rates that banks like Compartamos and Azteca charge are unusually high—upwards of 100 per cent compared to 28 per cent in India. These banks say that the costs of giving out loans is steep hence the pricy rates, but Indian MFIs in the business of servicing hard-to-reach rural clients levy a much lower fee. Perhaps the lack of competition enables Mexican banks to jack up the interest. There might be other countryspecific cultural or economic explanations. Still, the fact is that a hefty 24 per cent chunk of Compartamos’s interest income from lending activities went directly towards its profit numbers according to CGAP, a microfinance think tank at the World Bank versus a 7 per cent average for most Indian MFIs. Here’s how Mexican banks supposedly make their money: Loan reps are promised 120 per cent of their salary based on loan growth, so there is a mad rush to sign people up regardless of need. Some sneakily tack on life insurance policies into a group’s weekly payments—commissions are handed out for doing this. Expensive consumer electronics are widely flogged where low weekly payments are emphasised in ads but the very high financing rate isn’t mentioned. Soon, some poor “clients” are so far behind in their ability to pay that they are forced to go back to a loan shark in order to pay the first loan off. While India is still eons behind Mexico in these kinds of shenanigans, the absence of any kind of regulatory framework or consumer watchdog group that can safeguard the poor doesn’t bode well for the future of Indian microfinance. —Rajiv Rao

Issues of scaling aside, the larger question that haunts the microfinance industry today is, how effective are these small loans in alleviating poverty in India? Not very effective, thinks Aneel Karnani, who teaches strategy at the University of Michigan’s Ross School of Business. First, if you have too many grocery sellers in a village—the most common of microfinance activities—fierce competition ensues and the person doesn’t eke out enough of a living to get out of poverty, says Karnani. The small sizes of these loans “do not enable most borrowers to do much except to ease liquidity problems,” concurs Srinivasan. Moreover, the possibility of everyone becoming an entrepreneur is a romantic notion—it results in an inefficient and fragmented economy, says Karnani. The real effort, he feels, should be on investing in small to mid-size enterprises, which are the real engines of job creation.

If that’s the case, how does one tackle endemic poverty? Every nation that is wealthy today with high levels of literacy and social welfare transitioned from being mainly a rural economy to an industrialised, urban one. A small percentage of highly productive farmers emerged to grow food for a country that prior to the shift had a large farm sector which employed a majority of the population. Industries hired workers and paid them far superior wages to what they would have made as farmers. India cannot sustain itself as a largely agrarian nation in its current form—most of the rural population consists of either agricultural labourers living in wretched conditions or “2-acre” farmers who struggle to keep their tiny plots financially afloat. Microfinance, while often proving to be the key in increasing the quality of life for its poor, rural clients, can only be a temporary, stop-gap measure, argue many economists.

Moreover, MFIs in India are hardly paragons of virtue. Irresponsible lending behaviour in the country is already rife, says Chuck Waterfield, who started Microfinance Transparency along with Grameen godfather Muhammad Yunus. Waterfield points out that today, almost every MFI in India routinely tries to understate its interest rates to its clients and markets its loans as costing just 15 per cent— which is actually 15 per cent “flat”, a loan where the principal amount never declines, and, therefore, is closer to an annualised 27 per cent rate. Many simply emphasise the weekly payments instead of highlighting the interest rate being charged.

In the final analysis, for-profit MFIs are simply small cogs in the overall machinery tackling poverty alleviation in India. Firms like SKS and Share Microfin have succeeded in conceptualising a whole new model for poverty alleviation— a model that is transparent and sustainable—compared to the billions of dollars squandered over past decades through inept, state-spearheaded rural credit initiatives. Whether these firms have made the poor better off or not is something for a neutral impact study to determine. Most industry observers feel that they have, but not by much. Reality is, the trade-off between scale and quality of coverage for an MFI will always exist in a for-profit model, at least in the initial stages of growth. Nervous about ceding ground to a client-hungry competitor, an MFI wants to grab as much market share as possible in order to secure a large client base for future products.

However, without significant state intervention in areas like health and education—underwhelming to date—the mission of poverty alleviation in India will be a distant dream, regardless of the MFIs. Plus, concerns about MFI’s profit motives aren’t trite. Private equity investors of an MFI expect both consistent and growing profit numbers, as well as the capital appreciation of its stock. Fact is, when consistent profit and an increasing share price for a firm is fundamentally linked to handing out as many loans as possible to the most vulnerable segment of India’s population, it seems unlikely that the social good will play a major role in an MFI’s activities.

Life and goals Hyderabad Blues Geddadha Roja, 32, wants her 12-year-old daughter to become an air hostess and her 13-year-old son to become an engineer. That, to her, is transformation—the kind of change that could propel her and her family into the stratosphere. Roja wants to ensure that her family sees life beyond the Fateh Nagar slum in suburban Hyderabad—a city that has become the epicentre of microfinance activity in the country. Roja is a tailor, and her husband Geddadha Jonah, 39, an iron welder. Unable to survive on their combined incomes of close to Rs 5,000, Roja became a member of a group of 10 borrowers of an MFI and took out an 8,000-rupees loan in 2006. With the loan money, Roja bought a sewing machine and got it fixed to a motor, thereby substantially improving her output. The next year, Roja took out another loan, this time for Rs 10,000, which enabled her to hire another worker to help her in tailoring work in return for a paycheck based on output. The loans made a huge difference to Roja at the time. Her family income nearly doubled. However, Roja still feels that she is far short of resources, skills and earnings that she will need in order to realise the goals that she has set out for her children. What Roja really needs is good advice and someone who can guide her regarding the latest trends in the market. As it is, Roja is living out of rented premises, and being evicted from rental properties is always a constant source of worry for the poor. She is also completely unprepared for any health-related emergencies or educational expenses that she might have to bear in order to send her children to the kind of schools that they will need to attend in order to begin the climb out of poverty. All that Roja can do, she says, is take out another loan for a sewing machine, which she can put to use to generate a little more income. With few options to save, invest and seek things beyond credit, Roja realises that any hopes of upward mobility today are essentially distant dreams. —E. Kumar Sharma