Off the mark on microfinance

Writing in the Ethical Corporation newsletter, Rajesh Chhabara recently opined on the near-term prospects for microfinance in Asia. Their take? Things are just hunky-dory:

Despite the trouble in global financial markets, investors continue to put money into Asian microfinance. A $40m fund aimed at financing start-ups in microfinance was launched in October by the India-based Institute for Financial Management & Research Trust, supported by a group of investors including India’s Icici Bank. In May, ASA International of Bangladesh, ranked number one on the Forbes list of top 50 microfinance institutions, raised $125m in funding – the largest ever by a microfinance institution – through private equity firm Catalyst Microfinance Investors...

Diverse sources of funding and a sustainable business model mean the microfinance sector is well placed to withstand upheavals in the global financial markets. And the trend of banks and private investors putting more funds into the sector looks set to continue.

Nowhere in the article is any mention made of the very nasty second-round effects of the financial crisis on the real economy. Yet it is clear that demand for exports from emerging markets is falling rapidly and remittances have taken a serious hit. The Global Economic Prospects 2009 report, released earlier this month, contains the following prediction:

With world trade volumes projected to contract 2.1 percent in 2009, developing countries will see a big drop in their exports. Tighter credit conditions and increased uncertainty are expected to see investment growth in both developing and high-income countries slow in 2009—actually falling 1.3 percent in developed countries and rising by only 3.5 percent in developing countries versus 13 percent in 2007.

It is hard to see how this kind of macroeconomic environment won't translate into higher default rates for microfinance institutions. Perhaps microfinance will fare relatively well compared to other sectors, but surely the second-round effects of the financial crisis deserve at least a mention.

Update: Asif Dowla in the comments section wonders in turn whether I am off the mark. Here is my response:

• The first paragraph of Dowla's comment discusses funding for microfinance institutions. Dowla points out that MFIs that rely on savings deposits will have a stable source of financing, a point I agree with. (In fact, I didn't even discuss this issue in the post.) As the summary from the recent CGAP Virtual Conference points out, "The strongest message from the conference was that deposit-taking MFIs are well-insulated from refinancing risks."

• Dowla states that "Even commentors in CGAP's virtual conference that was reported in this blog mentioned that deposit-based MFIs are unlikely to be affected by the financial crisis." In fact, conference participants had a much more nuanced take on the issue. As the summary states it, "That said, most deposit-taking MFIs mobilize larger deposits from nonpoor customers, and these may be more sensitive to the economic downturn." Also, Ranjan Kumar, a rating analyst at Micro Credit Ratings International Limited, made the following points, "Higher delinquency and default: The present crisis is leading to slump in overall demand which may lead to reduction or even nil returns on micro enterprises which could increase delinquency and default. This would require the MFIs to increase their loan loss provisioning."

• In the second paragraph, Dowla argues that clients of MFIs don't depend on export receipts, so they will be unaffected. If the world were experiencing a mild downturn, I might agree. However, the current global recession is anything but mild. As Simeon Djankov reported in the Crisis Talk blog, China's exports fell over 10 percent year-on-year in November, the first fall since 1999. Some 40 percent of China's GDP is accounted for by its exports - there is no doubt that this sharp drop will have negative repercussions for the rest of its economy.

• Finally, one point that is not directly related to Dowla's comments. The Ethical Corporation article states:

"[M]icrofinance has gained a reputation for near-zero default rates and a stable rate of return over the long term for investors. These returns are estimated at about 6% a year, with the best-performing funds returning three or four times that amount."

• At no point in the article does the author question these rosy assumptions, which are based on historical experience. However, we find ourselves in an unprecedented global economic environment, so I think the issue of default rates at least deserves a mention, even if it is to argue that microfinance will fare relatively well.