Abdallah 1 Ahmad Abdallah Prof Hashim RHET 1302 December 12, 2012 Microfinance as a Stimulant of Economic Growth: Case

Studies from Bangladesh and India Microfinance is a relatively new concept in the economic world. Though only a few decades old, it is playing a huge role in changing the economic scenario in the world. Microfinance, when correctly applied, has been a stimulant of economic growth, a process by which societys living conditions are improved. Microfinance can be defined as low interest micro-loans directed to the needy poor, who cannot get loans through the traditional banks. Thus, microfinance is providing the much needed capital to a portion of the population that was previously unreached by the traditional banks, and therefore unleashing their previously limited potential for economic development and their contribution to the economy as a whole. Since its inception, microfinance has been effectively applied in an assortment of developing countries, including but are not limited to, Bangladesh, India, Bahrain, various African countries. In all these countries, microfinance was generally applied based on only one model, that of Self Help Groups (SHGs). The SHGs are basically small groups of similar minded people who would like to borrow some money from the bank and invest it. There were certain regulations among these groups, e.g., if a member is unable to pay the debt, then other members of the group will help him out; or if a member doesnt pay back the debt willingly, the other members will convince him to do so, and if he still disagrees, he will be expelled from the group (Edward and Olsen). This model made it clear that when traditionally non-creditworthy individuals are grouped

Abdallah 2 together, they can become a more reliable borrower than creditworthy individuals. The members of these SHGs, by the help of loans acquired through microfinance, have been playing an active role in both personal and collective economic development. This paper demonstrates with the help of case studies from India and Bangladesh that microfinance, through social capital formation and the use of SHGs, stimulates economic growth, and should be employed countries with similar economies to boost economic growth. Economic growth can also be defined by the increase of real gross domestic product per capita; or the real output per capita. The real output per capita is used more often to calculate economic growth, as it takes into consideration the size of the population. This is achieved by dividing the real GDP, which is the gross domestic product adjusted for inflation, by the size of the population (Darity). There are three main factors of economic growth namely supply factor which means that in order for an economy to grow, there should be an increase in supply of resources; demand factor which states that in order for an economy to grow, there should be demand for the goods and services produced; and efficiency factor which states that in order for an economy to expand, an economy must strive to achieve economic efficiency and must attain full employment (Darity). Microfinance contributes to the supply and efficiency factors of economic growth in several ways. Firstly, it helps more people to be self-sufficient. This promotes a rise in the quantity and quality of human resources, by providing people the capital required to start their own enterprise. Microfinance has also been playing a major role in bringing out the surplus labor out of family enterprises, such as family farms, etc. and channeling them into the workforce. Microfinance also increases the stock of capital goods, by providing the poor the necessary amount of capital to start their own enterprise, so that they can actively contribute to the increase in real GDP per capita. By bringing down the number of surplus labor,

Abdallah 3 microfinance increases the efficiency of the economy, and leads it towards full employment. Bangladesh is the home of microfinance and the practice of microfinance has been introduced extensively in Bangladesh. The GDP growth data from Bangladesh is presented in the table below: Table 1: Annual GDP Growth in Bangladesh Year GDP growth (%) 1983 4 1990 6 1995 5 2000 6 2005 6 2009 6

Source: World Bank Databank, Annual GDP Growth in Bangladesh, World Bank Databank, Mar. 2010, Web, table 1. From the above table it is evident that Bangladesh has experienced a steady growth after the advent of microfinance in 1983. Though the GDP growth cannot be directly related to microfinance, it can be safely assumed that microfinance has played a key role in the process given that it was first applied in 1983 (Darity). One of the major goals of microfinance is to create social capital, which can be defined as the sum of the actual and potential resources embedded within, available through and derived from the network of relationships possessed by an individual or social unit. Social capital thus comprises both network and the assets that can be mobilized through that network. (Nahapiet and Ghoshal) A field study conducted in Chandair, a rural village in Bangladesh by Kanak and Iiguni (2007) points out how microfinance has contributed to social capital building and as a result has positively affected the economic scenario of that certain village. They also researched on the activities of the various Self Help Groups, Non-Government Organizations (NGOs), and Micro Finance Institutions (MFIs) operating in the area. Their research led them to the conclusion that there are many ways how NGOs or MFIs help out their members in building

Abdallah 4 social capital, which include but are not limited to, promoting group solidarity and better interactions among members of the same organization by organizing regular meetings and ensuring a flawless flow of information, allowing members to access people in positions of influence, and organizing training sessions to foster better interactions among family members (Kanak and Iiguni). These group activities organized by microfinance play a huge role in building social capital among the rural poor, in turn increasing their potential for development and economic advancement. This also contributes to eventual economic growth because the mobilization of assets through the network results in more connections and employment. Though research has shown that social capital formation is not a natural outcome of microfinance, the MFIs always emphasize on the formation of social capital, as it plays a huge role in poverty alleviation and eventual economic expansion. The links established through social capital formation leads to a lot of employment opportunities for the rural poor, because they are now able to get information about employment opportunities through their networks. This eventually brings down the unemployment rate and increases the efficiency of the economy. Before the advent of microfinance in late 90s, most of the loans to the poor in India were offered by the government banks. A lot of private banks have joined the scene recently. In India, usually after a natural disaster that affect crop production, such as draught or flood, the government writes off the loans on moral grounds. As a result, the private banks were also forced to write off a lot of loans, resulting in huge losses. Also, this led the poor population to take loans in a hope that the government will intervene and write it off one day, with no intention to pay it back whatsoever. This contributed to the development of a bitter relationship between the private banks and poor borrowers. Since the inception of the microfinance system, the conventional

Abdallah 5 banks were reluctant to join in because of the absence of collateral, or a security for the lender in case the borrower fails to repay, in microlendings. Because of the bitter relationship between the banks and the poor population in rural India, the banks were very reluctant to do business with the poor. Then the SHGs came into play. The main goal of the formation of SHGs was to access capital from the bank. And the banks agreed to loan out money to the group because the social pressure to pay back the money would act as a collateral, and also lending to groups seemed to be of higher economic advantage to the banks than to a single poor person only to get the debt written off (Edward and Olsen). Though the Indian state of Andhra Pradesh has only 8 percent of the Indian population, it has 60 percent of the nations SHGs (Edward and Olsen). With the formation of higher number of SHGs in Andhra Pradesh, and realizing the economic advantage of doing so, the local banks started lending money to the SHGs. This provided the poor people, who were not able to access capital before, a chance to get the funding they needed to do something on their own or to make an investment. The loan sanctions to the SHGs contributed in several different ways. First, it encouraged poor people, who were previously reluctant to borrow money from the local traditional money lenders because of the exorbitant interest rates, to join SHGs and borrow money. This provided them with an access to capital that they needed. This also drew people away from the local money lenders, who were really oppressive in nature. Second, it provided poor people access to capital and has given them something they could invest and depend upon. Third, it has professionalized the relationship between laborers and employers. Previously, the relationship between the employers and laborers were very dependent on trust and obligation. The laborers worked for the employers for a long time out of trust that they will be paid and out of the fear of losing the job if they ask for their salaries. But now, since the laborers have access

Abdallah 6 to capital through SHGs, it has provided them a platform to speak from. They are not afraid of losing their job, because they know that they can access capital through SHGs and do something for themselves. So now they not only voice their demands for due salaries, but also bargain wages if they think they are being paid unfairly. Moreover, the high repayment rate of money loaned to SHGs led a lot of private banks to start funding SHGs, thus providing access to capital among the rural poor population. The managers of private banks in Andhra Pradesh regularly reported that the repayment rates of the SHGs were always over 95 percent, comparable to other micro finance institutions. As a result, the percentage of banks in Andhra Pradesh providing microcredit rose from 1 to 99 (Edward and Olsen). Also, access to capital encouraged a lot of women to leave what they were doing at home and get loans to start a business and get involved in economic activities, generating income. This in turn resulted in poverty alleviation. All these factors channeled surplus labor (underemployed and underproductive) to borrow money through SHGs and engage in income generating activities, leading to increased productive employment. Despite the numerous successes of microfinance, the opponents of microfinance might bring up the example of the recent crisis in India where a lot of the borrowers ended up defaulting on their loan repayments and bringing the microfinance industry to its knees. The reasons for the recent failure of the microfinance enterprise in India, in particular the state of Andhra Pradesh can be attributed to a few main causes. The banks are charging the borrowers much higher than microfinance suggests. They were charging them interest at a high rate of 30 percent before the crisis, which they now have reduced by 6 percentage points to 24 percent, as opposed to the 20 percent or below rate proposed by microfinance (Polgreen and Bajaj). The borrowers are not well-informed about the money-lending process, and therefore take more loans than they can afford to. They are gullible and tend to believe what the banks tell them, and

Abdallah 7 eventually get into trouble. The banks are convincing the poor borrowers that the loans are very easy to pay back, where in reality they are not. Also, the borrowers dont trust the bank and think that the banks are tricking them out of their money. The banks are now mainly focused on growth and ignore the fact that the poor borrowers not only need the money, but they also need the guidance on how to invest them. There are no programs that help the borrowers decide on the best way to invest their money, and therefore they make poor investment choices resulting in the failure to pay back the loans in time. This can be cited as an example of how the wrong application of microfinance can lead to disastrous and undesired results (Polgreen and Bajaj), and can easily be remedied by a strong management and the proper application of microfinance guidelines. Microfinance has played a vital role in fostering economic growth in the places it has been properly applied. In Andhra Pradesh, it has brought private banks into the scene, generating a huge pool of capital for the poor borrowers. By 2003, the source of capital for microfinance from private banks rose to 99 percent from a measly 1 percent (Edward and Olsen). In both Andhra Pradesh and in Bangladesh, it has successfully increased the efficiency of the labor force by encouraging the surplus labor to do something for them by taking small loans. It has created a source of income for households that previously had no income, and in doing so helped them generate savings, which eventually helped them cross the poverty line. According to Grameen Banks internal survey, 42 percent of its borrowers have crossed the poverty line by 2001. As of now, Grameen Bank has dealt out the equivalent to US $6.55 billions in loans, of which US $5.87 billions have been successfully repaid. According to the Banks internal survey, the repayment rate has gone up from 95 percent in 1998 to a staggering 98.7 percent (Hughes and Eades). This clearly demonstrates that microfinance has helped people generate more income

Abdallah 8 and therefore enabled them to successfully pay back the loans. More income for people indicates a higher productivity, which in turn signals economic growth. The concept of microfinance has been generally applauded by the international community. In recognition of the success of microfinance, Dr. Muhammad Yunus and his Grameen Bank were awarded the Nobel Peace Prize in 2006. The success of microfinance in Bangladesh and India means that it should be successfully applied to countries with similar economies, such as Vietnam, Burma, and Venezuela; and under proper supervision it will lead us to a poverty free world.

Abdallah 9 Works Cited Bank, Grameen. "Pricing Certification Report." 2011. International Encyclopaedia of the Social Sciences. Ed. William Darity. 2. Vol. 5. Detroit: Macmillan Reference USA, 2008. International Encyclopaedia of the Social Sciences. Ed. William Darity. 2. Vol. 2. Detroit: Macmillan Reference USA, 2008. Edward, Peter and Wendy Olsen. "Paradigms and Reality in Micro-Finance: The Indian Case." Perspectives on Global Development & Technology (2006): 31-54. Hughes, David and Daniel Eades. Encyclopedia of World Poverty. Thousand Oaks, CA: Sage Reference, 2006. Kanak, Saharia and Yoshiaki Iiguni. "Microfinance Programs and Social Capital Formation: The Present Situation in a Rural Village in Bangladesh." The InternationalJournal of Applied Economics and Finance (2007): 97-104. Nahapiet, J. and S. Ghoshal. "Social Capital, Intellectual Capital and the Organizational Advantage." Academic Management Review 23 (1998): 242-266. Polgreen, Lydia and Vikas Bajaj. "Microcredit Is Imperiled in India By Defaults." New York Times. New York, 18 November 2010.