The Micro Economic Environment
Microcredit Programs differ considerably from formal banking methods in that they attempt to work exclusively with the poor offering a service which is amenable to the conditions of these households (lack of mortgagable assets, often low levels of skills, need for small loans due to necessary risk adversity, small manageable loan repayments, use of peer influence and provision of positive incentives for repayment etc.). Most programs are operated by socially motivated NGOs whose management places heavy stress on their concurrent developmental and poverty alleviation objectives. The motivations of formal banks differ and consequently even where the economic climate is highly conducive to the success of microcredit very few banks have adopted the process.
Microcredit programs in most countries target poor, landless households which eke out a living from wage labour or small businesses in processing farm produce or in the service sector. These households generally have small but regular income throughout the year and lend themselves to the mechanism of small weekly savings or loan repayments. In fact here lies one of the most critical components to MCP success. Regular small weekly instalments are manageable to poor households. Microcredit programs with small frequent loan repayments effectively enforce a discipline of weekly thrift. Any surplus funds above those absolutely essential for survival are set aside for the weekly instalment and therefore are unavailable for even the smallest of luxuries or friends and relatives who may pressure to borrow any surplus cash lying in the house.
Consequently a major obstacle faced by the proposed program is the fact that households in the project target area are not landless with small regular income but rely primarily upon subsistence agriculture and have lumpy sources of cash income.
In village banking schemes there is a tendency to neglect the valuable role a savings facility can play in poverty alleviation. Unfortunately the Ag. Bank of China does not offer a savings service to small depositors which can compete with the ravages of inflation. For larger deposits however, inflation adjusted term deposit rates are quite attractive (up to 27%). Scope may exist for the project to access this rate for villagers for pooled savings deposits.
The Micro Economic EnvironmentAn important characteristic of Microcredit programs is that loans used for productive investments rarely rely on these investments to contribute much to loan repayment instalments. Few investments are able to provide the 120% or so return on capital (with first instalment starting at week 1) required to repay within a year the loan principle and interest without eroding the capital asset for which money was borrowed. Generally borrowers make repayments out of their other sources of income. In this way, in many cases, borrowers are able to gain a valuable asset through the provision of a loan, then scrimp and save in order to be able to hold on to that asset without eroding its principal value.
Microcredit Programs either allow borrowers to accumulate fixed capital assets (so called productive loans) or cover household needs during periods of cash flow crisis (consumption loans) followed by a period of enforced saving. In some circumstances enterprises which involve high labour inputs relative to the capital investment (such as bicycle rickshaws, sewing machines etc.) it is possible that loan repayments may be derived from investment profit. The same rationale applies to savings programs except the procedure is in reverse. Regular small deposits build equity (and accumulate interest) to enable the eventual purchase of fixed assets or use at a time of cash flow crisis. Unfortunately in Qinghai state controlled interest rates for small deposits are well below the rate of inflation, which very much discourages savings.
Because of the ability of borrowers to repay loans over short terms (usually 1 year) microcredit programs rarely bother to extend this period. Although this is an impediment for slow maturing investments, in most cases borrowers are happy with short loan terms as they allow quicker graduation to larger loan sizes.
Therefore, microcredit programs in most countries target poor, landless households which eke out a living from wage labour or small businesses in processing farm produce of in the service sector. These households generally have small but regular income throughout the year and lend themselves to the mechanism of small weekly savings or loan repayments. In fact here lies one of the most critical components to MCP success. Regular small weekly instalments are manageable to poor households. Microcredit programs with small frequent loan repayments effectively enforce a discipline of weekly thrift. Any surplus funds, above those absolutely essential for survival, are set aside for the weekly instalment and therefore are unavailable for even the smallest of luxuries or friends and relatives who may pressure to borrow any surplus cash lying in the house.
The target households of the Qinghai Community Development Project on the other hand are generally not landless households deriving a living from wage labour or small businesses in processing farm produce. As a result of China's past land redistribution policies they are subsistence farmers with inadequate land to support themselves. Their income is not regular but, in the most part, seasonal.
The present lack of diversity in the farming system reduces the possibilities for small scale processing. In the project area agricultural produce is basically limited to wheat, potatoes, rape seed, oats, peas and barley. Cattle, sheep and goats provide meat and wool. The difficulties of developing off-farm household level enterprises is evidenced in fact that only traditional, primary production based, Income Generating Activities (IGAs) were recommended in the appraisal by the Micro-enterprise Specialist during the Inception Phase.
Of these recommended proposals sheep, cattle and Yak breeding/fattening constitute serious environmental concerns due to existing and ongoing pasture degradation. Despite the hope that these ruminants may be stall fed on crop by-products and surplus grain, this appears unlikely from my investigations which indicate that grain is considered too scarce and valuable to feed ruminants, and that popular perception is that the hills provide a free, if not abundant, supply of grass.
Village economies in the Haidong prefecture are not diverse so there are few existing off-farm enterprises to provide a potential investor with experience or even inspiration. With little surplus agricultural wealth, opportunities for provision of service industries are few. The geographical remoteness of villages and subsequent marketing constraints also acts as a disincentive for investment in small industries which could serve the more affluent urban populations, or rural - urban trade in commodities.
Nevertheless demand for credit is high and often unsatisfied, especially in poor households.
"While credit is available to those who can provide the required level of security, poor households are often unable to meet these criteria. There is no differentiation in the security requirements for loans financed from poverty alleviation sources as opposed to loans from routine sources, and in any case the majority of poverty alleviation loans are being granted for higher level enterprises, not household level activity"
It would appear, however, that most farmers can get access to small fertiliser loans of 200 to 400 yuan in size. Small loans have higher recovery rates in places like Bangladesh but are Chinese borrowers better disciplined with larger loans? In 1992 the reported recovery rate for industrial loans in Bangladesh was a mere 20% against about 70% for agricultural loans and a remarkable 98% for NGO managed microcredit loans to poor landless households.
As did critics of the microcredit approach when it started in Bangladesh, so now government and bank officials in China reject the wisdom of lending to the very poor. Yet even in our limited research in Haidong prefecture, indications are that small loans are more secure. For example the Guchong and Shihuiyao Rural Credit Co-operatives in Pingan, lending primarily small loans to agricultural households, have recovery rates of about 90% and 92% respectively. In contrast the County Agricultural Bank of China in Pingan which lends larger loans for larger agriculture sector projects has a recovery rate of only 63%.
Will Microcredit Programs work for seasonal loans? Having lost the strategic advantage of using small manageable loan repayments can microcredit programs still work?
In general microcredit programs have two other main methods to encourage, if not facilitate, loan repayment. First is that they reward 100% loan repayment with eligibility for another larger loan which enable continued business expansion. However, the elasticity for expanded production through increased inputs on fixed acreage of land is limited, particularly where land is of poor quality and more diverse markets are distant. For farmers in the project area who use credit to meet seasonal cash flow problems, there may not be a great demand for increasing loan sizes and therefore this mechanism may not be as effective an incentive for loan repayment. For example, money borrowed for annual fertiliser inputs usually results in improved yields and therefore, improves harvest income. But, unlike our usual borrower of microcredit discussed above, this money is not sunk in a fixed asset and therefore becomes available again for consumption. Consequently, each year farmers are again dependant on a fertiliser loan, having no savings to contribute themselves.
The second system is that of group guarantee. As a method of influencing loan recovery, should remain as effective as it is for non seasonal loans. Yet as discussed in Loan Security: Collateral, Wealth Begets Wealth on page 9 the use of group collateral can backfire in some circumstances causing a complete collapse of loan repayment discipline.
As it is difficult for farmers with annual harvest based incomes to make regular loan repayments, so is it difficult for them to make small regular savings which, under the existing Microcredit Program design, is the key criteria for eligibility for loans. In any case, the Project Implementation Document (PID) appears to have misunderstood the purpose for which some NGOs link savings capacity to the loan size for which they are eligible. Savings are not meant to be used as a collateral for future loans.
It hardly makes sense to hold say 100 yuan in savings as a stick to force borrowers to return 1000 yuan of borrowings. Rather NGOs use weekly savings prior to loan approval as a guide to the size of weekly loan repayments (from non investment sources) members will be able to afford after taking their loan.
It would appear that for good reason microcredit programs around the world focus upon households with a regular trickle of income from small off-farm business or wage earnings.
Taking Two Bites of the CherryYet there is one possibility that the microcredit program could be adapted for subsistence farmers. Microcredit Programs avoid the use of collateral, not because it is morally unsound, but simply because the poor households with which they work simply have no assets to mortgage. On the other hand, even the poorest households in Haidong Prefecture have relatively large stores of grain lying idle in their houses which they gradually consume from one harvest to the next. In effect this is idle cash.
If instead farmers were allowed to repay their loans in the form of small quantities of grain into a village grain bank it would effectively replicate the use of cash for this purpose. Alternatively, and perhaps more simply, following harvest a quantity of grain could be sold to the Microcredit Program for the equivalent amount of cash to allow a short term investment in some income generating activity over the winter months. This grain could be monetised or, more likely, be purchased back by the farmer when her loan investment comes to fruition.
While Grain Banks have been quite successful in many parts of the world, to my knowledge they have not been used quite in this way(ie. as a village based source of short term capital, using stocks destined for household consumption).
A possible obstacle is the understandable anxiety households may feel at temporarily losing control over their essential food stocks. This perhaps could be offset through the provision of insurance against;
While crop failures are easy to assess and verify the same for investment failure can be difficult. A dead pig! Did it die naturally or was it slaughtered? An unprofitable business! Was the income generated really that small?
- crop failure: (if the grain used represents emergency stocks in case of a poor harvest the following year) or,
- investment failure: if the particular income generating activity for which the loan is taken does not yield the expected profit, thus compromising the household's ability to purchase back its mortgaged grain.
Nevertheless, Grain Banks maybe an very useful means of mobilising investment capital from idle assets. This could be further explored by the QCDP, particularly if additional microcredit technical/research support was made available.
Is there an opportunity to capture any small surplus of cash which maybe available seasonally in a savings scheme? Farmers in developing countries tend not to save in banks. Rather they invest, if possible, in liquidable capital assets such as livestock, or otherwise capital improvements such as housing, to store wealth. This also represents a wise hedge against inflation. The project may be able to strengthen this habit of wealth accumulation.
Poor families in the project target area generally have two income peaks. The most clearly defined is associated with harvest of rape seed, wheat and barley in autumn and the other is associated with the sale of livestock which is less defined but often at the time of the spring festival. The average incomes of households surveyed by Michael Finlayson and Zhu Xiaoyang in 1994 is categorised by source in Table 2, "Annual Cash Income and Expenditure of Households Surveyed". Livestock and crops provide 223 and 154 yuan per annum respectively.
There may be an opportunity to capture some of this income by using savings at the end of harvest. These savings could be a requirement for winter loans and be used together with the loan for stall fattening of livestock prior to the spring festival. This again is a mechanism designed to encourage thrift and the accumulation of capital by locking up savings in new investments.
Table 2 Annual Cash Income and Expenditure of Households Surveyed
Although off farm employment is shown in Table 2 as contributing highly to average household income this is probably not so for the poorer households. As there is a strong negative correlation between household labour availability and poverty levels, it is likely that off farm employment is mostly a characteristic of the relatively better off households. This is consistent with my poverty rankings and discussions with villagers in which the wealthier families often had off farm income.
Figure 3 Off-Farm income of households surveyed in project area
Figure 3, "Off-Farm income of households surveyed in project area" shows in fact a heavy skew in the distribution of off farm income earned. Nevertheless, the fact that 35 out of 59 households (nearly 60%) earn some off farm income is encouraging in that it represents an important flow of cash back into the villages. Some of this income would be regular (where it is earned locally with a daily or weekly wage) and may be suitable for repaying loans in small frequent instalments. However, the majority comes from itinerant work and would not be available until the particular worker periodically returns home.
Robert Hickson Robert_Hickson@msn.com
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Hari Srinivas - email@example.com
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