40722550.pdf

Questioning Bangladesh's MicrocreditAuthor(s): Rafiqul Islam Molla, M. Mahmudul Alam and Abu N.M. WahidSource: Challenge, Vol. 51, No. 6 (NOVEMBER-DECEMBER 2008), pp. 113-121Published by: M.E. Sharpe, Inc.Stable URL: http://www.jstor.org/stable/40722550 .Accessed: 06/02/2015 00:42

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International Development

Questioning Bangladesh's Microcredit Rafiqul Islam Molla, M. Mahmudul Alam, and Abu N.M.Wahid

Microlending is widely seen as a development program that has worked for the world's poor. But there has been inadequate study of the results. The authors undertook a pilot study in Bangladesh, and their results are deeply disappointing. A high proportion of loans are taken for consumption, not investment, and make little contribution to the creation of jobs.

MICROCREDIT (MC) PROGRAM OF BANGLADESH S a Well-knOWIl SUC-

cess story for generation of self-employment and alleviation of poverty. Variants of this MC model are being implemented in

more than sixty different countries. It has become almost a universal antidote for poverty, especially since 2006, when Professor Muham- mad Yunus, the founder of Grameen Bank (GB), and the bank shared the Nobel Peace Prize. Although GB is a pioneer of the MC program

RAFIQUL ISLAM MOLLA is a specialist in economics, Multimedia University, Maleka, Malaysia. M. MAHMUDUL ALAM is a customer relations manager at Grameenphone, Dhaka, Bangladesh. ABU N.M. WAHID is professor of economics and finance, Tennessee State University, Nashville, TN.

Challenge, vol. 51, no. 6, November/December 2008, pp. 113-121. 2008 M.E. Sharpe, Inc. All rights reserved. ISSN 0577-5132/ 2008 $9.50 + 0.00. D01: 10.2753/0577-5132510608 Challenge/November-December 2008 113


Molla, Alam, and Wahid

in Bangladesh,1 many nongovernmental organizations (NGOs) offer the same program in Bangladesh with different forms and names. The providers of MCs claim that the overwhelming majority of the borrowers are using the loan funds profitably for productive purposes, repaying the loans and interest regularly, and thus steadily improving their socioeconomic conditions. The findings of the present study are somewhat contrary to the claim of the MC programs.

This study finds that the bulk of the MC is borrowed for nonproductive purposes. About a quarter of the borrowers use the credit exclusively for consumption and debt repayment. Nearly half of them use the credit entirely for investment purposes. The other 25 percent is used for both consumption and investment purposes. For all, the return on investment is very meager. About two-thirds of the borrowers have, on average, an impressive 83 percent net return on investment available for payment of interest and dividend in addition to the principal. But in the case of the remaining third, average return on investment is not enough even to cover the minimum, or tolerance level of, wages for family labor, let alone paying any interest or making any profit.

When Yunus was a professor of economics at Chittagong University in Bangladesh in the early 1970s, he witnessed the miserable plight of the rural poor of the country with his own eyes. On his way to the university campus, in the nearby village of Jobra, he regularly watched the villagers, especially the women, engaged in economic and business activities. He found them hard-working, yet their con- dition remained unchanged for years. He took an interest in their affairs and discovered that those small entrepreneurs were running their businesses with funds borrowed from local moneylenders at an exorbitantly high rate of interest- sometimes over 120 percent. That was one of the main reasons that they were trapped in the vicious cycle of poverty, debt, and low income. He approached some local banks to get small loans for these entrepreneurs at the market rate of interest. The banks refused to deal with them, as their lack of col- lateral made them too risky.

To make loans available to these micro-entrepreneurs at an afford- able and reasonable rate of interest, Yunus founded GB in 1976 as a

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Questioning Bangladesh's Microcredit

pilot project with some borrowed capital from the Agricultural Bank of Bangladesh. However, nearly seven hundred NGOs of various sizes also provide MC to millions of borrowers there. At present, about 9 million households in Bangladesh benefit from microcredit offered by GB and other NGOs.2

A Critique of the Microcredit Program, and Our Pilot Project The interest rate being charged by GB and other NGOs in Bangladesh is very high- as high as 25-65 percent ("Specialist" 2004). Thus, the providers of microcredit come under harsh criticism from economists, development activists, and politicians. In 2005, Saifur Rahman, then finance minister of Bangladesh, declared that if the NGOs lending microcredit continued to charge impoverished borrowers such abnor- mally high interest rates, the lot of the poor could not be improved even over centuries. According to Saifur, the MC providers receive the bulk of their funds from the government and international agen- cies at an interest rate of only 4-5 percent, so they should not charge poor borrowers more than 8-9 percent interest ("Saifur Blasts NGOs" 2005). The NGOs, however, argue that the cost of microcredit delivery and supervision is very high, and therefore a high interest rate is required to cover them. They also claim that the borrowers' high rate of growth at this interest rate indicates that microcredit is highly productive and profitable for the borrowers, making them capable of easily repaying the loan and interest.

The Consultative Group to Assist the Poor (CGAP) observes that impoverished borrowers have only very low-return economic opportunities, so there is no reason to believe that they can afford to pay the high interest rates (Todaro and Smith 2006, 753). An empirical study (Wahid 1994) suggests that the microcredit programs and institutions have in fact generated a positive but marginal change in the incomes of beneficiaries.

Now that GB and its founder have been awarded the Nobel Peace Prize for pioneering microcredit as a tool for fighting poverty, many

Challenge/November-December 2008 115



serious empirical studies of delivery cost and borrowers' benefits are required to properly evaluate the effectiveness of the microcredit program as a strategy to alleviate poverty. In an attempt to reevalu- ate the claim of the MC providers, we have undertaken the present pilot study in Dagon Bhuyan Upazilla in the district of Feni. This pilot study, carried out in 2005-6, selected a sample of twenty-five borrowers from three villages. The convenience of the researchers, the cooperation of the borrowers, and the coverage of borrowers of different sizes and economic activities guided the selection of sample villages and borrowers. The research therefore suffers from all the usual methodological limitations of a pilot study- location specific and too small a sample size- making it unable to accommodate the great variations that prevail in the country.

In analyzing the benefits to the borrowers and the effectiveness of the microcredit programs, the NGOs resort to calculating the profit of borrowers' business enterprises and ignoring their implicit costs, contending that the opportunity cost of labor is zero or near zero in these countries. This argument is certainly not tenable. To insist on it amounts to going back to the concept of distressed selling of labor (much like slavery) in the Middle Ages, making it self-defeating as a strategy for alleviating poverty. Moreover, because of the country's high rate of unemployment, many members of rural poor households may be virtually without any productive employment during a certain part of the year, though not the whole year. During the sowing and harvesting seasons, there can even be shortages of labor, resulting in very high wages. In this study, therefore, we have used the concept of economic profit in benefit analysis of the borrowers to determine the maximum interest rate that the borrowers can afford to pay and still be motivated to borrow money for carrying on entrepreneurial operations that earn normal profits (profit that is at least equal to the implicit costs of labor). Keeping in mind the periodic fluctuation of employment and wages and other social circumstances in rural areas, we used a very conservative wage rate per hour of Taka (Tk) 5 for men and Tk3 for women in calculating the imputed cost of the microcredit borrowers' economic operations.

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Questioning Bangladeshi's Microcredit

Use of the Borrowed Funds One of the key and traditional features of microcredit is that the small borrowers take out loans most often for consumption (including marriage of children and socioreligious rituals) and debt repayment purposes rather than investment. In the pilot project survey, we found that only 48 percent of the borrowers (twelve out of twenty-five sample borrowers) use the credit fund entirely for investment in productive economic activities. Six of them did not make any investment at all. They used the entire borrowed fund for consumption. Thirteen used the borrowed funds for both consumption and investment. Thus nineteen of twenty-five used the borrowed funds for investment purposes either fully or partially. Twelve of those invested their past savings in addition to the borrowed capital at the beginning of the project period. Sixteen added more funds to the borrowed capital from their own resources later in the project period of 2004-5. Among the nineteen who made investments, the average size of their investments from borrowed funds is Tk4,806. The average size of their own investment both initially and later during the project period was Tk9,105. Thus, the total average investment is Tkl3,911. Average gross profit is Tk27,084. Average implicit cost of labor for these nineteen is Tkl3,798. Thus the net profit available for the payment of interest and dividend is Tkl3,286. The average picture appears to be quite rosy. However, if we look at the individual situation, out of these nineteen borrowers, six ended up with negative net profit.

Therefore the bulk of the microcredit loans are for nonproductive purposes without any scope or expectation of revenue generation for loan repayment; these are mostly for survival and meeting contin- gencies. Economic demand (economic costs) from these borrowers does not make any sense. Our study shows that the claim that microcredit is a "strictly supervised credit" is no longer valid; often credit money gets diverted to nonproductive purposes, leaving borrowers in a distressed situation when the time comes for repayment. In that situation, the loan is repeated just to enable the borrower to make the weekly installment payments, with tacit approval of the microcredit dispenser to show high repayment rates to the outside world.



Molta, Alam, and Wahid

Social Aspects of the Microcredit Program in Bangladesh Selling labor in the open market is not prestigious in Bangladesh's traditional rural culture. Therefore, many poor people, despite des- perate economic conditions, do not want to work for others. They would prefer to work on their own farms and businesses even if these ventures are much less rewarding. Sometimes they earn at or below a subsistence level of income from self-employment. Taking this and other social dynamics into account, we use the lowest wages at Tk5 per hour for men and Tk3 for women in imputing the lowest wages for family labor used in the economic enterprise.

Use of Borrowed Funds and Cross Profit

Per our survey results, the nineteen enterprises' production to generate surpluses is barely enough to pay family labor wages at the normal rate per hour (TklO for men and Tk6 for women), and they are left with nothing at all for payment of any interest or for capital, much less a dividend for the household entrepreneurs. However, if family labor is paid wages at only a tolerance or below-subsistence level per hour (Tk5 and Tk3), a net worth or surplus of Tkl3,287 is available for paying interest and dividends. The surplus amounts to about 96 percent of capital invested. After paying interest on capital at a rate as high as 25 percent (Tk3,478), an impressive amount of surplus TklO, 433 is available even for paying dividends to households. But if we dispel the magic of the average, the real stories come out.

Survey findings also suggest that about 68 percent (thirteen of nineteen) of those who made some investment on average are productive enough to generate a surplus high enough to pay family labor wages at the normal rate and end up with a balance- that is, net worth- amount- ing to 83 percent of the capital available for paying interest on capital and dividends for the household. On the other hand, 32 percent (six of nineteen) are not able to generate a sufficient surplus even to fully pay family labor wages at a tolerance or below-subsistence level, much less pay any interest or dividends. For them, the average imputed tolerance

7/8 Challenge/November-December 2008



level of family labor cost is Tkl7;380; whereas the surplus available is Tk9,313- just over half the minimum level of wages for family labor.

Therefore, if any interest is paid for the credit capital, it will be at the expense of sacrificing the meager wages for family labor. In fact, this result is the harsh reality and the core of the problem for a substantial number of microeconomic enterprises operating in rural areas. In the absence of a built-in institutional provision for debt relief/ exemption, this large group of microcredit borrowers is pushed into a vicious cycle of poverty and debt, with no hope of gaining freedom from the bondage of debt.

Opportunities for Those Who Invest Their Entire Borrowed Funds

Borrowers who invest their entire borrowed funds are relatively better off. They generally borrow to add to their own funds for investment, and they are relatively large investors. Their average total investment (Tkl8,125) is nearly three times that of those who use only part of the borrowed funds for investment, but their average net worth (Tkll,421) is less than that of the smaller investors. Those who rely heavily on borrowed funds for investment are generally small investors. Where borrowed funds constitute 52-100 percent of total investment, the average total investment is Tk8,524, and where it is 16-22 percent, the average total investment is Tk24,105.

However, it is not clear that large investors necessarily have a large net worth, which tends to suggest that microcredit borrowers in rural areas are engaged in low-return economic activities. There is not much scope in the types of economic opportunities available to higher investors, which lends support to the CGAP;s observation that the majority of the microcredit borrowers face only very low-return economic opportunities.

Prospects of Productive Self-Employment from Microcredit

Scholars and researchers agree that microcredit and microeconomic enterprises cannot be relied on as a growth strategy for economic development. However, rural development- and, for that matter, rural small-scale




economic enterprises-and microcredit facilities are complementary features of any development strategy. Job creation for millions of unskilled and semiskilled laborers is the bottom line for any development strategy in any labor-abundant developing country. Therefore, any microcredit program has to be assessed based on its potential for job creation (that is, its role in promoting productive microeconomic enterprises and self- employment). This social dimension of job creation (self-employment) is the most prominent feature of a microcredit program.

The study also found that in 37 percent of cases (seven of nineteen), borrowed funds constitute over 50 percent of their total investments. It also revealed that, on average, each borrower with an investment of Tkl3,911 is able to create opportunities for 431 man-days of family labor (minimum total wages for family labor divided by the average of male and female wages per hour divided by eight hours of work per day: [13,798 - (5 + 3) / 2] - 8). This means that each Tkl,000 annual investment creates opportunities for about 431 -r 13,911 = 31 man-days of family labor. Therefore, investment of around Tkl2,000 is required for creating self-employment for a person for a year.

For groups of large and small investors, job creation per Tkl,000 invested ranges from 23 to 443 man-days of family labor. Thus, there is no clear indication that higher investment, within limits, creates opportunities for a higher rate of self-employment- again suggesting that higher investment has limited social and economic prospects for economic activities open to the microcredit borrowers in rural areas.

Conclusions

Microlending and microcredit have become integral parts of development strategy in almost all developing countries. According to the findings of this study, the likelihood that microcredit will enhance meaningful and productive self-employment and real income of rural households is at best marginal. Any investment of less than Tkl2,000 is not sufficient to create one productive full-time job for a year. The study reveals that if family labor is paid the minimum tolerance level of wages, microenterprises on average may have enough surplus

120 Challenge/November-December 2008



income to pay the current high rates of interest charged by GB and NGOs. This suggests that the exorbitantly high interest rates charged by the loan providers are, in fact, forcing the workers to sell their labor at or below a subsistence wage level.

More important, for a significant proportion of borrowers (32 percent), gross profit is not sufficient to pay even a below-subsistence level of wages for family labor, much less payment of interest and dividends. The microcredit providers in Bangladesh must find more socially equitable and justifiable ways to address this issue. Otherwise, the very basis of microcredit will eventually fail. Most of the millions of borrowers will remain trapped by poverty and debt.

The findings of this pilot study are disturbing because they clearly contradict the claims of the microcredit providers in Bangladesh. However, it must be taken into account that the sample of this pilot project is too small. We cannot draw conclusions about millions of borrowers based on a sample as small as only twenty-five. However, we believe that it is worth reexamining the usual claims of NGOs by undertaking more comprehensive research projects with larger samples in various parts of Bangladesh.

Notes 1. Oxfam International defines microcredit as a variety of small-scale financial

services, including savings, loans for emergencies, day-to-day living, and investment in productive activities.

2. Out ot 9 million, nearly 6.7 million are exclusively GB clients. 3. [16,959 (5 + 3) / 2] + 8 - 12,016 = 44; [17,825 (5 + 3) / 2] - 8 + 24,105 = 23; and

[7,525 (5 + 3) / 2] + 8 + 8,524 = 28.

For Further Reading "Saifur Blasts NGOs for Fleecing the Poor/' 2005. Independent (Dhaka), November 11. "Specialist- Abu Barakat's View About Microcredit Programs That Are Run by

NGOs." 2004. Third Sector (Dhaka) (March): 24. Todaro, Michael P., and S.C. Smith. 2006. Economic Development. 9th ed. London:

Pearson and Addison- Wesley. Wahid, Abu N.M. 1994. "Grameen Bank and Poverty Alleviation in Bangladesh:

Theory, Evidence and Limitations/' American Journal of Economics and Sociol- ogy 53, no. 1.

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Article Contentsp. 113p. 114p. 115p. 116p. 117p. 118p. 119p. 120p. 121

Issue Table of ContentsChallenge, Vol. 51, No. 6 (NOVEMBER-DECEMBER 2008), pp. 1-128Front MatterLetter from the Editor[pp. 3-5]The Presidential Agenda IssuePolicy and Security Implications of the Financial Crisis:A Plan for America[pp. 6-25]The U.S. Economy After Bush[pp. 26-37]Economics Still Matters to Poorer Voters[pp. 38-51]Money Manager Capitalism and the Commodities Market Bubble[pp. 52-80]Reconciling Development, Global Climate Change, and Politics[pp. 81-90]Rethinking Fiscal Policy[pp. 91-104]

International DevelopmentThe World Bank's New Poverty Estimates:Digging Deeper into a Hole[pp. 105-112]Questioning Bangladesh's Microcredit[pp. 113-121]

From the Publisher: The Case for Government[pp. 122-123]Back Matter

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