‘Virtuous’ debt status and precarious living

Updated October 28, 2013

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- Illustrated by Abro
- Illustrated by Abro

The recently released 2014 World Development Report’s central theme is risk and opportunity.

This is the World Bank’s annual publication, and the focus this year is on how people manage risk; for risk is a fundamental part of life, especially in the developing world and particularly in the wake of the recent economic and financial crises.

In typical World Bank fashion, the document describes finance as a crucial tool for helping ordinary folks in developing countries manage their risk and turn it into an opportunity.

While the report admits that the financial sector has been the reason behind much of the economic mess we find ourselves in, it continues a strong tradition of idealising the sector as a bastion of opportunity and hope in the face of precarious living.

Such ideas are often echoed in the literature on finance and economics. Robert Shiller of Yale University, for instance, is known for his ‘democratisation of finance’ proposition, through which he argues that finance must be made accessible to the rich and poor alike, so that the benefits of credit and other financial services are not just enjoyed by the rich, but by everyone, rich and poor, male and female.

This is an interesting suggestion; for to present credit as a basic human right, is to turn the idea of debt as a burden on its head. Debt has always been considered a risk; a bondage, and a sure-fire source of impoverishment (in case of default), and associating it with opportunity and freedom, especially when it comes to the poor, is elevating it to a benign, virtuous status indeed.

But Shiller and the World Bank are not alone in glorifying credit in particular and finance in general. In the late sixties and early seventies, economists McKinnon, Shaw and Goldsmith argued that financial development was a necessary precursor to economic development.

Since then, economists have generally believed that a fully functioning financial system — one that includes a thriving banking sector and a well-developed stock market — is necessary for economic growth and macroeconomic stability.

The theory has since been extended and it is further proposed that in order to address the problems of poverty and inequality in developing countries, financial systems need to be deepened and strengthened; that is, their outreach and breadth must be expanded.

In line with this, many governments expanded the scope of their banking sectors through public policies that required banks to open branches in rural areas, and extend subsidised credit to agriculture and other priority sectors.

While the role of finance in economic development is admissible, the role of finance in reducing poverty and inequality is less obvious, and even mistaken to many scholars of development.

Nevertheless, there is a strong global push currently underway towards achieving financial inclusion, which generally means providing formal financial services such as microcredit to those who have traditionally not had access to commercial bank loans. These ideas have promoted the growth of microfinance, mobile banking and financial literacy campaigns across developing countries.

Though a latecomer to the microcredit market, Pakistan has taken a lead in promoting financial inclusion by establishing a regulatory framework for microfinance banks, promoting the growth of mobile and branchless banking, and most recently, by launching an ambitious financial literacy campaign.

For this, Pakistan has won international recognition, and it has consistently received a top rank in global microfinance rankings by the Economist Intelligence Unit in the last few years. The latest rankings place Pakistan’s microfinance sector at number three in the world, and praises the country for having developed one of the most enabling legal frameworks in the region and across the globe.

The word ‘enabling’ is interesting, but the report does not clarify who it considers enabled. A local newspaper recently interpreted the statement to mean that the regulations enable the poor.

Yet, if you ask State Bank officials, they will clarify that microfinance is not about poverty alleviation, but simply about providing a viable option to those who have been left behind by commercial banks to tap into the formal financial sector. This should not surprise anyone, for nowhere in the world is a central bank expected to alleviate poverty, and Pakistan should not be made an exception.

You can argue though that to enable does not mean to alleviate poverty; it just means increasing opportunities for the poor. There are two responses to this.

First of all, microfinance banks (MFBs) in Pakistan have realised that microcredit is not for the poor, and they have moved their target market to those who are often well above the poverty line. Even the Prudential Regulations for Microfinance Banks define a poor person as one whose annual household income is less than or equal to Rs300,000. The national poverty line estimates, on the other hand, consider only households with less than Rs100,000 in annual income as poor.

Secondly, if enabling is not akin to alleviating poverty and is only about increasing opportunities, then how relevant are financial inclusion initiatives for the poor? Unless it can be demonstrated, which unfortunately it hasn’t by any recent studies, that increasing financial opportunities also alleviates poverty, providing such opportunities does not mean much to those living in poverty.

Last summer, when I interviewed microcredit borrowers in Karachi, Lahore, Rawalpindi and the outskirts of Hyderabad, I met very few that considered themselves empowered through credit. Those that seemed content — and these were few and far between — had private or public sector jobs.

But those that were running their micro-enterprises in these precarious economic and political times felt burdened by the debt they had taken on and told me they prayed for the day they would be debt-free.

Yet, even the World Bank has admitted that credit is less empowering than other financial services such as microinsurance and microsavings. Unfortunately, the market for microsavings and microinsurance in Pakistan is not very well developed.

Microfinance institutions (MFIs) and MFBs often make it mandatory for borrowers to take credit life insurance for the life of the loan, but this is usually to reduce their own risks rather than to provide any real benefit to their clients, as documented by a Pakistan Poverty Alleviation Fund (PPAF) report.

Similarly, MFIs such as the National Rural Support Programme (NRSP) ask borrowers to deposit a fixed percentage of their loans into a savings account, and they refer to this as microsavings. While these are indeed the savings of the poor, they are more of a risk-reduction strategy for the institution than an opportunity to save for the borrowers.

Most MFBs do not stipulate that their borrowers give up a portion of their loan proceeds and place them in savings accounts, but savings collected by MFBs are not necessarily the savings of the poor. MFBs, in fact, compete with commercial banks to attract deposits from the general public, both rich and poor, in order to fund their operations.

Thus, the idea that by democratising finance and promoting financial inclusion we are in some substantial way improving the lives of the poor is too broad and vague, and is unsubstantiated by the harsh realities on the ground in developing countries for those who are living in poverty and facing economic exclusion.

Ghazal Zulfiquar, a PhD in public policy, teaches economic development at the University of Massachusetts, Boston