MICRO-FINANCE: A VENTURE CAPITAL PERSPECTIVE
Written by: K. B. S. Sidhu in 2007
With Bangladesh’s Grameen Bank winning the Nobel Peace Prize this year, the concept as well as the practice of Microfinance has come into a sharp focus once again in the policy, academic and business circles. Its champions laud it as a wonder prescription that can ameliorate the poverty of the people at the “bottom of the pyramid”, especially the illiterate rural folk. It is seen not only as an instrument of economic uplift but also as a tool of social empowerment for the teeming millions, more particularly women, who are otherwise ignored by the formal credit institutions.
Government institutions like NABARD and leading private sector banks like the ICICI Bank are taking vigorous steps to promote micro-credit, especially through the “Self-Help Groups”. NGOs like the Ahmedabad-based SEWA are at pains to explain that the idea is not indigenous toBangladeshand that Indian success stories have been around since 1974. Private sector companies have also spread their network, especially in the southern states like Andhra Pradesh. Some such companies have also been in news as they have attracted significant venture equity capital from some well-knownSilicon Valleyentrepreneurs of Indian origin. The success of such schemes, which often boast of recovery rates in excess of 99%, is also quoted by the exponents of free-market economics, who describe these as “efficient market mechanisms”. The relatively high interest rate is often attributed to the “high risk” of lending and the fact that no collateral security is insisted on.
However, the critics of such schemes dub such micro-credit merely as usurious loans that are deceptively packaged as Manna for the rural population. Simple arithmetic calculations are effected to demonstrate that the effective rate of interest can sometimes exceed even 100% per annum. The unwritten practice of obtaining security like the title deeds of the modest dwelling units of the borrowers is also highlighted. The strong-arm tactics to effect recovery as well as the unreasonable peer pressure from the members of the Self-Help Group is projected as instruments of exploitation. The borrowers have recently organised themselves in places likeKrishnadistrict of Andhra Pradesh and pledged not to re-pay the high-cost loans. Such groups have also found sympathetic support from the political parties as well as the District Administration.
Where does the truth lie? My hypothesis is that as along as we continue to regard the micro-finance as micro-credit and persist in juggling with interest rates, we may not be able to understand the true nature of this financial instrument, which is inherently more akin to equity or venture capital.
Let us work with a simple example. A petty vegetable vendor (rehriwala) has borrowed Rs 500/- which he uses to buy to the vegetables from the whole-sale market. On an average, he makes a daily net profit of Rs 100/-, of which he pays an “interest” of Rs. 5/- to the lender. He never repays the principal amount and is quite happy to settle the interest payment on a daily basis, since it does not hurt him much on account of his daily cash flow.
Such rate of interest, however, would be any Chartered Accountant’s nightmare, who would call it “criminal extortion”, since this works out to 365% per annum, even on simple-interest basis. If daily-compounding is effected, the actual interest rate might well be in the vicinity of 500% per annum. This cannot but be described as day-light robbery and neither any Civil Society nor any democratic Government would obviously permit, much less encourage, such an astronomical rate of interest. No amount of “high-risk of lending”- talk can convince anyone that this rate is fair, just and reasonable.
Let us, however, now, view this arrangement from the perspective of equity Venture Capitalist. He sees a reasonably certain daily income stream of Rs 100/-, after all expenses of the micro-enterprise have been paid. He sees his share only 5% of the net daily proceeds. The net annual revenue of the enterprise is about Rs 36,500/-, of which the VC’s share is merely Rs 1825/-. Assuming a modest Capital-Output ratio of 10%, our petty vegetable vendor’s modest business enterprise has been valued by the VC at Rs. 3.65 lacs! This is quite high a figure considering the relatively small investment in the “rehri’ as well as the opportunity cost of the vendor in term of wages and no traditional banking institution would be willing to accord such a valuation. However, our VC friend sees Rs. 500/- that he has advanced not as a loan but as a seed equity capital, which enables the vendor to not only operationalise his business but also to unlock the in the inherent value of his enterprise and get it valued at a figure as high as Rs 3.65 lac. And, remember, the vendor continues to have command over 95% of the “share capital’ as well as 95% share in profits, after meeting all other expenses. Not a bad deal by any means, one would say!
This rudimentary example, may thus perhaps help us in understanding the micro-credit needs to be viewed from this new perspective, so that the dreaded vision of ruthless loan sharks can be consigned to the intellectual dust-bin. The subject needs to be researched more deeply from this stand-point.
Written by: K. B. S. Sidhu, an IAS officer of Punjab Cadre. The views expressed are his own. He can be contacted at firstname.lastname@example.org
Home address: 60, Sector 19-A,Chandigarh160019