India Uncut

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Thursday, October 19, 2006

Microfinance, Hurricane Katrina and rural India

Mohammad Younus has an excellent piece in the Wall Street Journal on how microfinance can be used to rebuild the areas affected by Hurricane Katrina.

But can microfinance work in all conditions? I don't know much about the local economies of New Orleans or Mississippi, but it's not been a roaring success in India yet. Karthik/SK/Wimpy/SKimpy explains why it is "not exactly suited for the Indian context":
The simple fact is that in rural India, the major demand for loans comes from agriculture, which involves large negative cash flows up front and (hopefully) large positive cash flows a few months down the line and the microfinance institutions here barely seem to understand this.

One of the fundamental principles of finance is that the cash flows of the source of funds should approximately match the cash flows of the application of funds. And therein lies the major failing of Indian microfinance. What Equated Weekly Installments implies is that if I give you a loan at the beginning of the crop cycle, I expect you to pay me a large part of it before the completion of the cycle! And the only way (in most cases) that you can make such payments is by going to the local moneylender, thus getting stuck in a debt death spiral.

The reason the model has worked so successfully in Bangladesh is because there the loans are not for agriculture. They are doled out to women so that they can start their own small businesses, which usually yield steady weekly cash flows – you might notice that the cash flows from the business are in tune with the cash flows from the loan.
A fine insight.

(SKimpy link via email from Aadisht.)

Cross-posted on The Indian Economy Blog.
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