Authors: Cornelius Chong and Megha Ranjan
Publication Date: 01 Mar 2021
Introduction
March 2020 saw one of the largest economic and health shocks to hit the global economy since the 2008 financial crisis: The Coronavirus pandemic. As of February 4th 2021, 105,320,359 individuals have been infected with COVID-19 worldwide, and 2,290,397 individuals have died (Worldometers, 2021). Virtually all economies went into complete or partial lockdown – all individuals experienced restricted movements, incomes, and livelihoods. Whilst the deleterious consequences have been felt worldwide, low-income economies have felt them disproportionately higher; the IMF has been approached by 90 emerging economies for emergency financial assistance (Hawker, 2020). Due to this unprecedented economic shock, microfinance institutions in these developing economies have also suffered. In this paper, we will examine the effects of this pandemic on microfinance institutions, particularly in three South Asian countries - Bangladesh, India, and Pakistan.
Section I will provide an overview of the COVID-19 situation in the three South Asian countries, exploring the ways in which the fundamentals of these three countries differ to developed countries. Section II will discuss how microfinance institutions have evolved over time and how their funding structure operates. Section III will discuss the impact of COVID-19 pandemic on different stakeholders in the microfinance industry, citing evidence from the three South Asian countries.
SECTION I
Bangladesh, India, and Pakistan are large and rapidly developing economies in South Asia, home to an estimated 1.78 billion individuals today, making up roughly 23% of the world population (Worldometers, 2021). All three countries have fundamental features in their economies which have helped shape the way in which the pandemic has affected these three areas. Firstly, this section will explain such factors. The next section will then explore the prevalence of COVID-19 for such economies, and finally we will explore the changes in Microfinance funding over the years.
Country Characteristics
The disproportionate effects of the COVID-19 pandemic felt by emerging economies compared to developed economies has been due to the ways in which the economies of India, Pakistan, and Bangladesh differ to those of more advanced countries, for example Finland or Switzerland. Firstly, the distribution of economic sectors is extremely different; Bangladesh, India, and Pakistan still operate large primary and secondary sectors, whilst the tertiary sectors are predominantly responsible for the GDP of developed economies. Fig.1 shows the proportion of GDP that comes from each sector in the economy for the three South Asian countries of interest, compared to three developed economies.
In order to stop the spread of COVID-19, it is essential that a minimal number of workers be outside. This is much easier to achieve in an economy that is dominated by the services sector, as the transition to a work-from-home environment can be done more easily for individuals who can work online. Agricultural and manufacturing workers, however, do not enjoy the same privilege. Hence, many essential workers would necessarily have to continue carrying out their essential jobs outside during a lockdown compared to those in developed countries. Hence, this is one factor that creates negative consequences for the three economies and exacerbates the effects of the pandemic.
Another significant factor is the population density of the three countries. India has 464 people per Km2, Bangladesh has 1265 people per Km2, and Pakistan has 287 people per Km2 (Worldometers). In countries with such high population densities, it is inevitable that a contagious virus such as COVID-19 would spread more rapidly than in countries with lower population densities. Furthermore, whilst this is an average of the population distribution in each area, these figures are much higher for villages and shanty towns riddled with poverty. This is exacerbated by the fact that sanitation and hygiene would be negligible in such areas, rapidly increasing the spread of the pandemic.
Following from this, a third factor is the sanitation in the three countries. In 2017, 59.5% of India’s population had access to basic sanitation services, 48% of Bangladesh’s population, and 60% of Pakistan’s population (World Bank). These are incredibly low figures compared to developed countries, who enjoy an average of 99% for the same statistic. Given that the virus spreads largely through contact, access to basic sanitation services is extremely important for limiting the injurious consequences of a pandemic.
Prevalence of COVID-19
As of September 30, India, Pakistan, and Bangladesh saw 6.3 million, 312,806, and 363,479 cases respectively (National Health Ministry). The death rates of the three countries were 1.6, 2.1, and 1.4 per 1000 persons respectively (National Health Ministry). After spiking between June and July 2020, the infection rates in Bangladesh and Pakistan have fallen, but they are at risk of a second wave as governments gradually ease restrictions. In India, the number of recorded cases is still rising rapidly. COVID-19 was initially concentrated on a few large and densely populated cities in India, but is now prevalent in virtually almost every state and across smaller towns and rural areas.
Fig 2: Shape of COVID-19 curve in Pakistan, Bangladesh and India
Source: BBC News
However, it is important to note that the reported figures for each economy are likely to be grossly underestimated because of the lack of testing in South Asian nations. The benchmark range for adequate testing set by the World Health Organization (WHO) is between 10 and 30 for each confirmed case. However, India is at the lower end of the range, while Bangladesh and Pakistan are testing far below the range. The following figure shows how the three nations’ testing compares to other nations and the WHO benchmark.
Fig 3: Tests per confirmed case across countries
Source: Our World in Data
Factors explained in the previous section can help explain why the testing is so low. All three nations are riddled with high levels of poverty, and in particular, India has a substantial number of individuals that reside in undeveloped residential areas such as Shanty towns. These individuals do not have access to testing sites easily and even if they did, are unlikely to have perfect information regarding the handling of their symptoms. Whilst the data shows otherwise, a survey by WHO has suggested that 22% of a large city such as Delhi have coronavirus antibodies.
COVID-19 Effects on the Economy
Whilst the prevalence of coronavirus in the three economies has been discussed, this subsection will explore how this has affected the economy, as this is ultimately what affects Microfinance institutions.
Near the end of 2020 after experiencing almost 9 months of the pandemic, India’s GDP contracted by nearly 24% (Washington Post, 2020); an enormous drop in a country that has been experiencing large levels of growth consistently. Similarly, Pakistan saw a drop of 10% in the last quarter of 2020, whilst Bangladesh has kept relatively stable levels of GDP growth. (MDPI, 2020). The following figure shows how the GDP growth rate has differed in South Asian countries, showing huge drops for a country such as India.
Fig 4: GDP growth rates across South Asian countries
Source: MDPI
Evidently, the pandemic has been an enormous negative shock in the economy, affecting the GDP in different ways. Consumption has faced huge drops due to animal spirits in the economy falling, individuals becoming unemployed and hence losing their disposable income, as well as simply because goods and services are less available in a lockdown economy. Specifically, India saw unemployment rates as high as 24% in the peak of the pandemic (Statista, 2021), and Pakistan is predicted to have experienced job losses of up to 18.5 million workers (Subohik 2020). Higher unemployment rates also exacerbate a negative demand shock to the economy as lower consumption does not just lead to lower disposable income, but in this case leads to the complete loss of disposable incomes by many individuals. Hence, these individuals now spend a lot less into the economy and the overall negative multiplier effect on the economy is larger. Ultimately, this leads to a much higher contraction in output that is observed with the data.
SECTION II
This section will explore how Microfinance institutions have evolved over time with regard to their funding structure, and why this has made them particularly sensitive to this recession.
Prior to the financial crisis of 2008, the correlation between the success of Microfinance institutions (MFIs) and the success of international capital markets as well as domestic economic conditions was not particularly high. MFIs had empirically shown to be relatively economically resilient during recessions, for example during the Latin American debt crisis and the Asian financial crisis of 1997. This was due to the independent nature of MFIs, and their underexposure to the commercial capital market at the time. However, leading up to the crisis, there was an evolution in the funding structure of MFIs. Just as wholesale funding and the securitization of assets grew within the financial sector, MFIs analogously started to integrate into the financial markets. This, in turn, increased their sensitivity to the global liquidity crisis and hence a higher empirical correlation can be observed for the ways the financial crisis affected MFIs (Parvin et al, 2020).
It is worth noting why this increased exposure to financial markets came about for MFIs – this is due to the capital investment structure of Microfinance investment vehicles. These institutions pool money together to invest into an MFI, which sustains the institute’s work of giving loans to low-income individuals who do not meet the requirements for a mainstream bank. The empirical success in the 1990s of Microfinance as a means to alleviate property made it an attractive investment, attracting institutional investors and other individual private investments. In particular, it caught the eye of socially conscious investors and foundations who were sensitized to the burgeoning ESG investment landscape. Investments by pension funds increased, and so did the investments by the private arm of international financial institutions. This can be seen on the following graph as the percentage of portfolio of risk growing up till the point of the financial crisis, which measures the exposure of the MFI to the commercial market.
Fig 5: Changes in PAR-30 leading up to the financial crisis
Source: (MDPI, 2020)
This was the trend leading up to the financial crisis, which has continued following the crisis, leading up the 2020 covid-19 pandemic.
The following graph shows the way that the capital funding structure of MIVs has changed since 2006. Private institutional investors have grown the most with a compound annual growth rate of 26%, retail investors following with a CAGR of 16%, and public funders experienced a CAGR of 18%. Due to the increased portfolio exposure of microfinance institutions in the current globalised landscape, they are left more vulnerable to global shocks such as the pandemic. Specifically, the market for MFIs has had a compounded growth rate of 20% of total assets. Institutional investors that operate privately now make up 52% of MIV’s capital, and funds now contribute 20% (CGAP, 2017). This means that when faced with an economic shock, as liquidity in the economy is constrained, so is the capital for the MFI. This is pronounced as the funding structure has diversified in such a way that now private institutional investors and retail investors own vulnerabilities factor more greatly into a MIV’s ability to fulfil its purpose. Hence, MFIs have evolved into being in a more vulnerable position in face of this pandemic.
Fig 6: Capital funding structure of MIVs
Source: CGAP
SECTION III
While COVID-19 has impacted all parties in the microfinance industry, ranging from borrowers, investors, to microfinance institutions, the effects are unevenly distributed, with some stakeholders bearing a bigger brunt of the pandemic. This section will highlight some of these impacts, by drawing on data from India, Pakistan and Bangladesh.
Impact on Microenterprises
With lockdowns imposed to varying degrees and the closure of business activities, borrowers have been adversely affected by the pandemic. In Pakistan, lockdowns were implemented on a region-by-region basis, but by the start of April, all educational institutions, shopping malls, public transport and entertainment venues had been closed across the country. Religious and social congregations were banned, and only essential shops (grocery and medical stores) were allowed to open under restricted hours.
Pakistan’s situation is especially dire, given that micro, small, and medium-sized enterprises (MSMEs) represent over 90% of national enterprises in Pakistan and contribute 40% to Pakistan’s GDP, with over 40% to export earnings (Shah, 2018). These Microenterprises are often financed by microcredit, and are a key part of the Microfinance industry in Pakistan. Microenterprises create employment and income generation opportunities for low-income groups, and at the same time contribute to human capital through on-the-job training (Oxford Review of Economic Policy, 2020).
Figure 7 below shows that sales in the week after the lockdown against sales in the week before the lockdown decreased dramatically in Pakistan. For sample A (regular borrowers), weekly sales fell by 91% on average, from a mean of $33 to a mean of $3, while for sample B (graduated borrowers), there was a 93% decline on average, from a pre-lockdown mean of $52 to $4 after the lockdown. To get an alternative perspective on the impact on Microenterprise performance, loan officers were asked to think about a ‘typical’ client, for whom they had to estimate the pre-lockdown and post-lockdown sales. They reported that their typical client experienced a decrease in sales of 83 per cent, in line with the results from Samples A and B.
Fig 7: Impact on sales of Microenterprises in Pakistan
Source: Oxford Review of Economic Policy
Impact on Loan Repayments
In Pakistan, the impact of COVID-19 is exacerbated by existing loans held by borrowers, with 97 percent of regular borrowers and 45 percent of graduated borrowers having an outstanding loan. More worryingly, the average repayment rate decreased to 81 percent in March compared to 98 percent in February (which partially reflects the effect of the lockdown in the third week of the month), and a significant decrease to 34 percent is expected in April. This is shown graphically below.
Fig 8: Changes in Expected Repayment Rates
Source: Oxford Review of Economic Policy
Another interesting thing to note is the nebulous debt restructuring plans available in Pakistan. Despite many MFI CEOs stating that the official policy was to allow debt restructuring for all borrowers, 96% of clients stated that they have not been contacted by the MFI to offer repayment flexibility. This contrasts starkly with the 60 percent of loan officers who stated that they had offered repayment flexibility to their clients, or that they were intending to do so.
Impact on Women
Female-run businesses were found to be hit harder by the pandemic; they are 8 percentage points more likely to experience a 100% decrease in business revenue than those run by men in Pakistan. This is likely due to the fact that women-owned Microenterprises are smaller than their male counterparts, and hence are less resilient when crises strike (World Bank, 2020). This may also be due to the fact that women are over-represented in the sectors negatively affected by COVID-19 such as tourism, hospitality and agriculture.
In addition, women dominate the informal economy, and these jobs are the first to go when economic crises strike. In Bangladesh, six times more women than men have been laid off during the coronavirus recession (International Finance Corporation, 2020). Over a quarter of Pakistani women have also been fired or suspended from their jobs in various sectors (World Bank, 2020). With children at home during lockdowns, women are also shouldering most of the care work, further reducing their economic opportunities. It does not help that women are frequent borrowers too: as of November 2019, Grameen Bank has provided collateral-free loans of more than $20 billion to the poorest of the poor in rural Bangladesh, including 97% of women borrowers. (Zheng and Zhang, 2021). The impact on women is indeed disproportionate.
Impact on profitability of MFIs
As countries imposed lockdowns, MFIs could no longer operate, and they could not disburse loans and collect installments. In Bangladesh, collection was non-existent in the months of April and May, and even though it resumed in June, the collection was far from ideal. Fig 9 shows the collection ratio, disbursement target and achievement related information for some MFIs in Bangladesh for the months from January to June 2020, attained through detailed interview sessions (IDLC Finance, 2020).
Fig 9: Collection rates in Bangladesh
Source: IDLC Finance Limited
This has severe implications on the profitability of MFIs. Non-performing loans, shown in Fig 10, have already risen in Mar 2020. With MFIs already facing collection problems which may continue for a couple of months, and with costs largely remaining the same (operational cost, salary, infrastructure etc.), it will not be surprising if COVID-19 sounds the death knell for some MFIs. However, the government of Bangladesh has introduced a slew of stimulus measures to support the Microfinance industry, and MFIs will hope that they will be able to tide through this difficult period with this support.
Fig 10: Non-performing loans in Bangladesh
Source: IDLC Finance Limited
In India, the situation is even more acute, given that MFIs were already facing difficulties prior to the pandemic. PAR for the sector for repayment between 31 and 180 days stood at 1.5 percent for Q3 of 2019-20, 50 percent higher on a year-on-year basis. There has also been no formal announcement by the Reserve Bank of India about a moratorium to MFIs from their lenders and the delay could severely impact their ability to pay interest on their borrowings. In a study of 29 MFIs whose combined portfolio is around 70 percent of the Microfinance industry, these MFIs had around Rs 8,000 crore of total repayment obligations and operational expenditure for the June quarter. However, their combined on-balance sheet liquidity buffer is around Rs 5,400 crore only, a shortfall of Rs 2,600 crore with no scope of any external funding (ICRA, 2020). As a result, ICRA projects the credit costs for the MFIs will rise from current levels of 1.0-1.5 percent to 2.5-3.0 percent.
Impact on efficiency of MFIs
In a study of 11 Asian countries, including Pakistan, it was also found that COVID-19 decreased the financial efficiency, but increased the social efficiency of MFIs. Financial efficiency is measured using gross loan portfolio and financial revenue, while social efficiency is approximated by taking data showing the number of active female borrowers, as well as how beneficial the loans are to the poorest in the country. This conclusion is easy to explain - the demand for small loans has increased, and MFIs are willing to provide these loans for the poor to tide through these economic hardships, but at high interest rates. This accounts for the increased social efficiency. However, the high interest rates would indubitably mean that vulnerable borrowers may default on their loan repayments, and many existing borrowers have already done so, leading to decreased financial efficiency for MFIs (Zheng and Zhang, 2020). What this ultimately means is that MFIs may face liquidity and insolvency concerns in the future, years after the pandemic.
Conclusion
As seen, the COVID-19 pandemic has had enormous impacts on the Microfinance industry, hitting both borrowers and MFIs hard. Government stimulus measures, as well as targeted support toward different stakeholders in the Microfinance industry, is desperately needed. Moreover, structural reforms may be necessary, as the impact is likely to linger even after the pandemic. A review of regulations may be needed to make MFIs financially more robust, and governments may have to step in to intervene for borrowers that will default. It is also critical to view the Microfinance industry as a small part of an entire country’s ecosystem. With that in mind, policies for the Microfinance industry can be better integrated with other social and economic policies, ultimately with the goal of protecting businesses, institutions and livelihoods. Short-term prospects for the Microfinance industry may be dim, but it will hopefully serve as a lesson for the sector to undergo changes that will make it more resilient for future crises.
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