Can microfinance be used as a macroeconomic tool to control inflation?

What is microfinance?

Microfinance is the provision of financial services to low-income clients or solidarity lending groups including consumers and the self-employed, who traditionally lack access to banking and related services such as credit, savings, insurance, and fund transfers.

Relevance of microfinance in Indian Context

RBI statistics show that 41 per cent of the adult population in the country is unbanked; that is, do not have a bank account.

In semi-urban and rural areas, the percentage is much more – 70 per cent do not have a bank account. The extent of exclusion from the credit markets is much more – the number of loan accounts is only 14 per cent of the adult population with the ratio again being lower in semi-urban / rural areas at only 10 per cent. These are all-India figures disguising significant regional disparities. These statistics are also reflected in the fact that the top 100 (urban) centers in India account for as much as 75 per cent of the total deposits / credit of the entire banking system.

In addition the informal economy (unregulated) was recently estimated as comprising 60% of net domestic product, 68% of income, 60 % of savings, 31% of agricultural exports and even 41% of manufactured exports. It is obvious that enormous work needs to be done to correct these anomalies. Greater medium term economic stability – meaning price and output stability – crucially depends on achieving greater financial inclusion.

Possible benefits of increased focus in microfinance

1. Microfinance would mean better availability of the cash to the poorest of the poor. This improved economic condition would fuel the local economic activity and growth. Since these people have the highest MPC, the overall impact on the growth will be manifolds.

2. Increased focus on microfinance would also mean an increased regularization of the informal economy. That would in a way help government formulate the policies and to regulate and control this sector for better (hopefully).

3. Another impact of microfinance would be on the availability of information on savings, health and insurance related services to the people. This would in turn fuel the demand and hence growth in the above mentioned sectors.

Possible negative impacts of microfinance

1. A significant part of the transactions for the poorest include barter or quasi-barter transactions Since there is minimal cash involved, and their transaction is not indexed to any currency, the accounts payable/receivable act as a natural hedge against inflation. The situation will change (for good or bad) in case the banking services are available.

2. The informal economy tends to be rural/semi-rural settings without much connection with the global economy. As a consequence, a global inflationary spiral is irrelevant, since the linkages with the global economies are not there. For instance, while a country can import inflation through their need to import increasingly expensive oil, this small village’s dramatic isolation isolates them from development and inflation. The linking of global economy to the informal economy would expose the local economy to external factors.

Conclusion

Microfinance could be used as a tool to fuel the demand/growth at the BOP sector. The major benefit lies at providing the credit facility to the poorest of the poor who in turn could use it to start a growth engine. However there is something which will necessarily happen and then there are things which may or may not happen. Microfinance would definitely improve the consumption and hence the demand of the goods and services. Depending on the type of the inflation, this tool may help to tackle demand constraint inflation.

Looking at the current indices, even though the food inflation is in double digits, the wholesale price index is in single digit. This could primarily mean that India is a supply constraint economy. Using microfinance as a major focus would worsen this inflation as the demand would increase. A better tool could then be focus on the supply side measures such as improving the agricultural infrastructures, supply chains and storage facilities.

At best keeping the current situation of the country in mind, microfinance should be used a long term policy tool to alleviate poverty and increase demand. It will not be able to provide short term /quick fix solution to the inflation problem.