Finance: Poisoned chalice of informal borrowing – Business – DAWN … –

In the rural areas of Pakistan, especially southern Punjab, interior Sindh, and Baluchistan, access to credit is limited. The poor often have to rely on informal moneylenders who charge high-interest rates, making it difficult for them to break out of the vicious cycle of poverty.
Theoretically, microcredit should provide a more affordable and accessible alternative and protect the poor segment of society against financial vulnerabilities.
The best example of microfinance is Muhammad Yunus, who won the Nobel Peace Prize in 2006 for his work promoting microcredit, which is the practice of providing small loans to people in Bangladesh, particularly women, who are too poor to qualify for traditional bank loans. His microfinance campaign helped 2.4 million people in poverty.
In Pakistan, there are 11 Microfinance Banks, and of them, Khushhali Bank Limited, NRSP (National Rural Support Programme) Micro Finance Bank Limited, Sindh Microfinance Bank Limited, and Tameer Micro Finance Bank Limited are more vibrant in providing microcredits in rural areas.
The aggregate gross loan of the microfinance industry in Pakistan grew to Rs449 billion ($2bn) as of June 2022, and borrowers grew 3.5 per cent quarter-to-quarter to 8.4m.
On the flip side, the annual percentage rate of microcredit is 25pc-35pc, depending upon the loan amount and period, which is even higher than the annual profit in small businesses.
Borrowers may feel pressured to repay quickly, even if it means taking on additional debt
Let’s look under the hood: an average per acre wheat yield in Punjab is reported at 32-35 maunds. The support price is fixed at Rs3,900 per maund. In this way, the total output per acre is Rs124,800. The small farmer has to pay Rs30,000 as the rent of land.
In contrast to land rent, fertiliser, seeds, pesticides, cultivation, and harvesting cost more than Rs90,000 per acre. A farmer can earn Rs30,000 profit against Rs90,000 investment per acre, which is almost a 30pc profit margin.
The average inflation rate in Pakistan last year was reported to be more than 20pc. If we calculate the real rate of return taken into consideration after inflation, then his profit margin is only 10-12pc. They have to pay 25pc-30pc per annum as a loan cost which is 13-15pc semiannually.
Consequently, they are earning just to pay the cost of the loan.
According to renowned economist Thomas Piketty, if the rate of return on capital is consistently higher than the rate of economic growth, then there will be a tendency for wealth and income to become concentrated in the hands of some families.
For example, those who own capital in Pakistan can earn 20pc-25pc, while those who rely solely on labour income or industrial profit, which is 10pc-15pc, are not experiencing the same level of wealth accumulation, which leads to inequality.
According to a dialogue published by the Lahore University of Management, the wealthiest 10pc of households own 60pc of the household wealth. Consequently, inequalities in rural areas of Pakistan are increasing drastically.
Similarly, whenever they experience a poor yield of crops due to bad weather eg the recent example of flood in Southern Punjab, Sindh, and Baluchistan, it makes it challenging to cover their expenses and meet their financial obligations.
They are forced to take out loans to pay for basic necessities, such as food, housing, and healthcare, and then find themselves unable to repay the debt.
Moreover, according to the survey, most borrowers needed money for an agricultural sector-related requirement: 20pc needed it to buy livestock, 17pc for farming goods, and another 14pc required a loan to purchase farmland. This leaves them vulnerable to exploitation by landlords and lenders who offer to pay off their debts in exchange for labour.
On the flip side, formal borrowing usually involves more documentation and regulations, such as credit checks, income verification, and collateral requirements. This can be time-consuming and complicated and may not be feasible for people with poor credit scores or a weak financial situation.
Informal borrowing, on the other hand, is simpler and more convenient. It often involves borrowing from vendors, fertiliser suppliers and land elite. It also provides short-term relief to those who need cash quickly but can create significant long-term vulnerabilities such as debt bondage, forced marriage, and abusive relations.
Informal borrowing often occurs in the shadows without documentation, especially vendors providing fertiliser at a high price on credit which means that farmers end up paying more in the long run.
Sometimes, they do not disclose all the terms and conditions of the sale on credit. They also use aggressive tactics to collect repayments, such as harassment, threats, or physical violence.
Borrowers may feel pressured to repay quickly, even if it means taking on additional debt or sacrificing basic needs. As a result, according to Global Slavery Index 2020, Pakistan is ranked 6th in the modern slavery index having more than 2.1m bounded labour workers, consisting of 16.8 and 63 workers as victims and vulnerable to modern slavery per 1,000 population, respectively.
The writer is an assistant professor (PhD Financial Economics) at the National University of Modern Languages, Islamabad. He can be reached at
Published in Dawn, The Business and Finance Weekly, April 3rd, 2023
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