Micro credit: A Catalyst in Economic Development

Published on 12th December 2006

Micro credit has found remarkable and laudable ways to lift millions from poverty, but so far credit is not among them. According to Grameen (rural) Bank founder and winner of the 2006 Nobel Peace Prize, Muhammad Yunus, the concept of micro credit or lending small amounts of money to groups that are excluded by the conventional banking system can help any country in the world as proved in Bangladesh. Professor Yunus believes micro credit could provide a solution in alleviating poverty and unemployment. Since the Grameen Bank was established in 1983 more than 50 million households have benefited from micro credit in Bangladesh and India alone. In China, however, where the rural population stands at a weighty 700 million, only some 100,000 people have borrowed from micro credit institutions. How successful is the micro credit?

The Eritrean Community Development Fund (ECDF) Project was launched in July 1996 to; support the pilot Savings and Micro Credit Program (SMCP) of the Ministry of Local Government. The SMCP model, like that of Bangladesh, has three loan products. First, group-guaranteed loans are extended to individual members of solidarity groups (Tier - I loans); second, loans to individual borrowers or associations (Tier - II loans). The third product enables solidarity group members who demonstrate good repayment performance in four prior Tier-I loan cycles to borrow, following agreement, but without the guarantee requirement of solidarity members. In this case, loan size limits are the same as those for Tier I. The interest rate is set at 16 per cent for all products.

SMCP was separated from ECDF in 2002 and became an autonomous micro-finance institution, currently operating under the Ministry of National Development. A five-year Strategic Business Plan by SMCP in July 2003 envisages the number of clients to grow to about 42,000 by 2007.  It is reported that from 1996 to September 2005, the village bank savings captured Nakfa 15.5 millions.

Micro credit in Eritrea remains a foreign-funded activity limited to a few NGOs like Africare, Accord, Oxfam, Vision Eritrea and Italian NGOs among others. The National Union of Eritrean Women (NUEW) also exerted efforts to develop the micro credit to different provinces of the country.  However, the operations of SMCP are limited to fewer areas since the financial resources are inadequate and micro credit programmes are currently only allowed to provide loans and cannot accept deposits with some exceptions. It is equally important to promote deposits and saving habits among the rural people. According to Professor Yunus this system is like “policy and legal restrictions have taken the teeth out of microfinance.”

Eritrea's agricultural economy was largely devastated by its 30-year-long independence war with Ethiopia and hurt again by the strain of the 1998–2000 border war. More than 70 per cent of the population is involved in farming and herding. The country's agricultural products include: sorghum, wheat, corn, cotton, coffee, and tobacco. Cattle, sheep, goats, and camels are raised, and hides produced. There is a fishing industry and some pearl fisheries remain in the Dahlak Archipelago. Imports (consumer goods, machinery, and petroleum products) greatly exceed the value of exports (livestock, sorghum, and textiles). To run all these activities, finance is greatly needed. Eritrean’s limited banking system continues to be dominated by the state-owned banks. The few banking institutions like Bank of Eritrea, Commercial Bank of Eritrea, Housing Bank, and Eritrean Development and Investment Bank cannot cater for all the economic activities in the country, particularly in the rural sector. The SMCP has thus been filling this gap through its micro credit programmes.   

The economic growth that occurred in the country may lead to a sharp income gap between the rural and urban areas. While rich and urban middle class Eritreans who benefit from easy bank loans are busy buying homes and cars causing the country's policy makers to devise ways to cool down the economy, hundreds and thousands of farmers in the countryside have virtually no access to credit. The prospect of increased access to micro credit for Eritrea’s poor has become imperative.

Micro credit based on Trust

 

Professor Yunus credits the Grameen bank's amazing recovery rate of 98 per cent to the fact that the entire system is based on trust. “We put our trust on the borrowers; in people that the rest of society has written off and in return they want to honor that trust.”

Explaining the difference between conventional banks and micro credit, the Nobel laureate says that in conventional banks the more you have, the more you get, whereas in micro credit the less you have, the more priority you get. Grameen Bank requires no collateral at all from borrowers. “The idea is to turn conventional banking on its head, so we don't go into a borrower's past at all. We run no credit checks and absolutely no one is excluded,” he says.

It is a general understanding that, the only path to a better life for the rural poor in Eritrea today, is to migrate to the country's cities like Asmara, Massawa, Keren, and Asseb among others, in search of work at the factories/offices. But with micro credit, these people would have another choice in life; self-employment. One does not need any special skills to do this. He can take the money to buy materials to make a hundred baskets (Zebenas) and suddenly have a viable business. This in turn will not only change their life but also contribute to the national economy.

Micro credit and Poverty

 

In Eritrea, 66.4 per cent of the population lives below the poverty line. Micro credit will serve as a useful complement to the survival strategies of poor households. Although micro credit loans are small, they substantially contribute to poverty alleviation and growth. In both absolute and relative terms, the rates of interest (in nominal and effective terms — were 15 and 30 per cent in Bangladesh in 2004, around 24 per cent in India and 16 per cent in Eritrea) charged on micro credit loans are very high. Whereas there might be a monopolistic element in these rates, there are also structural reasons why they tend to be high. One aspect of micro credit that attracts conventional bankers is the high repayment rate. One of the reasons for high repayment rates is close supervision of loan portfolios. Supervision being expensive, the transaction cost of micro credit lending is high, leading to structurally high interest rates.

 

Conclusion

 

The (SMCP) Programme has embarked on many projects in different provinces of the country to alleviate poverty. If micro credit is properly harnessed it offers a variety of benefits to the Eritrean people especially those living in rural areas. Foremost, micro credit initiatives can effectively address material poverty, physical deprivation of goods, services, and attainment of income. When properly guided, the material benefits of micro credit can extend beyond the household into the community. At the personal level, micro credit can effectively address issues associated with non-material poverty, which include social and psychological effects that prevent people from realizing their potential. Micro credits will make a big difference in reducing the high poverty rate in the country and thus develop its national economy.

 


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