The Global Credit Crunch and Economic Stimulus Packages - Does Microfinance Belong?

Editor's Note: The following item is cross-posted on the CGAP Microfinance Blog.

Hopes that the developing world would sidestep the worst effects of the global credit crunch are fading, as it becomes apparent that the transmission of problems from the sub-prime niche to broader credit markets to whole financial systems is now leading to the real economy. The IMF adjusted its month-old economic growth forecasts for developing countries downward.

Governments around the world over have serious stimulus measures on the drawing board to cushion their economies and citizens from the worst effects of recession in the North. Keeping domestic credit flowing is typically a central component. Will these policy prescriptions include support for microfinance? And if they do, is this something to be applauded or criticized?

This week China announced a massive stimulus package, much to the relief of its Asian neighbors and the many developed and developing countries that rely on the economic juggernaut to buy their commodities and goods. For the first time in many years, projected growth in China will be in the single digits. While the details remain to be revealed (and realistically, there will be even less specificity than in the stimulus packages under consideration in capitals across the developed world), clearly the Chinese leadership is worried about negative economic and political impacts of the slow-down – unemployment, migration flows, and civil unrest.

Similar concerns have motivated strong policy responses around the globe, in countries where the political economy is very different from China’s. Some of the responses include direct support to keep business and household credit flowing. For example, in Brazil and Russia, governments have announced major new SME funding programs through state-owned development banks, in response to domestic credit crunches that appeared to be threatening broad-based growth.

In the US, plans are advancing for a major stimulus package. At the same time, more and more observers are asking why the $700 billion financial rescue package did not include stronger requirements for banks to open the lending spigots (as was the case in the UK, for example). Some are suggesting that it could be appropriate for the government to set aside a small percentage of the bailout funds for lenders more likely to serve the communities, businesses and households that are hardest-hit by the foreclosure crisis and looming recession. It is argued that these “community development financial institutions” – specialized banks, credit unions, and non-profit loan funds – would help buy political legitimacy and breathing room for the more macro-type fixes to take effect.

As policy makers and politicians consider the options, isn’t it likely that they will look at the microfinance sector in a similar way? Channeling government funds into specialized financial institutions that serve poor people and places has a definite logic and appeal as part of the overall package. China has been scaling up government-supported MFIs rapidly over the past few years as a way to tackle the politically tricky disparities between the booming cities and the lagging western rural regions. It wouldn’t be surprising if support for microfinance is an element in the massive Chinese stimulus package. Governments in Delhi, Brasilia, Moscow, and Washington might also be drawn to credit mechanisms targeted to people and places that are hurting. The IMF and international development agencies and donors might also find a microfinance “ask” in the counter-recession package.

Is this a bad thing? We have tended to look askance at government-supported microfinance, especially if delivered by state-owned banks but even if channeled through national “apexes” created to promote and scale up the microfinance sector with financial and technical assistance. In more normal times concerns about such interventions, in terms of potential political interference and crowding out of the private sector, are quite valid. As part of major economic stimulus packages, however, perhaps the risk-reward calculus is a bit different. We should be prepared to answer the question: “Why shouldn’t poor people’s financial institutions be part of the solution?” And if the answer is that perhaps they should, we then need to have clear answers about the best way to help the microfinance sector play its role in cushioning the poor in the roller-coaster years to come.

Katharine McKee, Senior Adviser