Policy finance for micro-enterprises

The View From Taft
Benel P. Lagua

Posted on January 03, 2013

THE EXPERIENCE of the micro-finance industry in the Philippines has proven that there is significant potential for enterprise creation even among the poor. But micro-finance is so expensive for the end clients and is thus a mismatch for the need of growing and expanding enterprises for competitively priced funds. At the moment, the micro-finance industry is hardly able to report significant graduation of micro-enterprises (MEs) into sustainable and competitive enterprises.

In strategic terms, the micro-financing system addresses the credit access issue in the ME sector with financing cost as a trade-off. This is probably adequate for majority of MEs at the livelihood level. However, the disproportionately heavy burden of financing for more mature MEs probably results in significant opportunity losses in the sector; that is, there is a need for competitively priced funding sources for MEs that have growth and expansion potential.

A variation of the venture capital concept will address the credit cost issue in stimulating the creation of enterprises among the poor. The venture capital model is rarely applied to MEs given the cost of investment-relevant information at the ME level. While it can be argued that the rate of success at this market will probably approximate the rate of success from conventional venture capital markets, returns (recoveries plus profit) will probably be at disincentive levels. Thus, some form of affirmative action is necessary.

But if subsidies through cash transfers can be justified in terms of poverty alleviation objectives, a more directed intervention for enterprise creation is all the more justified. Admittedly, neither micro-finance credit nor a modified venture capital funding as explored here, being competitive and directed, can match the broad quick relief impact of cash-transfer models. In theory, since returns are not expected anyway given that a broader socioeconomic impact is presumed from the start, a simple cash transfer model is direct and faster implementation-wise.

On the other hand, because accountability is always an aspect of any government program, pure cash transfers are actually costlier and non-sustainable in the long run. The cost of information needed to establish necessary accountabilities in the model eventually overcomes the cost of information in more competitive and directed models (credit or venture capital). Moreover, the transaction costs for the more competitive interventions are potentially mitigated by the availability of implementers and expertise in the system. And more rigid governance systems can be introduced to ensure benefits to intended targets.

This leads to a policy finance initiative that will jump-start the graduation of MEs into viable small businesses through a modified venture capital model for which the initiator, presumably the government, must embrace the higher risk of exposure. Given the higher incentives involved, the program will have a subsidy component. However, the socioeconomic benefits are promising and more than offset the costs.

A well-designed program will recognize the different objectives of cash transfers and financing for enterprise development among the poor. Consequently, micro-finance and the modified venture capital model explored here should complement the main cash transfer model as value-enhancing interventions. Only a limited portion of the market (the poor) is a valid target for competitive interventions.

A simplified comparison of objectives would be: (a) pure conditional cash transfer (CCT) is food on the table; (b) micro-finance is extended but eventually diminishing cash flow from needs-driven micro-enterprises; and (c) modified venture capital is for competitive, opportunity-driven MEs.

Comparisons in terms of intervention strategies would be: (a) pure CCT is intervention to enhance purchasing power in the sector; (b) micro-finance is value creation by providing credit access for ME stimulation; and (c) modified venture capital is value propagation by improving competitiveness and growth and expansion opportunities for MEs with competitively priced capital.

Distortions in the micro-finance market must be avoided. Directionality and competitiveness must be assured by implementers. Assurance mechanisms should involve risk participation, albeit probably to a limited extent to encourage quick deliveries.

Returns must be defined for the participants. Expectation from profit-sharing shall mitigate the cost of transactions of implementing agencies. Benefits and returns from fund re-flows and funding cycles (leveraging effect) will help reduce the subsidy component, unlike the traditional CCT fund, which is one-directional.

There is a case to be made for a more aggressive government stance to support SMEs through a policy finance budget similar to CCTs. We can only hope it happens soon enough.

(With an AIM MBA and a Harvard MPA, the writer teaches Financial Management in the MBA program of the Ramon V. Del Rosario College of Business of De La Salle University. He is likewise president and COO of the Small Business Guarantee and Finance Corp. The views expressed above are the author’s and do not necessarily reflect the official position of De La Salle University, its faculty, and its administrators.)