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Mongolian microfinance: Some first insights from a randomised field experiment

Ralph De Haas Senior Economist — Thu, 25 Feb 2010 13:46:42 +0000

In Mongolia, as in numerous other countries, microfinance has attracted attention as a potentially powerful tool to generate pro-poor growth. Many Mongolians live in poverty and income disparities between urban and rural areas are significant. The rural economy remains vulnerable to variations in weather conditions; droughts and harsh winters often lead to large-scale livestock deaths, also this year. As a result, there is wide-spread migration from the countryside to urban centres, such as the capital Ulaanbataar.

Ger – a portable, felt-covered dwelling – in rural Mongolia

Although microfinance has grown rapidly over recent years, hard evidence on its socio-economic impact is only emerging slowly. To what extent does microfinance lift people out of poverty by allowing them to generate income from small-scale enterprises? And is group lending (‘joint-liability’) or individual lending the best way to reach out to borrowers? These are questions that XacBank, a leading microfinance institution in Mongolia, has been grappling with as well. The bank wanted to expand its outreach to indigent rural borrowers, in particular female ones, who hitherto had only limited access to financial services. But what is the best way to expand lending to such ‘difficult’ customers?

On the one hand, individual loans may be more suitable in a country in which the nomadic lifestyle may have limited the build up of social capital outside of the family structure. On the other hand, group lending may work well if the looser ties within groups reduce the risk of collusive behaviour. Moreover, since monitoring costs are particularly high – loan officers have to travel extremely large distances to reach remote clients – the reduction of such costs through a group lending structure may be particularly valuable.

To help XacBank with its strategic decision making and to assess empirically the impact of access to microfinance on small business development and poverty reduction, a project team at the EBRD (Ralph De Haas and Heike Harmgart) and the Institute for Fiscal Studies (Orazio Attanasio, Britta Augsburg and Emla Fitzsimons) designed a so-called randomised field experiment. The design entails an experimental set up involving 40 soums (villages) across 5 aimags (provinces). Together with the Mongolian Women’s Federation (MWF) a list was drawn up in each village with the names of relatively poor women who were interested in a XacBank loan to expand or set up a small business. These women were also asked to form preliminary borrowing groups. All 1,148 of them were then interviewed by a survey company in March 2008 (the baseline survey).

Session of MWF representatives involved in the field experiment

The 40 soums were then randomly divided into 10 ‘control soums’, 15 ‘group lending soums’ and 15 ‘individual lending soums’. Information from the baseline survey confirmed that the randomisation worked well: the participating women in all three types of villages were on average very similar across a wide range of observable characteristics.

In a next step, all women in group-lending soums were visited by a XacBank loan officer and groups that were deemed credit-worthy were offered a group loan. In the individual lending soums, women were offered an individual loan, while in the control soums XacBank delayed the roll-out of lending for the duration of the experiment. Importantly, when the women signed up to the project it was carefully explained to them that they would only have a 75 per cent change of actually obtaining a loan during the first year (since XacBank would delay the introduction of lending in 10 out of 40 villages).

A follow-up survey was conducted in October/November 2009, about 20 months after the baseline survey. Four interview teams re-interviewed 982 of the initial respondents; a re-interview rate of 86 per cent. This means that for 982 respondents we have detailed information from both the baseline and follow-up surveys on income, consumption and saving patterns, asset ownership, (in)formal enterprises, and exposure to shocks. Respondents were also asked about their income expectations and attitudes towards risk. Finally, novel questions were asked to gauge how well group members knew their co-borrowers, with the aim of allowing us to make inferences about the ‘information asymmetries’ within joint-liability groups. Detailed information was also gathered on the characteristics of villages and loan officers that participated in the experiment, while XacBank provided the project team with comprehensive repayment data on all loans.

Respondent being interviewed. The stones are used to answer questions about the respondent’s own expectations about her future income.

The project team is currently combining and analysing all of these data. This should allow us to compare how the respondents in the control soums (no loans offered) and the treatment soums have developed over time. Since the women in the treatment and the control villages were on average very similar before the experiment, differences in their subsequent development and outcomes will only be related to whether or not they received a loan.

This comparative analysis is of particular interest given the global financial crisis, the impact of which was felt in rural Mongolia in the period between the two survey rounds. Cashmere prices dropped by more than one third over a short period of time, adversely affecting many herder families. We hope that our results shed light on the question of whether the availability of microfinance has alleviated – or maybe even increased – rural households’ financial vulnerability during the crisis. Complete results are expected to be available in June of this year and will be summarised on this blog. For now, the data collected during the baseline survey already provide some insights into the state of rural microfinance in Mongolia. Three observations stand out:
First, we find that only 44 per cent of respondents had no outstanding debt at the time of the first interview while 46 per cent already had a loan. Almost ten per cent of respondents even had two or thee loans. Contrary to popular perception, penetration of microcredit was already quite advanced across rural Mongolia, even among our sample of relatively poor women who were selected because of their supposedly limited access to finance.

Second, virtually all respondents with a loan took out that loan in 2007 or 2008. Almost half of the respondents had not had another loan (whether repaid or not) in the last five years. Competition for rural customers – in particular between Khan Bank, XacBank and Mongol Postbank – had intensified in recent years. In our sample, Khan Bank has by far the largest market share: we find that just over one half of those with an outstanding debt owe it to Khan Bank.

Third, we find that between 70 and 80 per cent of the debt outstanding at the start of the experiment was used for consumption purposes and not for financing micro-entrepreneurial activities. This is an important finding since it shows that even though microfinance in rural Mongolia has advanced rapidly in recent years, the vast majority of loans has been used for consumption rather than income-generation. That is not to say that these loans have not been ‘useful’: the ability to smooth consumption is particularly important at low income levels. But it will be interesting to see whether the crisis has impacted households with varying debt levels differently. Moreover, it will be of interest to find out to what extent the individual and group loans disbursed during our experiment, which were intended to finance businesses, have indeed been used for such income generating purposes.

Stay tuned for more…

Let’s Stick Together: Pros and Cons of the Tripartite Customs Union in the CIS

Ralph De Haas Senior Economist — Mon, 01 Feb 2010 12:52:23 +0000

Authors: Ralph De Haas, Alex Plekhanov
As of January 2010, Russia, Kazakhstan and Belarus apply a common external customs tariff (CET) to imports from third countries. The CET is mainly based on the Russian duties that prevailed until last year. Since these were the highest among the three countries (Figure 1) there have been significant duty hikes in Belarus and Kazakhstan. For example, in Belarus the import duty on a 2003 car with a two-litre engine increased from 800 to 8,000 euros. Duties on televisions doubled. In Kazakhstan, average tariffs increased from 6.2 to 10.6 per cent. Why did the three countries follow this route?

Figure 1 Average level of import duties in international perspective

Abstracting from geopolitical considerations, the economic reasons differ per country:

Russian manufacturers profit from the common external tariff. By heightening the ‘common tariff wall’, Russian producers of cars, trucks, buses, flat metals and metal pipes, dairy products, and milling products face less competition in Kazakhstan and Belarus because producers from third countries (such as China and Southeast Asia) have been put at a disadvantage;

Belarus may benefit from uniform pricing of energy for Russia and Belarus. Minsk expects to no longer have to pay duties on the oil that it imports from Russia, refines, and then exports to the EU or back to Russia. The likelihood of this will be higher if Belarus agrees to sell significant stakes in two large oil refineries, modern and close to the EU market, to Russian companies. Negotiations are ongoing;

Kazakhstan seeks to boost exports of commodities. Kazakhs producers can now supply the Russian market with metals, petrochemicals, and coal without paying customs duties.

If the customs union remains in place, there may be economic benefits to the extent that the removal of internal tariffs and non-tariff barriers increases trade (trade creation), boosts international competition, and allows firms to serve a larger market and hence produce more efficiently by exploiting economies of scale.

However, the regional nature of the union may lead to negative effects that may overshadow its benefits. In particular, the CET may act as a shield to protect local manufacturers from ‘real’ outside competition. Regional customs unions can lead to ‘too much’ trade between the countries involved and not enough trade between the bloc and the outside world. Such trade diversion can lead to substantial welfare losses, which is what happened in regional customs unions in Latin America and Africa. Consumers either have to pay more for high-quality products from outside the union (because of the higher CET) or have to put up with inferior products.

Trade diversion is also likely to happen in the CIS customs union. In particular for Kazakhstan there is a risk that trade will be diverted from more efficient exporters (China and other Asian exporters pur sang) to less efficient producers in Belarus and Russia. Due to the large hike in the CET for cars, Kazakh consumers will have to pay more for imported Asian cars. Alternatively, they have to switch to potentially inferior cars produced inside the customs union. In both cases there is a welfare loss.

In addition, Kazakhstan has negotiated higher CET tariffs on food products that the country imports (rice, starch, edible oil, dairy products) but would like to produce domestically (import substitution). This means that local producers of rice and starch have become shielded from competition from mainly Thailand and China, respectively. This will come to the detriment of consumer purchasing power, as Kazakhstan does not seem to have an obvious comparative advantage in rice production.

For these reasons, economic simulations suggest that the entrance of Kazakhstan into a regional customs union may lead to significant welfare losses (Tumbarello, 2005; ADB, 2006). Kazakhstan has nevertheless entered the union because President Nazarbayev has been a strong proponent of regional integration, explicitly referring to the success of the European Union in allowing poor member states (Ireland, Spain, Portugal) to converge to higher income levels. However, the example of the EU is misleading since a customs union among relatively poor countries – unlike one among relatively rich countries – is likely to lead to divergence rather than convergence among the countries joining the union. This is the case because the ‘winners’ in a customs union tend to be those countries that in terms of comparative advantage are closest to the world average. So in a rich-country club, the winners are the poorer countries with labour-intensive industries that get protected from the rest of the world. In a poor-country club, the winners are the richer countries with a production structure that is closest to the world-average (Venables, 2003).

Applied to the tripartite customs union, this means that Kazakhstan has probably the most extreme economic dependency on commodity exports with only a very limited contribution of manufacturing. While Russia’s economy is commodity-driven as well, it has a more developed manufacturing industry than Kazakhstan. Since the economic structures of both Belarus and Russia are closer to the world average, they will profit most from the protection offered by the customs union and the access to the larger common market. In contrast, while Kazakhstan may profit from an expansion of its metals, oil, unprocessed food, and other commodity exports to Belarus and Russia, the customs union will also lock it further into its commodity dependence and hamper economic diversification. The likely impact of the customs union on firms in Belarus and Kazakhstan can be summed up as follows:

Belarus

Belarus has been able to negotiate higher CET import duties on trucks, electrical engines and equipment, and a number of other key Belarusian export products. This has increased the relative competitiveness of these key Belarusian products in the Russian and Kazakh markets;

Some increased attractiveness of sectors where trade barriers with respect to inputs have been reduced (pharmaceuticals) as Belarusian producers of these products now face lower production costs;

On the negative side, the union will adversely affect the effective purchasing power of consumers through its impact on key consumption items subject to import duty hikes, such as passenger cars and television sets. In addition, the relative competitiveness of certain products in the Russian market will decline (buses, certain household appliances).

Kazakhstan

Producers of certain commodity-related industries (metals, petrochemicals, coal, unprocessed food) may profit from the customs union as they will be able to supply the Russian market without paying customs duties. The customs union may thus result in a need for additional investments in primary agriculture, chemical industry, mining and metals processing as well as in infrastructure projects to allow these products to reach the Russian and Belarusian markets;

The formation of the customs union does not bode well for Kazakhstan’s diversification efforts as non-competitive manufacturing may be put under pressure. Kazakh manufacturers and agroprocessors have lost protection from Russia and Belarus and will start to feel the competitive pressure of relatively high quality and cheap Russian and Belarusian products. Many Russian manufacturers are already present in Kazakhstan and may start to compete harder with local producers, especially in agriculture and foodstuffs;

In sectors like automobiles, where Kazakhstan imports from multiple countries, consumers may find themselves with less choice as Russian exports supplant, for example, Asian and European cars. The new common tariff for imported cars is 25 per cent compared to 10 per cent until last year. Furthermore, Ford, Toyota, Renault and Hyundai already have production facilities in Russia. The customs union means that they are likely to use these existing facilities to serve the whole region rather than establish new ones in Kazakhstan.

References

ADB (2006), Central Asia: increasing gains from trade through regional cooperation in trade policy, transport, and customs transit.

Tumbarello (2005), Regional trade integration and the WTO: which is the right sequencing? An application to the CIS, IMF Working Paper No. 94, Washington D.C.

Venables (2003), Winners and losers from regional integration agreements, Economic Journal, 113, 747-761.