A Cautionary Look at Micro-Finance

Public Probity, Private Penury: 

Micro-Finance in Papua New Guinea

by

Ben Havenga and Scott MacWilliam

As more and more effort has gone into reducing public expenditure and encouraging successive PNG governments to produce balanced budgets, indebtedness has been shifted to households. Instrumental for the shift from public to private provision of vital consumer goods have been firms which operate in the controversial area of micro-finance.

While not yet as visible as similar institutions operating in other developing countries, including the Grameen Bank in Bangladesh and India, in PNG there are a growing number of lenders operating at the margins of the banking and finance industry. With micro-finance having lost the halo it once wore as an important means for reducing poverty in a number of countries,¹ the role of these lenders in increasing private indebtedness in PNG deserves examination. Of equal importance, it should also be asked if increasing household borrowings for education and health is the best way of funding commodities critical for producing and reproducing a healthy labour force and national population.²

There is limited regulation of micro-finance in PNG. The ‘PNG Association of Microfinance Institutions’ (PNGAMI) was created out of the last ADB Microfinance Project with the goal of assisting smaller MFIs. In an environment where there is limited regulation, in its current form PNGAMI is not yet effective. With an ever increasing demand for microfinance in a sector with limited regulation the risks of over-indebtedness and unscrupulous practices by loan providers are increased. Effective annualised interest rates can range between 65% and 520% for eight MFIs surveyed. These rates compare with the Bank of the South Pacific rate of 9.6% on unsecured loans. ³

To illustrate the effects of micro-financial institutions we examined the impact unregulated financial providers have had on Papua New Guineans working for a major government department.

There are an estimated 23 micro-finance lenders providing loans to staff of the Department. With a continuous real increase in living costs in PNG, and declining levels of public services, employees of the Department bridge the gap between household income and expenditure by borrowing, including from micro-finance institutions. It has become common practice for individual employees to negotiate numerous loans from different loan providers. This practice of multiple borrowings is, of course, not confined to PNG alone.⁴

One micro-finance company Fincorp boasts that it is the ‘largest customer based finance company in PNG with over 20,000 clients and growing’.⁵ Their ‘credit ready’ product is provided to PNG Government Departments, who have an agreement with Fincorp. These loans range from PGK300 to PGK7,000. The ‘credit ready’ product generates interest totalling PGK862 on a loan of PGK1,000 over 26 fortnights (one year). This equates to an annual effective interest rate of 86.2%.⁶ In 2005, Fincorp had over PGK500,000 owed by employees of the Department.⁷

Due to the agreements between Departments and MFIs, deductions are paid directly from employee salaries to MFIs. Departments act as loan collectors for the MFIs, reducing firms’ transaction costs and further boosting profits. In some instances staff receive as little as 50 toea (20 cents) per fortnight in wages and salaries after loan repayments are deducted. There are also cases where staff pay sheets record negative amounts. This practice is employed by Departments to satisfy their accounting requirements even if the amounts owed are never collected from indebted staff. When employees find themselves in financially dire straits, staff revert to ‘inventing’ ways to defraud Government Departments to keep the lenders at bay. Defrauding takes various forms, including creating ghost employees, manipulating taxation and superannuation deductions.

The pressure to repay loans at such high rates of interest is so great that employees and vendors end up threatening accounts staff or they provide ‘backhanders’ (bribes) to ensure procedural barriers are circumvented. As a result payments are processed without too many questions and the Department becomes another statistic of ‘fraudulent practices’.

At an interview with one of the smaller MFIs the question was asked whether any training or even explanation is provided to lenders from a particular Department to assist them with better management of their loans. The answer provided was ‘it was not their fault the Department employed stupid people’.

This type of predatory behaviour is increasingly synonymous with micro-finance, and its extent concealed by internal fraud practices in government departments. Again, PNG is not alone. Research in India has shown similar trends within that country’s micro-finance industry.⁸ India’s microfinance sector is valued at $7 billion and ‘aggressive’ loan providers in some instances charge interest on loans of up to 120% per annum.⁹ In India the problems arising from the combination of readily available, largely unregulated credit and inadequate public expenditure on services have spiralled out of control, with many borrowers defaulting and some subsequently committing suicide.

In the initial phase of urbanisation in PNG, the much-vaunted ‘wantok’ system of household and consumer lending among people of similar rural origins, lineages etc assisted in coping with sudden emergencies and social obligations. Such practices still exist. However the current response to the inadequacy of public facilities and the gap between wages and costs of living is something very different to personalised support. Micro-finance is a practice pressed on top of ‘wantok’ arrangements, and the extent to which indebtedness affects the latter in contemporary PNG is a matter for further research.

However it is already clear that borrowing from micro-finance firms able to charge interest at ‘whatever rates the market can bear’ creates substantial pressure on PNG Government employees to find ways of accessing financing regardless of the consequences. Once trapped by these expensive and addictive forms of finance, pressure shifts to paying off these debts. Employees are forced to enter into other possibly more expensive arrangements to pay off previous and cumulative debts. This dangerous cycle of ‘borrowing from Peter to pay Paul’ creates a downward spiral into an ever increasing debt and poverty trap.

At the same time, tax rates on company dividend income are low, well below personal income tax rates, so that firms accruing substantial income from shareholding in mining and other commercial activities are extending their operations into micro-finance.

An especially prominent micro-finance institution is PNG Microfinance Ltd. The firm is a 48.65% owned subsidiary of PNG Sustainable Development Program Ltd, which has a majority shareholding in the OK Tedi Mine. The Bank of South Pacific owns 32% of the shares and in 2007, the investment arm of the World Bank Group, the International Finance Corporation, became a 19.35% owner. Initially formed in 2003 to ‘provide financial services to low-income households and village communities’ PNGMFL provides small loans, below PGK 15,000 at 36% per annum and loans above this amount at 24%. For comparison purposes the effective rates of interest on these loans if settled over a 26 fortnight period are 19.8% (on a PGK 1,000 loan) and 12.9% (on a PGK 15,000 loan).¹⁰

In 2008 and 2009 PNGSDP received dividends from the operations of OK Tedi of USD 182 million. The Group posted a surplus from all its activities before tax of USD 270 million, on which tax amounted to USD 30 million, or just over 11%. In 2009, the Group also had a deferred tax liability of USD 35.5 million.¹¹

Public probity, as in balancing budgets, reducing tax rates and government expenditure per head on health and education, is in contemporary PNG directly related to private penury. Micro-finance which exacerbates impoverishment joins the latter to the former, and tightens the noose around the necks of more and more PNG citizens. Urging better regulation of micro-finance in such circumstances, while fashionable, underestimates the power of the intimate connection between government revenues and expenditure and rising private indebtedness.

1 http://www.staradvertiser.com/news/20110106_15_years_in_Microcredit_has_made_a_few_enemies.html ; Vikas Bajaj ‘Penny Pinchers: Microloans were supposed to help alleviate poverty. What’s gone wrong?’ The Australian Financial Review 11/2/2011, Review p.5

2 There is increasing criticism in PNG about the declining standards of primary, secondary and tertiary education, as well as the disjunction between official statements on the importance of education and the performance of governments. See, for one instance, ‘PNG education in crisis, says expert’ http://www.pina.com.fj/index.php?p=pacnews&m=read&o=3646241874d5af5deb4804042cdd66&PHPSESSID=133dbbf6cc78425b01f9c9ad1536b73c

3 Interest calculated on the fortnightly reduced capital basis

4 It has been reported from India that some individual lenders have as many as eight different loans. Morris, M, 2011, ‘India’s Microcredit meltdown’, BBC News, www.bbc.co.uk/programmes

5 http://www.fincorp.com.pg/index.html

6 Calculated using the Fincorp ‘loan calculator’ on 26 January 2011 - http://www.fincorp.com.pg/loan_calculator.html

7 More recent data is not available.

8 Biswas, S, 2010, `Crisis hits India's small loans industry,’ BBC News, http://www.bbc.co.uk/programmes

9 Biswas, S, 2010, ‘India's micro-finance suicide epidemic’, BBC News, http://www.bbc.co.uk/programmes

10 Interest calculated on the fortnightly reduced capital basis

11 See http://www.pngsdp.com/images/documents/2009_annual_report.pdf and http://www.pngsdp.com/index.php/subsidiaries/43