1 Effect of Microfinance on Vulnerability, Poverty and Risk in Low Income Households Centre for Microfinance, IFMR, Chennai 8 th January 2008 Ranjula Bali Swain Department of Economics Uppsala University (co-author: Prof. Maria Floro, (co-author: Prof. Maria Floro, American University, D.C)

2 Aim Investigate the impact of Microfinance (Self Help Group Program) on Vulnerability Self Help Group Program VulnerabilitySelf Help Group Program Vulnerability Examine why and how a household’s participation in SHG may influence household’s ability to manage risk

3 Theoretical formulation of effect of SHG participation: 1. Pecuniary (Π) and earning effect through SHGs credit and saving provision leads to increase in income (also difference in perceived income) reflected in function 2. Non-pecuniary effect (Ξ) through mutual support and institutional arrangement in group and outside (difference in perceived risk), reflected in ability to cope with unexpected shocks defined by the subjective probability distribution of future income with mean ξ Therefore, the perceived risk and perceived future earnings will cause SHG household’s probability distribution of future income to differ from a non-SHG member Therefore, the perceived risk and perceived future earnings will cause SHG household’s probability distribution of future income to differ from a non-SHG member

4 Causes two shifts in the SHG’s probability distribution of future income Causes two shifts in the SHG’s probability distribution of future income Additive shift (θ) which is an increase in the mean with all other moments constant Additive shift (θ) which is an increase in the mean with all other moments constant Variance shift (γi) by which the distribution is more dispersed (or stretched) around zero. Variance shift (γi) by which the distribution is more dispersed (or stretched) around zero. Holding other factors constant, we then test whether a decrease in the SHG household’s uncertainty leads to an increase or decrease in present consumption, and hence, a decrease or increase in risk coping ability Holding other factors constant, we then test whether a decrease in the SHG household’s uncertainty leads to an increase or decrease in present consumption, and hence, a decrease or increase in risk coping ability

5 Theoretical Framework Household is an economic actor that makes decision on how much risk to undertake, given its propensity to manage (ψi) – Risk Coping function is Non SHG risk coping ai is the level of saving, credit and other resources available to the household i for coping which do not depend on participation in SHG SHG risk coping ψi is the propensity of a household to deal with shock, and Yi is household income. A higher ψi reflects the household’s ability to set aside a larger portion of household income in order to cope with shock.

6 Theoretical Model explains that: Household’s risk coping ability is affected not only by the change in earnings in a given time period, but also by the household’s perceived future earnings (Π) and perceived risk (Ξ) implying that a participation in SHG is likely to affect the household’s consumption smoothing ability and hence reduce its vulnerability.

7 Measuring Vulnerability Unlike poverty one cannot rely on measuring household income or exp. Because the household welfare is presumed to depend not just on what consumption expenditure are actually realised but on what consumption expenditures might be Unlike poverty one cannot rely on measuring household income or exp. Because the household welfare is presumed to depend not just on what consumption expenditure are actually realised but on what consumption expenditures might be Therefore measuring vulnerability involves two steps: Therefore measuring vulnerability involves two steps: 1. Estimate the distribution of future consumption expenditure for all households 2. Construct a statistics from this estimated distribution, meant to capture the reduction in household welfare due to risk in household welfare resulting from the risk in the household consumption expenditure (summarizing the welfare consequences of this variation)

8 Three main approaches in literature : Three main approaches in literature : 1. Focus on responses of household consumption expenditure to various observable shocks such as drought or idiosyncratic fluctuations in income 2. Adapt std. poverty measures to a non-deterministic setting by estimating the expected value of poverty measures 3. Utility approach to measure the welfare impact: Use von Neumann-Morgenstern utility functions (particularly Hyperbolic Absolute Risk Aversion, HARA) to measure the welfare loss associated with risk – Ligon and Schecher (2003) adopts a transformation of HARA

9 Ligon and Schecher (2003) Measure Define Vulnerability as Decomposing this Vulnerability into measures of poverty and risk by taking expectations Minimising Vulnerability is similar to maximising utilitarian social welfare function subject to aggregate resource constraints

10 Estimating Vulnerability Choose the utility function Assume for any household probability distribution of consumption in the two period Step I estimate the consumption prediction equation (different from L&S because we estimate log-linear) Use restricted least squares to estimate Step II these are used to construct conditional expectation The components of Vulnerability are then regressed on household characteristics

11 Data Data Scientific Survey of the Households 2 time periods: 2000 and 2003 Scientific Survey of the Households 2 time periods: 2000 and 2003 Quasi Experimental Design Quasi Experimental Design Total Sample =1025 households (SHG plus control group)

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13 India India Survey conducted in 5 states in India Orissa (Koraput and Rayagada) Andhra Pradesh (Medak and Rangareddy) Tamil Nadu (Dharamapuri and Villupuram) Uttar Pradesh (Allahabad and Rae Bareli) Maharashtra (Gadchiroli and Chandrapur) Back to slide

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16 Table 5. Percentage contribution to the total vulnerability for model and (in percent) SHG HouseholdsNon-SHG households Poverty component of vulnerability76.8%80.6% Aggregate risk10.2%8.7% Idiosyncharactic risk0.7%.7% Unexplained risk12.1%10.1%

17 Conclusions Vulnerability lower in SHGs as compared to control groups Vulnerability lower in SHGs as compared to control groups Main component of vulnerability is from poverty; aggregate risk is also important Main component of vulnerability is from poverty; aggregate risk is also important Microfinance (SHG) leads to decrease in vulnerability Microfinance (SHG) leads to decrease in vulnerability

18 Thank you for your attention!

19 Self Help Bank Linkage Program

20 Self Help Group (SHG) Program Self Help Group (SHG) Program Group of about 15 people from a homogenous class - financial discipline through self savings and lending within the group initially. Group of about 15 people from a homogenous class - financial discipline through self savings and lending within the group initially. When group demonstrates this mature financial behaviour banks are encouraged to make loans - peer pressure ensures timely repayments NABARD, When group demonstrates this mature financial behaviour banks are encouraged to make loans - peer pressure ensures timely repayments NABARD, use of the existing and extensive infrastructure of rural bank branches for disbursing microfinance services –refinancing by NABARD, linked to groups through commercial banks, NGOs etc. use of the existing and extensive infrastructure of rural bank branches for disbursing microfinance services –refinancing by NABARD, linked to groups through commercial banks, NGOs etc. Government also implementing poverty alleviation programs through SHGs Government also implementing poverty alleviation programs through SHGs Back

21 Vulnerability Household’s sense of well-being depends not just on its average income or expenditure (poverty) but the risk it faces- particularly important for low-income/resource households Household’s sense of well-being depends not just on its average income or expenditure (poverty) but the risk it faces- particularly important for low-income/resource households We define it as the household and its members’ ability to deal with risks, shocks and proneness to food security and hence their attitude towards undertaking risks. Back