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T E C H N I C A L W O R K I N G PA P E R S E R I E S
SMALL AND MEDIUM
UNITED NATIONS INDUSTRIAL DEVELOPMENT ORGANIZATION
economy environment employment
SME TECHNICAL WORKING PAPERS SERIES
Working Paper No. 14
Synergies between Cluster Development and Microfinance Acknowledgements The author would like to thank the staff of UNIDO’s SME Branch, Alexandra Sagarra Ballesteros and Ashwini Saxena for comments on a previous draft of this paper. Special thanks go to the cluster development agents in Chanderi, Sindhudurg and Kota as well as to the focal point team of UNIDO’s Cluster Development Programme whose assistance during field visits to India was greatly appreciated. Above all, the author would like to thank the members of the selfhelp groups interviewed. They readily devoted their scarce time and patiently answered a myriad of questions, which was invaluable to writing this paper.
UNIDO would like to acknowledge the financial support and the technical inputs provided by the Swiss Development Cooperation under the framework of the "Thematic Cooperation between UNIDO and SDC in the Field of SME Cluster / Network Development" (project US/GLO/02/059).
Synergies between Cluster Development and Microfinance by Anke Green UNIDO Consultant
UNITED NATIONS INDUSTRIAL DEVELOPMENT ORGANIZATIONSmall and Medium Enterprises Branch Programme Development and Technical Cooperation Division Copyright© 2005 by the United Nations Industrial Development Organization (UNIDO) First published August 2005 SME Technical Working Papers Series The SME Technical Working Papers Series is a series of occasional papers arising from the work of the Small and Medium Enterprises Branch of the Programme Development and Technical Cooperation Division (PTC/SME) of UNIDO. It is intended as an informal means of communicating important insights and findings from the technical cooperation and research activities of the Branch to a wider public of interested development practitioners, policy-makers and academics. The Branch would welcome comments and suggestions on the issues raised in these papers, which may be
Wilfried Lütkenhorst Director, PTC/SME UNIDO P. O. Box 300 A-1400 Vienna Tel: +43 1 26026 4820/4821 Fax: +43 1 26026 6842 E-mail: W.Luetkenhorst@unido.org
Previous publications in this series:
Paper No. 1 Case Study on the Operation of Three Romanian Business Centres
Paper No. 2 SME Cluster and Network Development in Developing Countries:
The Experience of UNIDO Paper No. 3 Capacity Building for Private Sector Development in Africa Paper No. 4 Financing of Private Enterprise Development in Africa Paper No. 5 Assistance to Industrial SMEs in Vietnam
Paper No. 6 Cluster Development and Promotion of Business Development Services (BDS):
UNIDO’s Experience in India Paper No. 7 Women Entrepreneurship Development in Selected African Countries
Paper No. 8 Thailand’s Manufacturing Competitiveness:
Promoting Technology, Productivity and Linkages
Paper No. 9 High-Tech Incubation Systems as Drivers of Innovation:
The Case of Central European Transition Countries Paper No. 10 Credit Guarantee Schemes for Small Enterprises: An effective Instrument to Promote Private Sector-Led Growth?
Paper No. 11 Reforming State-Owned Enterprises: Lessons of International Experience, especially for the Least Developed Countries Paper No. 12 Malaysian Electronics: At the Crossroads
Paper No. 13 Corporate Social Responsibility (CSR) and the Development Agenda:
Should SMEs Care?
The designations employed and the presentation of material in this publication do not imply the expression of any opinion whatsoever on the part of the Secretariat of the United Nations Industrial Development Organization concerning the legal status of any country, territory, city or area, or of its authorities, or concerning the delimitation of its frontiers or boundaries. The opinions, figures and estimates set forth are the responsibility of the authors and should not necessarily be considered as reflecting the views or carrying the endorsement of UNIDO. The designations "developed" and "developing" economies are intended for statistical convenience and do not necessarily express a judgement about the stage reached by a particular country or area in the development process. Mention of firm names or commercial products does not imply endorsement by UNIDO.
This document has not been formally edited.
SYNERGIES BETWEEN CLUSTER DEVELOPMENT AND MICROFINANCE iContents
Boxes Box 1.1 Credit Needs in the Handloom Cluster of Chanderi
Box 1.2 Credit Needs in the Agro-Processing Cluster of Sindhudurg
Box 1.3 The Kisan Credit Card Scheme in India
Box 1.4 Rotating Savings and Credit Associations in Chanderi
Box 1.5 Insurance Scheme in Chanderi
Box 1.6 Benefits of Microfinance
Box 2.1 Characteristics of Well-Functioning SHGs
Box 2.2 SHG Federations in Two Indian Clusters
Box 2.3 Benefits of SHG membership in Sindhudurg
Box 3.1 UNIDO’s Approach to Cluster Development
Box 3.2 Good Practices in Microfinance Provision
Box 3.3 Benefits of SHG-Banking for Financial Institutions
Box 3.4 Impact Indicators
Box 3.5 Credit Needs of a Rapidly Growing Microenterprise in Sindhudurg
Figures Figure 3.1 UNIDO’s Cluster Development Programme
SYNERGIES BETWEEN CLUSTER DEVELOPMENT AND MICROFINANCE iii
EXECUTIVE SUMMARYFor a variety of reasons, poor people lack access to formal credit and must therefore shoulder the high interest costs and dependence associated with informal credit markets.
The negative implications on the development process have long been emphasised and microfinance, which includes microcredit but also other financial services such as savings facilities, insurance and payment services, has been identified as a viable solution to meeting the financial needs of the economically active poor. The UN has declared 2005 as the International Year of Microcredit to increase awareness of the fact that, when effectively delivered, microfinance can contribute to economic and human development and thus to achieving the Millennium Development Goals. Microfinance has the potential to stimulate the establishment of new businesses owned by the poor and to help existing microenterprises grow or diversify their activities. In addition, it can increase the standard of living of the economically active poor, improve their access to health care and education, reduce vulnerability and promote the empowerment of women and marginalised groups.
In India, the provision of microfinance is different from that in most countries due to the extensive bank branch network available. The most widely spread model of microfinance in India links so-called self-help groups (SHGs) with existing formal financial intermediaries rather than relying on the establishment of specialised microfinance institutions. This minimises set-up costs and ensures outreach. The main steps involved in the SHG-model include formation of self-help groups, accumulation of group savings, internal lending and on-lending of bank loans. In addition to improving access to financial services, the SHG-model also has significant social benefits. Nevertheless, like other types of microfinance programmes, it has its limitations.
It is now well over a decade that UNIDO has been implementing an innovative approach to assist micro-, small- and medium-scale enterprises (MSMEs) in the areas of network development. Its Cluster Development Programme assists MSME clusters, i.e.
geographical concentrations of enterprises operating in the same or highly correlated activities, become more competitive by fostering inter-firm linkages and collaboration with local support institutions. The Programme helps MSMEs combine their strengths to jointly take advantage of market opportunities and to solve common problems.
In its activities in India, particularly those focusing on promoting clusters of microenterprises in the handicraft and agro-processing sectors, UNIDO’s Programme repeatedly aimed at improving cooperation between cluster actors by creating and
strengthening existing, but non-operational, self-help groups. The fact that such revival of cooperation often calls for, or at least also involves, addressing deep-rooted financial problems suggests the existence of synergies between the Cluster Programme and credit institutions willing to provide microfinance to SHG members. Closer cooperation between UNIDO and microfinance providers can thus allow each organisation to focus on its own strengths and jointly offer a comprehensive package to promote enterprise and cluster development with a pro-poor bias. A variety of steps can be taken to create linkages between the SHGs and local financial institutions. These include exploring the financial needs of the cluster stakeholders, identifying suitable partner institutions, sensitising bankers to the needs and reality of the cluster, providing training for the economically active poor, and monitoring and evaluating the outcomes. With time, the Programme’s efforts to link cluster actors with financial institutions can trigger positive externalities to enhance the contribution of cluster development to poverty reduction. The quality and accessibility of financial services may improve for all those living in the cluster, even those who are initially not involved in cluster-related activities.
Due to the specifics of the Indian financial context, it may be difficult to transfer the SHGmodel of microfinance provision to UNIDO projects in other countries. Nevertheless, many features of the model remain relevant for countries beyond India and can be adapted to local circumstances.
Although the provision of financial services is a necessary condition for cluster development in any country, it is not a sufficient condition for pro-poor cluster development. Other constraints faced by the economically active poor must also be addressed.
In line with the objectives of the International Year of Microcredit, this paper draws attention to the importance of microfinance for human and private sector development and it explores innovative uses of microfinance. The first section is meant as little more than a simple overview of the very large and still growing literature on the rationale, benefits and limitations of microfinance. In section two, the Indian microfinance experience is described in greater detail. The third part, which is also the core of the paper, analyses the synergies between UNIDO’s Cluster Development Programme and microfinance. The concluding section discusses the transferability of UNIDO’s experience in India and it emphasises the importance of business development services in addition to financial services.
© United Nations Industrial Development OrganizationINTRODUCTION
Long before the term ‘microcredit’ was coined, governments and donors had devised schemes to reduce (rural) poverty through the provision of credit. Early schemes focused mainly on agricultural loans to small and marginal farmers. Credit for fertiliser and other farm inputs was intended to stimulate productivity and thus poverty reduction. However, past schemes to improve rural finance have mostly failed. The subsidised interest rates at which loans were provided were not economically viable and cheap credit was often captured by influential elites. Most loan programmes accumulated large losses and required frequent recapitalisation.
The failure of subsidised, directed credit programmes raised the need for market-based alternatives. The rise of microcredit in the 1980s and 1990s was partly advanced by the dominant development ideology of the time that emphasised market mechanisms, curtailing government intervention and the promotion of an entrepreneurial culture.
Borrowers of microcredit programmes were no longer perceived as beneficiaries, but rather as clients. Over time, however, it became clear that savings products and other financial services were often of greater importance to the poor than access to credit. It was also recognised that the poor need financial services not only for productive purposes, but also to meet household needs.
The term ‘microfinance’ therefore refers to the provision of a variety of financial products (including credit, savings, insurance and payment services) adapted to the needs of lowincome groups. Although precise definitions of microfinance differ, the main characteristics distinguishing microfinance services from those of conventional banks are the size (loans and amounts saved are micro, or very small, in size), the target users (microentrepreneurs and low-income households), the use of funds (for income generation, microenterprise development and possibly for consumption purposes) as well as the terms and conditions which are flexible, easy to understand and adapted to the needs of low-income groups. In India, for example, microfinance is typically defined as the provision of thrift, credit and other financial services and products of very small amounts to the poor in rural, semi-urban or urban areas for enabling them to raise their income levels and improve living standards (NABARD, 2004).
The past two decades have shown that microfinance can considerably contribute to economic and human development. Microfinance can foster enterprise and productivity growth by allowing working capital needs to be met, by enabling investment in productive equipment and by facilitating the development of innovative production methods and new markets. In addition to promoting the establishment or growth of microenterprises, microfinance can increase the standard of living of the economically active poor, improve their access to health care and education, reduce vulnerability and promote the © United Nations Industrial Development Organization