Financial Inclusion, Microenterprises and Jobs in India

20 April 2013
ABOUT THIS Perspective

For the PMJDY to be successful, expanding social insurance and assistance will be the lower hurdle, and creating jobs by extending banking facilities to more micro enterprises will be the larger challenge.

Financial inclusion has the potential be an optimal platform from which India’s BJP government could increase social protection through job creation. Prime Minister Modi is understood to be a believer of the “minimum government, maximum governance” mantra, which differentiates him from the welfare-minded Congress he routed. However, India’s low expenditure on social protection and health, at only 2.4 percent of its GDP in 2012, will only sustain the pressure on its government to meet welfare benchmarks set by other BRICs countries. Two recent endeavors of the government promise to improve social protection by creating jobs, without treading the welfare path.

The Pradhan Mantri Jan Dhan Yojna (Prime Minister’s People Money Scheme) is a national mission for financial Inclusion to ensure access to financial services such as deposit accounts, remittance, credit, insurance and pension in an affordable manner. The scheme can be linked to social insurance, social assistance as well as labor market interventions. These being the head, torso and legs of social protection, can help the government impact India’s poorest, while Modi takes credit for good governance.

For the PMJDY to be successful, expanding social insurance and assistance will be the lower hurdle, and creating jobs by extending banking facilities to more micro enterprises will be the larger challenge. Freeing up more capital could spur businesses in rural areas, where revenues directly fund healthcare and education for many who need them. That would be a reasonable labor market intervention from the demand side, and serve the dual purpose of driving up social protection as well as ensuring direct monetary returns and indirect returns from better livelihoods.

The PMJDY has taken insurance as the first step towards financial inclusion, offering life and accidental insurance cover of INR 30,000 and INR 100,000 respectively in its Phase- I. With only 14.4 percent of its workforce actively contributing to pension schemes currently, many Indians will eagerly await access to pension schemes for unorganized sector workers such as Swavlamban, promised in Phase – II.

Social assistance measures such as Liquefied Petroleum Gas (LPG) subsidies have also increased coverage. Since November 2014, the number of connections that are seeded to bank accounts has increased from 25 percent to 60 per cent of the 150 million households that have a cooking gas connection.

However, it’ll be through leveraging PMJDY for better microfinance that the BJP will be able to provide social protection by creating availability of jobs. Quality employment generation is at the core of welfare, and India has to grow its micro enterprises to be able to do that.

The establishment of the Micro Units Development and Refinance Agency (MUDRA) Bank at this juncture is therefore critical. Launched in April, 2015, this Bank will be responsible for regulating and refinancing all microfinance institutions (MFIs) which are in the business of lending to micro/small business entities engaged in manufacturing, trading and services activities. The Bank will partner with state level/regional level co-ordinators to provide finance to “Last Mile Financers” of small and micro business enterprises. A sum of INR 200 billion has been allocated to the scheme.

The MUDRA bank has the potential of being able to reduce cost of funds for microfinance institutions (MFIs). As cost of funds reduce and demand for micro credit increases, interest rates at which rural businesses get loans will go down. Going forward, leveraging the MUDRA bank for equity investments in micro enterprises could be an option for the government to consider. Currently, micro enterprises are entirely funded by debt and savings in India. Debt servicing takes away capital that could be used to grow business. If investment were in the form of equity, aim would be to increase the value of the asset rather than chasing dividends every month.

The focus of MUDRA bank on the manufacturing sector is also a beneficial step. Today, the bulk of micro credit goes towards the retail sector, which is not labor intensive. Because of the low skill level required, there is a general preference to startup demand driven, services sector business that does not require much investment. The financial boost to manufacturing will augment the government’s mission to impart specialized, business oriented skills in the rural areas. These will not only improve employment outcomes for an entirely new batch of rural business professionals, but also make many small businesses more bankable. For example, if rural youth were trained to be accountants over a period of time, the unprecedented supply would mean more micro enterprises would have accountants, and as a result a better record of accounts.

A study conducted by Massachusetts Institute of Technology’s Poverty Action Lab found that access to microfinance drive up investments in small businesses and profits among profitable firms. Household expenditure on durable goods has also been found to increase, thus creating greater aggregate demand in the economy. Thus the PMJDY and MUDRA could be perfect complements to Modi’s policy push towards pro big business and foreign investment measures like Make in India.