The Warsan

Microfinance – an effective strategy for Somali economy

Microfinance often operats in informal sector targeting micro and small businesses in all economic markets including post-conflict economies. What do we mean informal sector and what is the role of microfinance in the development of SMEs to contribute economic growth?
According to Organization of Economic Cooperation and Development (OECD) definition, the informal sector is broadly characterized as consisting of units engaged in the production of goods or services with the primary objective of generating employment and incomes to the persons concerned . The conceptual description given to informal sector by the International Labor Organization (ILO) is a “way of doing things characterized by include ease of entry, reliance on indigenous resources, family ownership and small scale operations”.

In this article, the synonym of informal sector is Small and Medium Enterprises (SMEs) and much focus will be given on the role of SMEs can play in the economic growth of the post-conflict environment if access to financial services is secured (of course through micro-finance). In general, given the nature and the complexity of the SMEs, it plays an important and controversial role. It provides jobs and reduces unemployment and underemployment, but in many cases the jobs are low-paid and the job security is poor. It strengthens entrepreneurial activity, but it does not often cooperate with the government financial systems and regulations, it helps alleviate poverty and increases income, however in many cases it does not guarantee sustainable livelihood.

Many of us would be surprised to know that SMEs contribute directly to the growth of all kinds of economic markets. Empirical studies conducted in 2003 have shown that SMEs contributed to over 55% of GDP and over 65% of total employment in high-income countries, over 60% of GDP and over 70% of total employment in low-income countries, while they contribute over 95% of total employment and about 70% of GDP in middle-income countries . The SMEs in many Sub-Saharan countries represent between 40-60 percent of GDP and due to improved business environment it was observed a strong shift towards high and persistent growth of SMEs in many of the countries in the region.

Despite the significant increasing number of SMEs, the vast majority of entrepreneurs engaged in the sector lack access to financial services and as a result it restricts market opportunities for them. The challenge of lack of access to financial services for SMEs is real in Africa, which hinders their emergence and eventual growth.

Access to formal finance is critically limited owing to the high risk of default among SMEs and due to inadequate financial facilities. The entrepreneurs’ main sources of capital are their erratic earnings, informal savings and loan associations in the form of Self-Help Group (SHG), which are unpredictable and not very secure.

Underperformance & Opportunity

It is fact that SMEs are under-performing in Africa because of small local markets and very difficult business conditions, which include awkward official procedures, poor infrastructure and dubious legal systems. Many SMEs remain limited in size and use simple technology that does not require great use of national infrastructure. In much of Sub-Saharan Africa the policy environment is not conducive to the development of efficient and equitable financial systems.

However, accessing microfinance services has been identified as a key element for SMEs to succeed in their drive to build productive capacity, to compete, to create jobs and to contribute to poverty alleviation in sub-Saharan African countries. Microfinance refers to a process by which financial and enterprise development services are directed to the owners of micro and small enterprises in a sustainable manner.

Obviously, the development of the SMEs varies greatly throughout Africa. In the context of Somalia, SMEs have become one of the major sources of income and employment for innumerable people since the collapse of the military regime. SMEs sustained the livelihood of many households and intensively contributed to the expansion of the local economy.

Let’s glance at some of the economic indicators of Somalia to have an idea of the conditions that the informal sector had emerged and operated during the difficult era.

The 2012 Human Development Report on Somalia estimates per capita GDP at $284 – against a sub-Saharan Africa average of $1,300 per capita. Official Development Assistance (ODA) per capita was $98 . According to World Bank, It is estimated that 43 percent of the population of 9.0 million are living in extreme poverty, meaning that they are living for less than $1 USD per day . The small and medium enterprises (SMEs) could represent an important segment in the country’s economic growth process if the demanded financial services are made available. The absence of restrictive government policies, state provision, regulation, and control, has tended to encourage competition and entrepreneurship .

The challenges ahead

However, market failures, such as monopolies, coordination failures, externalities, and public goods provision, rule out efficient market outcomes in the absence of regulation . Most of the SMEs are weak and often failed as frequently as they have succeeded in terms of efficiency. State involvement is missing due to inadequate financial system and commercial legal framework.

The challenges faced the SMEs in Somalia is not limited to the absence of the state involvement but also share the common obstacles with the most SMEs in Africa which is lack of credit supply from financial market to profitability and growth. Since, there is no commercial banking system and micro-finance institutions, the entrepreneurs of micro and small businesses do not have desired conditions and information for best business practices. Most entrepreneurs face significant uncertainty with regard to demand, reliability of infrastructure, trust and prices.

Any possible investment by the traditional financial markets is held back due to risks and this results in many small businesses to disappearing rapidly or may not be started due to lack of ability to overcome the challenges.

The government institutions and the traditional financial markets are yet to be aware of the need to alleviate poverty and encourage SMEs, through the provision of credit and introduction of policy reforms with respect to boosting microfinance service providers and creating enabling environment for SMEs access to small loans.

Microfinance has proved to be an ideal solution to the financial demands by micro and small businesses. Provision of microfinance spurs economic growth in the informal sector through fostering capitalization of business, employment creation, and long-term income growth. Microfinance refers to as the provision of financial services including savings, loans and insurance to economically active entrepreneurs living in both urban and rural settings who are unable to access services from the conventional financial institutions because they lack guarantors, assets and savings account in banks.

The future

Evidence shows that microfinance institutions (MFIs) operating in post-conflict environments can not only improve access to finance for those ultra poor, but also help to break the vicious cycle of economic stagnation and conflict that continues to affect one and a half billion people across the world .

Microfinance is an effective tool for economic growth for the post-conflict environments such as Afghanistan, Bosnia and Cambodia. According to a baseline study conducted Institute of Development Studies (IDS), participation in microfinance in Afghanistan has led to clients having better economic conditions and nearly 45 percent of all clients generated employment for others. Microfinance services in Afghanistan are currently provided by banks, NGOs (25 NGOs) and money lenders and shopkeepers .

The World Bank estimates that between 80% and 90% of the economic activity in Afghanistan occurs in the informal sector, and almost all credit and other financial transactions are still carried out in the informal sector . Similarly, Microfinance has made huge strides in improving the financial sector in countries such as Cambodia.

According to CGAP (Consultative Group for Assisting the Poor), supporting microfinance in devastated and fragile communities can not only be successful, but can also create the foundation for a fully integrated financial sector and fuel reconstruction.

Though there are some vocational training initiatives for unemployed youth in certain areas in the country carried out by NGOs yet they failed to yield any everlasting solution to the problem of unemployment due to the lack of provision of credit for business start up. There are rare practices of providing grants to those unemployed youth who graduated from short skills training programs but grant only creates dependency and is viewed like something that was obtained freely and losing it does not bear any pain.

Despite the fact that microfinance application is prevalent in the East African countries, it is unfamiliar in Somalia, where the traditional financial markets failed or were reluctant to provide small loans to the microenterprises who want to expand their businesses. Microfinance can be considered to be a viable intervention that meets the demands of the entrepreneurs for small businesses in Somalia to have credit facilities.

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