15 Foodinflation

Study on “Impact of food
inflation and monetary policy

on microfinance
institutions in Pakistan”
October 20,
October 20,2008
2008
Prepared for
The Pakistan Microfinance Network
The Pakistan Microfinance Network is an association of retail microfinance providers.
Our vision is to extend the frontiers of formal financial services to all and mission is to
support the sector, especially retail microfinance institutions to enhance scale, quality,
diversity and sustainability in order to achieve inclusive financial services.
Study on “Impact of food inflation and monetary policy

on microfinance institutions in Pakistan”
Authored by Intellecap
First printed in 2009 in Pakistan
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Printed by M/s Something Different, Islamabad
The views expressed in this document are those of the author and do not necessarily
reflect the views and policies of Pakistan Microfinance Network (PMN) or the donors
who have funded the study.
PMN does not guarantee the accuracy of the data and information included in this
document and accepts no responsibility for any outcome of their use.
on microfinance
2008
Prepared by
The Pakistan Microfinance Network
CONTENTS
1. Executive Summary
2. Introduction
3. Global Factors Contributing to Rising Inflation
3.1 Analysis of rising global food prices
3.2 Analysis of increasing oil prices globally
4. Inflationary Scenario in Pakistan
4.1 Pakistan Economy: Overview
4.2 Food Inflation in Pakistan
5. Policy measures to combat rising inflation in Pakistan
5.1 Policy Measures by SBP
6. Pakistan Microfinance Industry
6.1 Microfinance Sector Reforms
6.2 Demand and Supply Gap: Current and Future
7. Analysis of Impact Centers
7.1 Impact on the Cost of Funds
7.1.1 Impact on the Cost of Deposits
7.1.2 Impact on the Cost of Commercial Loans
7.1.3 Impact on the Cost of Equity
7.1.4 Impact on the Cost of Concessional Loans
7.2 Impact on the Cost of Operations
7.3 Client Impact
7.3.1 Impact on Client Demand
7.3.2 Customer Risk
8. Recommendations
8.1 Tactical Counter Measures for MFP’s
8.1.1 Re-align Growth Objectives
8.1.2 Manage Risk
8.1.3 Cost of Operations
8.1.4 Refinancing/ Restructuring of Loans
8.1.5 Portfolio Shift
8.1.6 Deposit Mobilization
8.1.7 Loan Redesign
8.2 Strategic Countermeasures for MFPs
8.2.1 Interest rate risk mitigation using Interest Rate Swaps (IRS)
8.2.2 Branchless Banking
8.2.3 Technology
8.2.4 Securitization of Loans
8.2.5 Microfinance plus plus (MF++)
8.3 Recommendations to the Government/ SBP
8.3.1 Encourage Commercial Lending
8.3.2 External Commercial Borrowings
8.3.3 Establishment of Credit Bureaus
8.4 Recommendations Overview
9. Conclusion
10. Annexure
10.1 Annexure 1: Key Inflation Indices
10.2 Annexure 2: List of Abbreviations
1. EXECUTIVE SUMMARY
Microfinance has been one of the effective This document seeks to provide a better
poverty alleviation tools the world over. The understanding of the impact of inflation on the
microfinance revolution started with the microfinance sector and its various components.
recognition that poor people needed access to It also seeks to explore the various response
loans and that they could use these funds tools and viable strategies available to enable
productively. It has also changed the perception stakeholders, such as the Government and
that poor people are not credit worthy. Records microfinance institutions to mitigate the effects
have shown that, instead, they are a good risk, of inflation on their activities. Key impact
with higher repayment rates than conventional centers across cost of funds, cost of operations
borrowers. In some of the most successful and client impact have been identified and the
microfinance institutions, repayment rates are effect of inflation on these impact centers has
as high as 98 per cent. Most microfinance been assessed.
initiatives began with a social flavor, with NGO’s
and development organizations taking the lead The paper also aims to draw out several tactical
in promoting microfinance activities. Today, and strategic countermeasures that can be
microfinance has taken an increasingly adopted to mitigate some of the effects of
commercial outlook with profitability and inflation on the Microfinance sector in Pakistan.
sustainability being key factors for most These recommendations are structured as
microfinance players (MFP’s). adoptive measures that can be taken by MFPs,
the Government of Pakistan & the State Bank of
MFP’s have in the past faced many challenges to Pakistan (SBP). The recommendations have been
microfinance commercialization, such as highlighted as measures that can be taken to
inappropriate donor subsidies, limited mitigate the key impact areas emerging out of
availability of commercial funding, high cost of the inflationary situation. The recommendations
mobilizing savings, poor regulation and pertaining to the MFPs are generic in nature and
supervision, and limited management capacity will need to be adapted within the larger goal
of microfinance institutions. To add to this, the and mission of the respective MFP. The
present economic environment characterized by recommendations made to the Government,
high inflation has thrown a new array of have been made considering the role it can play
challenges for microfinance players to to support the microfinance sector. However,
overcome. these recommendations will have to be looked
at from a broader perspective keeping in mind
Inflation has become a key concern for MFP’s the overall economic and social goals of the
present in Pakistan. Pakistan has been Government. The overall theme of this paper
witnessing substantial inflationary pressure on stresses the need for a consolidated approach by
its economy. The rising cost of debt and MFPs, the Government, the SBP and value chain
increasing operational costs are signs that at the augmenters such as the Pakistan Microfinance
macro level effects of inflation have hit Network (PMN), to overcome the present
microfinance players in Pakistan. Also, inflation challenges facing the microfinance sector.
has a pronounced effect on the poorer sections
of the society. Especially, when inflation is driven
by rising food prices, this effect is even more
prominent as a larger portion of the expenditure
basket of the bottom of the pyramid (BoP)
segment goes into food related expenses.
Impact Of Food Inflation 01

2. INTRODUCTION
Inflation is a crucial macroeconomic variable Inflation’s co-relation to microfinance could be

that exerts a significant influence over the even more severe. Though, substantial analysis
economic scenario of a country. Broadly, has been done on the impact of inflation on the
inflation has been defined as an increase in the various sectors of the economy, the impact of
price of a basket of goods and services that is inflation on the microfinance industry is still not
representative of the economy as a whole. very clear. With inadequate earnings and rapidly
rising prices of basic commodities thousands of
The inflation rate is the measure of inflation. poor families are grappling to deal with the
Different indices exist to measure inflation at rising problem. Additionally, inflation influences
various levels. The two most common indices the money supply in an economy and in turn
are the Consumer Price Index (CPI) & the affects the cost and availability of funds to
Wholesale Price Index (WPI). The CPI as the microfinance institutions that may be used to
name suggests, is a measure of price change for extend loans. It also
a basket of items at the consumer level. The WPI contributes to a general rise in prices which in
indicates relative price fluctuations for a basket turn affects the cost of operations for
of items at the wholesale level. Apart from CPI microfinance institutions and has a significant
and WPI, certain other indices are used from impact on the repayment ability of their clients.
time to time. Terminologies like headline Thus, the impact of inflation on the microfinance
inflation are adopted for uniformity in reporting. industry is many-fold and strategies to combat
For example, the headline inflation index in India the same are unique and dependent on a
is the WPI, while In the United States and in number of variables.
Pakistan, CPI is adopted as the headline inflation
measure. Core Inflation is a trimmed version of With several common global factors contributing
the headline inflation rate. For example, if the to inflation, it is crucial to study those that have
CPI consists of a basket of 400 odd items, the contributed to the steep rise in inflation in
core inflation index would consist of just 100 recent years. The following section discusses the
odd core items that are less volatile and have global factors that have contributed to inflation
less distinctive price behavior. This helps in in general and food and oil inflation in particular
isolating inflation levels for the core group of and also examines the impact such factors have
items in an economy. Another useful measure is had on the rising inflation in Pakistan.
the Sensitivity Price Index (SPI), which is
computed to assess the price movements of
essential commodities at short intervals (weekly
in most cases). In this study CPI has been used as
the key inflation index, unless otherwise
indicated.
Periods of excessive inflation often have a

devastating impact on the economy and in some
cases on the political stability of a country. High
levels of inflation hurt the real economy by
discouraging investment and hindering
productivity and growth. Over the past few
decades, many countries have experienced
periods of high inflation. Numerous economic
studies have shown that an inverse relationship
exists between rising inflation and growth rates.
Moreover, high inflation can easily erase the
progress of, and even destroy, certain industries.
02 Impact Of Food Inflation

3. GLOBAL FACTORS
CONTRIBUTING TO
RISING INFLATION
Inflation around the world 2001-07 16
Headline 14
Fuel 12
Food
10
8
6
4
2
0
China Russia Brazil 2001 02 03 04 05 06 07
14.0 India Pakistan
12.0
Real GDP growth
10.0
8.0
6.0
4.0
2.0
0.0
2006 2007e 2008f 2009f 2010f
Years

Table 1: Contribution of food and energy inflation to headline inflation
2006 2007
Food Energy Food Energy
Inflation Contribution Inflation Contribution Inflation Contribution Inflation Contribution
(%) (%) (%) (%) (%) (%) (%) (%)
World 3.4 27.0 11.2 19.9 6.2 44.3 4.1 8.0
Advanced
2.0 12.4 11.1 28.0 3.0 19.5 3.8 12.1
Economies
Developing
4.4 37.7 12.3 28.0 10.0 67.5 3.1 3.4
Asia
Source: World Economic Outlook, IMF, April 2008
The following table lists the contribution of food Chart 3: Global Food Inflation
and energy inflation on the overall headline
Foodstuffs Index
inflation. The percentage contribution of food
$450.00
and energy inflation have been segregated $400.00
across advanced and developing economies in $350.00
$300.00
order to ascertain the weightage of each of the $250.00
components on headline inflation in different $200.00
$150.00 Foodstuffs Index
regions of the world. $100.00
$50.00
$0.00
Based on the above table, it is observed that the
6
7
5
8
7
6
8
-0
-0
-0
-0
-0
-0
-0
-0
-0
-0
contribution of food in overall inflation has
pr
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ug
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ec
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-A
-A
-D
-A
-D
-A
-D
-A
-A
-A
01
01
01
01
01
01
01
01
01
01
increased significantly from 37% to 67% in the

Developing Asia region. While globally, food Source: Commodity Research Bureau
prices have been on the rise over the past 3
years, they have seen their steepest rise during Wheat and rice, the staple food diet of much of
the past one year. The Commodity Research the developing world, have been the biggest
Bureau Food Price Index showcases a rise of contributors to the rise in food prices. Since the
food prices by 24.91% over the past year (August beginning of 2006, the average world price for
2007 to August 2008). The following chart rice has risen by 214% and wheat by 81%. In the
details the rise in foodstuff prices from August second quarter of 2008, the price of rice nearly
2005 to the corresponding period in 2008. doubled in comparison to its price in the first
quarter of the same year.
Table 2: Global price rise of wheat and rice
Commodities 2005 2006 2007* 2007 2007 2008T 2008

(Q3) (Q4) (Q1) (Q2)*
Wheat 100 125.8 167.4 180.3 224.3 269.9 227.3

Rice 100 105.5 115.5 115.1 123.9 179.2 331.1
* Provisional
Source: Commodity Research Bureau

It is important to understand the factors that supply side constraints such as the sluggish
have contributed to global food inflation and its growth among non-OPEC (Organization of
contribution to the present food crisis in Petroleum Exporting Countries) oil producing
Pakistan. The factors influencing the prices of nations and an output restraint among OPEC
food-grains across the world are categorized as countries. The following chart depicts the trend
demand and supply factors as listed in the table in crude oil prices between January 2005 and
below. May 2008.
Table 3: Demand and Supply factors affecting global food prices
Demand Factors Supply Factors
Increasing demand: Curbing exports and high export taxes:

• Demand for food is increasing as the • Ukraine, one of the biggest wheat exporters in
world’s population expands and a the world, has curbed exports. So have Russia
swelling middle class has emerged in and Kazakhstan.
countries such as China and India. • India, Vietnam, Indonesia and Cambodia have
curbed rice exports. So too has Thailand,
traditionally the world's biggest rice exporter.
Alternate uses of food: Fertilizer costs linked with rising Oil prices:
• The development of the bio-fuel industry • The rise in oil prices has affected a
has reduced the availability of food, corresponding increase in the cost of fertilizers.
leading to a surge in prices. The use of This has in-turn led to an increase in the price of
corn by the US for ethanol has farm products as farmers have adjusted to the
consumed more than 75% of the rise in input costs.
increase in global corn production over
the past three years.
Unseasonable Droughts & Natural Disasters:

• Droughts & natural disasters across leading
food producing countries such as India, U.S.A,
Australia, Thailand, Burma, and others have
contributed to a shortfall in supply.
It is important to understand the factors that Chart 4: International crude prices trend
have contributed to global food inflation and its
contribution to the present food crisis in 160
Crude Oil Prices (US $/ bbl)
140
Pakistan. The factors influencing the prices of 133.88
120
food-grains across the world are categorized as 100 94.7
125.4
demand and supply factors as listed in the table 80

65.59
70.84
58.89
74.12 85.8
60 46.84
below. 40
59 58.32 54.51
63.45
20
In addition to rising food prices, rising oil prices 0

May-05
May-07
May-06
May-08
Mar-05
Mar-07
Nov-05
Mar-06
Mar-08
Nov-07
Nov-06
Sep-05
Sep-07
Sep-06
Jan-05
Jan-07
Jan-06
Jan-08
Jul-05
Jul-07
Jul-06
have played a part in the increase of inflation

globally.
Source: Energy Information Administration
3.2 Analysis of increasing oil prices The reasons for this sharp and regular rise in
globally crude prices are due to various factors that are
enumerated in the following table.
Oil prices moved sharply during the final months
of 2007 and continued on an upward spiral in
2008, surpassing USD 130 a barrel in May 2008.
The recent jump in oil prices is mainly due to

Table 4: Demand and Supply factors affecting global oil prices
Production
1. Oil production by OPEC declined due to large
cuts in production of 1.7 million barrels a day in
Emerging and developing economies together late- 2006/ early-2007. This contributed to large
have accounted for about 95% of the growth in declines in stock in the second half of 2007
demand for oil since 2003.5 resulting in a sharp increase in prices.
2. In the first quarter of 2008, Russian
production declined for the first time in nine years.
Costs
1. Oil production has been hampered by a
• Dollar weakness has boosted the price of number of factors such as rising costs, limited
dollar-denominated commodities and supply of materials and skilled labor, depletion of
helped oil to surge by more than a third aging fields, higher taxes, renegotiation of
since the middle of August. It has risen current contracts or de facto nationalization, and
more than 50 per cent this year. As the US diminishing access to abundant low cost
dollar declines, commodities including oil reserves. As a result, international oil companies
attract investors. Investing in futures are forced to explore and exploit reserves in
becomes both a hedge against a challenging environments, such as oil sands and
weakening dollar and an investment deep water oil deposits at a higher cost.
vehicle that could yield substantial profit.6 2. Increasing Costs associated with investment
in new capacities7: Market estimates suggest
that average field exploration and development
costs have doubled, from USD 5 a barrel in
2000 to USD 10 a barrel in 2007.
The following table lists the global oil production

and consumption since 2003. It can be observed
that global oil production has been more or less
constant around the 81 million barrels/ day
mark since 2005. However, global oil
consumption has increased steadily since 2003,
registering a year-over-year growth of 1.5% from
2003 to 2007.
Table 5: Global Oil Overview
Year Production Consumption Deficit

2003 77.03 79.30 2.27
2004 80.33 82.11 1.78
2005 81.26 83.32 2.06
2006 81.66 84.23 2.57
2007 81.53 85.22 3.69
(million barrels/ day)
Source: British Petroleum

4. INFLATIONARY SCENARIO
IN PAKISTAN
4.1 Pakistan Economy: Overview respectively) and the dismal performance of

manufacturing, particularly large-scale
Pakistan is a nation with a diverse economy that manufacturing. A series of domestic and
includes textiles, chemicals, food processing, external shocks such as political instability, a
agriculture, financial services and other worsening security environment, severe power
industries. It is the 40th largest economy in the shortages, weaker external demand and the
8 rising cost of doing business have all
world and the fifth largest emerging market by
population size. The following table depicts the contributed to the slowdown.
growth rate experienced in the Pakistan
economy between 2003 and 2006. Another of the key challenges for the Pakistan
economy is to tackle the problem of inflation.
Chart 5: GDP Growth Rate in Pakistan The problem of inflation has compounded in
severity since the beginning of this year from
just above 10% to over 20% in recent months.
Growth Rate
8
Inflation reached levels of 24.3%10during the
GROWHT RATE ( in %age )
7 month of July 2008. The following chart depicts

6
5
the month-on-month overall CPI inflation in
4 Pakistan and the food and non food inflation
35
2
since Aug 2006 to July 2008.
1
2003 2004 2005 2006 Chart 6: Inflation in Pakistan

YEAR
40
CPI Inflation Overall
Source: United Nations 35
CPI Inflation Foods
30 CPI Inflation Non-Foods
25
The year 2007-08 has been a difficult year for
20
Pakistan’s economy due to several political and 15
economic events, both internal and external. 10
The unstable law and order situation within 5
Pakistan; political instability lead by the judicial 0

Aug Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul
crisis; soaring oil and food prices internationally; 06 07 07 07 07 07 08 08 08 08 08 08 08
and a domestic food supply crisis adversely Source: State Bank of Pakistan
affected the key macroeconomic fundamentals
of the economy. The economy in Pakistan is There seems to be no clear respite for Pakistan
currently facing the following major challenges: from the inflationary pressures that has gripped
all sectors alike. The key reason behind this rise
• Deceleration in economic growth has been the skyrocketing food prices (food
• Rising inflation (particularly food inflation) inflation reached levels of 33.8% in July ’08,
• A growing fiscal deficit rising fourfold from 8.6% in August ‘07). A high
• Widening of trade and current account deficits fiscal deficit has prevailed since last year as the
• Political uncertainty (which is now clearing) Government continues to provide subsidies on
and fuel and energy due to political factors (2007-
• Geo-political factors such as Talibanization in 2008 was an election year in Pakistan) leading to
the north-west regions additional currency being printed by the Central
9
Bank, which is an inherently inflationary
Growth has decelerated to 5.8% in 2007-08 practice.
principally on account of the poor performance
of agriculture owing to the dismal performances
of major crops such as wheat and cotton
(together they contribute over 20% and 4% to
agriculture and Gross Domestic Product (GDP),

4.2 Food Inflation in Pakistan Chart 8: Price increase of key food-stuff’s in
Pakistan
Inflation in Pakistan has been driven by the rapid
rise in food prices. Those persons who receive 60 120%
less than 2,350 calories of diet per day are 23.8.2007 21.8.2008 % Increase
50 100%
bracketed among those suffering from the food
crisis.11According to the World Food Program, a 40 80%
United Nations body, the number of those
30 60%
suffering from the food crisis in Pakistan has
increased from 60 million to 77 million, nearly 20 40%
half the total population of the country.
According to the World Food Programme (WFP) 10 20%
statistics, 38% of Pakistanis are food insecure i.e. 0 0%

they are not able to afford the poverty line PKR RICE(Kg) WHEAT(Kg) BREAD(Each) ONIONS(Kg) MILK(Ltr)
intake of 2,350 kcal per day. The United Nation’s

Source: State Bank of Pakistan, Inflation Monitor
Food and Agricultural Agency (FAO) report put
Pakistan among the 37 countries where the food
Food can be further divided into perishable and
crisis looms.
non-perishable food items. The rise in the price
of perishable food items stood at 8.7% whereas
As seen in the graph below, food inflation
non-perishable food items stood at 13.6%.
contributes a significant amount to Headline
Inflation, approximately 62.04% in 2007-08
Wheat flour, rice, fresh milk, and vegetable
compared to 52.4%12in the comparable period
ghee, four essential food items, have together
last year. Thus any impact on food prices has a
contributed 42.5% to the overall increase in
substantial impact on inflation levels in the
general price level. International food prices to
country.
some degree have also contributed to the rise in
food prices in the domestic market. Also,
Chart 7: Contribution to Headline Inflation
domestic demand is on the rise due to the rising
per capita income and the growing economy. Per
Others , 9.45
capita income has grown at an average rate of
Apparel, textile &
footwear, 3.6 over 13% per annum during the last five years,
Fuel & Lighting,
rising from USD 586 in 2002-03 to USD 926 in
3.87 2006-07 and further to USD 1085 in 2007-08.13
Transport &
Communication
2.83
HRI, 18.21
Food, 62.04
Source: SBP Monetary Policy Statement,

July – December 2008
Prices for key food items have seen a drastic

increase, with rice leading the charge with an
increase of 108% in August 2008 compared to
August 2007. The following chart depicts the
price rise of key food items in Pakistan.

The following are the demand and supply factors
that have contributed to the food crisis in
Pakistan.
Table 6: Demand and Supply factors affecting food prices in Pakistan
- Rising international wheat prices led - Open lands which provided the city with
the Government to take misplaced vegetables in 1980s have now been turned
export decisions on wheat produce into commercial areas and housing societies.
only to have to import it later on when Fragmentation of the land is also hitting the
faced with short-falls. agricultural production.
- The dissolution of magistracy system
which used to keep a check on food
prices, had also contributed to the rise
in prices.14
- Atta smuggling to Afghanistan though - The oil-driven economy of Pakistan is facing a

North West Frontier Province (NWFP) serious shortage of energy resulting in
increased cost of production and
transportation costs
- Frequent power cuts disrupted the production
in flour mills which impacts wheat availability.
Tackling the food crisis and its resultant inflation

have become key priorities for the Government
of Pakistan and they have taken several
measures to address the problem.
Impact Of Food Inflation

5. POLICY MEASURES TO
COMBAT RISING INFLATION
IN PAKISTAN
The Government of Pakistan has taken the The State Bank of Pakistan too has taken certain
following interim measures to address the food firm measures to tackle the inflationary
crisis: scenario, which are highlighted in the following
table.
• During the period July - April 2008, PKR 157.6
billion of agricultural loans were distributed, a 5.1 Policy Measures by SBP
34.9% increase from the previous year.
• To encourage farmers to grow more wheat and The State Bank of Pakistan (SBP) is the Central
check cross-border smuggling the government Bank of Pakistan and plays the apex role in
has increased the procurement price of wheat managing the financial sector, including
from PKR 425/ 40kg to PKR 625/ 40kg, an microfinance actors. SBP is also responsible for
increase of 47%. implementing monetary and credit policies in
• The State Bank has proposed a revamp of its accordance with Government targets for growth
subsidized food program with private-sector and inflation and with the recommendations of
involvement. the Monetary and Fiscal Policies Co-ordination
• According to the State Bank, policy measures Board, without trying to affect the
are needed for establishment of future markets, macroeconomic policy objectives. The policy
countering threats (insuring crops, go-down measures employed by SBP to mitigate the
facilities), agriculture infrastructure (water current inflationary trend in the economy are as
supply, power, farm to market roads, etc…) and follows:
investment in value-addition sectors.
Table 7: Recent SBP Policy Measures
Impact Of Food Inflation

6. PAKISTAN MICROFINANCE
INDUSTRY
The provision of small scale credit has been Chart 10: Components of debt in 2010 (PKR Bn)
present in Pakistan for many decades but
modernstyle microfinance began in the late
1990s and has a limited outreach. Pakistan is Capital Markets
MIV’s - 2.04
among the largest potential microfinance 6.20
markets in the world with an estimated size of Commercial

Bank Loans -
10 million adults.15In 1999, the Government of 21.10
Pakistan made microfinance an explicit priority

Other
in its official Poverty Alleviation Strategy. This Concessional
Loans - 4.74
contributed to a massive up-front investment of
at least USD 400 million from 1999 to 2005
Source: PMN – SBI, Microfinance
largely funded by multilateral resources
Industry Funding Facility, Nov 2007
including the World Bank and the Asian
Development Bank. These investments have Thus, Commerical Loans (PKR 21bn) and Savings
helped facilitate the growth of the sector, (PKR 15bn) are estimated to become key sources
which has grown at a CAGR of 43% since 1999. of financing for MFP’s in the next few years.
While these sources contributed significantly to
the birth phase of microfinance in Pakistan, the
availability of these concessional funds have
6.1 Microfinance Sector Reforms
drastically reduced over time. The following
chart depicts the projected capital structure over As a newcomer to microfinance, Pakistan has
the next few years. learnt the importance of establishing an
enabling environment for microfinance from
Chart 9: Projected Capital Structure for MFP’s global experiences.
(PKR Bn)
Pakistan now has:
• A supportive regulatory framework for
70
specialized microfinance banks - with seven
10
Equity
60 MFB’s obtaining licenses and one recently
Debt
50 PPAF Debt receiving an No Objection Certificate (NOC) from
Savings 8 34 the Central Bank
40
• An apex funding organization for microfinance
30
7 25 (Pakistan Poverty Alleviation Fund)
20
5 17 10
• A well organized national association for
10 5 10 8 microfinance providers (Pakistan Microfinance
4 5
3
3 5
1
6
3
3
3 6
9 15 Network)
0 1
1 1 1
2004 2005 2006 2007 2008 2009 2010

• A comprehensive financial transparency
reporting system for the majority of its
Source: PMN – SBI, Microfinance microfinance sector
By the year 2010, it is expected that debt will

consitute 49% of the total capital structure. As
indicated above, it is estimated that
concessional debt will be scarce going forward
and MFP’s will increasingly be searching for
other forms of capital. Debt can be broken down
into four key forms, as captured in the following
chart.

Box 1: Pakistan Poverty Alleviation Fund
Pakistan Poverty Alleviation Fund (PPAF)

PPAF is sponsored by the Government of Pakistan and funded by the World Bank and other leading
donors. It is the apex financial institution for wholesaling funds to civil society organizations and
thus acts as a refinancing window for MFPs. The PPAF has a resource base of over USD 1 billion. In
July 2008, PPAF launched the Programme for Increasing Sustainable Microfinance (PRISM) at an
estimated cost of USD 46.6 million over five years. PPAF as the lead program agency would
endeavor to create the facility to leverage commercial lending to partner organizations.
Source: http://www.ppaf.org.pk/
Table 1: Contribution of food and energy inflation to headline inflation
Type of Institutions Number of Active Borrowers

2007 Q-4 2008 Q-1
MFBs 485,527 493,249
Rural Support Programs 529,666 620,539
MFIs 367,824 381,870
NGOs 73,565 79,556
Commercial Institutions 14,713 15,911
Total 1,471,295 1,591,126
Source: World Economic Outlook, IMF, April 2008

Loan portfolio in the last quarter of 2007 was
PKR 15,134 million, which increased to PKR
16,527 million during the first quarter of 2008,
registering a growth of 9%. The estimated
potential demand for micro-credit is
approximately USD 2 billion per annum based on
the number of poor households (6.6 million).
Overall, the microfinance market is
underdeveloped with an institutional outreach
estimated at 1.6 million borrowers of micro-
credit loans. This represents only 16% of the
minimum potential clientele of 10 million
borrowers.

7. ANALYSIS OF IMPACT
CENTERS
Rising inflation and the corresponding policy 7.1 Impact on the Cost of Funds:
measures initiated by the SBP to mitigate the
effects of inflation have affected the operations MFPs across the globe have more funding
of microfinance providers in a variety of ways. sources at their disposal than ever before. As a
Broadly, these effects have been experienced on result, they are able to increase their funding
the cost of funds and on several operational diversification and access non-traditional
aspects of microfinance providers. These effects funding sources such as securitizations/portfolio
have also impacted the demand for buy-outs, local bond issues, large-scale venture
microfinance and the repayment ability of capital investment and initial public offering of
clients. The following chart shows the various shares. The primary funding sources for MFPs in
areas impacted and the degree to which they Pakistan are grants or concessional loans,
have been impacted. commercial loans and client deposits. The
following section discusses each of these
Figure 1: Impact Map: Effects of inflation on funding sources in more detail.
MFPs
7.1.1 Impact on the Cost of Deposits:
In Pakistan, only Micro-Finance Banks (MFB’s)

are regulated to mobilize deposits in the
microfinance sector. The main factor that
influences the quantum of deposits is the
savings of microfinance clients. Savings, in turn
are a factor of income and expenditure, which
are both greatly affected by inflation. The
following section discusses the impact of
inflation on the savings of microfinance clients
and thereby determines the corresponding
impact on the cost of deposits.
Each of the impact centers are analyzed in
greater detail in the following section. The typical expenditure basket of target
microfinance clients in the year 2003-04 in
Pakistan is outlined in the following table.
Table 9: Expenditure basket of microfinance clients (2003-04)
Expenditure basket Percentage

Food 45%
Utilities 27%
Education 7%
Savings 13%
Rent 2%
Medical 6%
Total 100%
Source: Annual Report (2005) Kashf Foundation

As detailed in the above table, it is evident that
food forms a significant percentage of the
expenditure basket for a typical microfinance
client. Savings constitute a moderate 13% of the
total income.
The inflation trend for the major expenditure

items are detailed in the following table.
Inflation of major expenditure items is expressed
as a percentage from 2004 to 2008, for the
month of May each year.
Table 10: Inflation across key expenditure items
Expenditure May ‘05 May ‘06 May ‘07 May ‘08

Items Figures in %
Food 12.5 5.6 11.3 28.5
Education 4 7.2 6 7.9
Rent 12 8.3 6.2 12
Medical 0.8 3.9 10.2 14.1
The following table (Table 11) assesses the • The expenditure basket for the year 2003-04
change in expenditure basket of the major was taken as the base.
expenditure items 2004 to 2008. These figures • Expenditure baskets for subsequent years
have been adjusted for inflation (as detailed in were calculated by adding the inflation figure
table 10) with the expenditure basket for 2003- for the corresponding month of the year to the
04 serving as the base year. base expenditure basket. All other variables
(such as increase in consumption and change in
The following assumptions have been made consumption pattern) are assumed to be
while arriving at the subsequent analysis; constant
Table 11: Expenditure basket adjusted for inflation (based on expenditure basket of 2004)
Expenditure May ‘05 May ‘06 May ‘07 May ‘08

Items Figures in %
Food 50.6 47.5 50.1 57.8
Utilities
(general inflation rate assumed) 29.6 28.9 29.0 32.2
Education 7.3 7.5 7.4 7.6
Rent 2.24 2.17 2.12 2.24
Medical 6.0 6.2 6.6 6.8
Source: Intellecap Analysis

Based on the above table, it is observed that the Based on the above table, it can be observed
expenditure on food has increased from 45% of that the average daily wages of construction
total expenditure at the beginning of 2004 to workers have increased from PKR 199 in July
57.8% in May 2008, for the same basket of food. 2003 to PKR 363 in July 2008.
While expenditures have increased over the The following framework aims to analyze and
years due to inflation, wages of microfinance quantify the impact of inflation on the savings of
clients have also increased correspondingly. As microfinance clients. The following assumptions
per the Inflation Monitor Report by the SBP, the have been taken:
average daily wage of construction workers
(comprising of carpenters, masons, electricians, • The expenditure basket mentioned above has
plumbers and laborers) was PKR 199 in July been assumed to be representative of the
2003. entire pool of microfinance clients.
• The expenditure basket remains constant over
The following table lists the average daily wages the period of our analysis.
of construction workers from 2004 to 2008, for • The average daily wages of construction
the month of July each year. It also lists the workers are equal to the average income of all
percentage increase of wages with respect to microfinance clients, and these wages are the
the previous year. only source of income.
Table 12: Percentage increase in average wages of construction workers
Due to the unavailability of specific data for the In order to quantify the impact of inflation on
year 2008, the percentage rise in minimum savings, the following model has been
wages in Pakistan has been assumed to be developed, where the average monthly income
representative of the rise in wages of of a microfinance client has been assumed to be
construction workers as used in the above PKR 10,000 in 2003. The following table depicts
analysis. the impact of inflation on each of the variables
that affect the income and expenditure of
microfinance clients, thereby arriving at the
impact of inflation on savings.

Table 13: Impact of inflation on savings
2004 2005 2006 2007 2008

Absolute increase in wages 10,839 12,101 13,030 14,814 18,221
Food 5,365 6,126 6,192 7,420 10,536
Utilities 3,131 3,587 3,768 4,296 5,869
Education 779 881 978 1,099 1,376
Medicare 661 732 812 980 1,247
Rent 232 266 279 318 435
Total 10,169 11,592 12,029 14,112 19,464
Derived savings
(absolute numbers) 670 509 1001 702 -1,243
Savings
(% of total salary) 6% 4% 8% 5% -7%
Based on the above table, it is observed that devoted to expenditures rather than savings.
savings as a percentage of total income has been Thus, in the context of funding requirements of
declining over the years except for the year MFPs, savings and consequently deposit
2006, where the savings rate as a percentage of mobilization will need to grow at a substantial
income doubled with respect to the previous rate in order to meet the growing funding needs
year. The savings rate declined from 6% in 2004 of MFPs. This is an arduous task given the
to minus 7% in 2008. This is expected to have a current inflationary trend that has gripped the
consequent negative impact on the available economy as a whole.
pool of deposits that could be mobilized from
the market as a greater percentage of income is
Key Section Highlights
1 Though the income of microfinance clients has increased significantly in the last few years, this
increase has not been in line with the increase in the price of food items. As a result, this has had
an impact on the expenditure pattern whereby the proportion of expenditure on food items has
increased from 45% in 2003-04 to about 57% in 2008. The consequent impact of inflation on
savings has been intense especially in the last year, where savings as a percentage of income
was negative.
2 It can be inferred that not only does this impact the possibility of raising fresh deposits but also
impacts existing deposits held with MFB’s as clients might be inclined to withdraw their savings to
meet consumption needs.

7.1.2 Impact on the Cost of Commercial The following framework aims to depict the
Loans impact of changing interest rates over the next
few years on microfinance sector as a whole.
Commercial loans are a vital source of funds for The following assumptions have been made in
microfinance providers in Pakistan. Changes in order to estimate the impact of interest cost on
the rate of interest impacts the availability and the financial expenses of MFPs;
cost of commercial borrowing which in turn
affects the financial expenses and profitability of • Growth in commercial borrowings are
MFPs. assumed to be in line with historical growth
• No major change take place in the
In May 2008, in a bid to curb inflation SBP macroeconomic conditions over the next 3 years
announced an increase in interest rates to 12%,
an increase of 150 basis points. As part of the The base interest rate has been taken as the
SBPs interim monetary policy, it announced an prevailing policy rate i.e. 12%. The interest rate
increase in the CRR for all deposits up to one changes in the future are estimated to be an
year maturity by 100 bps to 9% and the SLR was increase of 150 bps in 2008 on account of policy
increased by 100 bps to 19% of the total time measures taken by SBP and a further increase of
and demand liabilities. These changes in liquidity 50 bps in 2009. With the stabilizing of the
requirements are applicable to commercial inflationary scenario, a reduction in the interest
banks, while the earlier rates of 5% and 10% for rate by 50 bps in 2010 is estimated. These
CRR and SLR respectively have been maintained estimations are based on the assumptions that
for MFBs. These regulatory changes will reduce the current inflationary conditions will continue
the liquidity with commercial banks and thereby to prevail in the future thereby affecting the
affect their investment decisions. This has had a changes in policy rates.
consequent impact on the cost of funds for
MFPs as commercial borrowings make up a
significant portion of their funds.
Table 14: Impact of change in interest rate on financial expenses for MFP’s
Year 2008 2009 2010

Figures in PKR mn
Base interest rate- 12%
Change in interest rate (bps) 150 50 -50
Cumulative change (bps) 150 200 150
Growth in Commercial Borrowing for the
sector 10,540 15,500 21,080
Financial Expenditure
(Base Interest Rate) 1,264 1,860 2,529
Financial Expenditure
(Revised Interest Rate) 1,422 2,170 2,845
Impact of change in interest rate hike on
Financial Expenses 158 310 316
Source: PMN – SBI, Microfinance Industry Funding Facility, Nov 2007, Intellecap Analysis

The changes in interest rates have a huge impact Chart 11: Total MFI Equity Worldwide, 2006
on the financial expenses and thereby profits of
MFPs. An increase of 150 bps in 2008 results in
an interest rate of 13.5%, which translates into
an additional interest expenditure of
approximately PKR 158 million for all MFPs.
Assuming, the current inflationary trend persists

and the interest rate is further increased by 50
bps to 13.5% in 2009, MFPs will be forced to pay
out an additional interest expenditure of PKR
310 million on account of the interest rate rise.
Based on the above analysis, it is evident that

interest rate risk is an important parameter that
needs to be addressed in order to minimize the Source: Council of Microfinance Equity Funds
impact of rising inflation on the bottom line of
MFPs. Recommendations on strategies to deal According to MiX market, there are 21 funds
with rising interest rates are discussed in the focused on the microfinance space in Pakistan at
recommendations section. the moment. Equity deals in Pakistan have been
slow and the large ones have been led by firms
with a social mandate. One such deal has been
7.1.3 Impact on the Cost of Equity International Finance Corporation’s (IFC) $1m
equity investment in Tameer Microfinance Bank.
Equity infusion into microfinance has still to kick However, as with the global scenario the true
off in a major way. There have been isolated nature of equity plays in the microfinance space
cases of MFP’s raising capital from the public is yet to garner steam in the Pakistan
and private equity markets, but the bulk of the microfinance sector.
sector still faces many challenges before it can
attract large scale investments. Equity infusion by its very nature is driven
mainly by the investment climate, the market
The Council for Microfinance Equity Funds environment and the performance and
estimates that in 2006 the total equity base of prospects of the target firm.
the sector was USD 1.5 Bn. Asian MFIs currently
serve over 50 percent of clients worldwide in The present investment climate has posed
spite of commanding only 44 percent of assets, greater challenges to the MFP’s ability to raise
38 percent of the portfolio outstanding and just funds.
26% of the total equity. At the opposite end of
the spectrum we find Eastern European As seen in chart 12 (next page), the total Foreign
institutions serving only 8 percent of the clients Direct Investment (FDI) in Financial Businesses
with 27 percent of the portfolio and 29 percent in Pakistan has slowed down dramatically.
of the total equity.

Chart 12: FDI Inflow into Financial Businesses in downturn with funds looking for attractive
Pakistan valuations. However, uncertainty is the
marketplace is the worst time for firms looking
2008-09(July-
to raise equity with most funds waiting for
265.5
September)
stability before they make investment decisions.
2007-08 1,607.60
The recent slowdown in growth in the

2006-07 930.3
microfinance sector is also expected to impact
2005-06 329.2 MFPs’ ability to raise equity.
FDI intoFinancial Business (USD mn)
2004-05 269.4
Another interesting point to note is that most
MFPs in Pakistan are considerably
0 200 400 600 800 1000 1200 1400 1600 1800 2000
underleveraged compared to commercial banks.
Source: Board of Investment, GoP
The Capital Adequacy Ratio (CAR) in Pakistan is
15% and most MFBs operate well above the
Equity investments are generally made on a case required percentage. Also, with the SBP directive
to case basis and are influenced by a number that MFBs can subordinate debt as Tier II capital,
of variables. While inflation on its own has from a regulatory perspective the urgency to
limited impact on the equity investment process, raise equity to meet CAR requirements has also
it has a negative impact on the overall eased.
investment climate. A good indicator of equity
markets is the stock exchange; the KSE 100 had Therefore, MFPs should view equity infusion
seen a huge drop of over 34% YTD20on 29th only in line with strategic goals and as a long
August, 2008. The private equity landscape in term outlook and not necessarily as a short term
Pakistan is relatively untapped, thereby making measure to raise funds for operations.
the prospects of raising equity through
organized private equity channels even harder.
7.1.4 Impact on the Cost of
Chart 13: Growth in equity projection in Concessional Loans:
Pakistan microfinance
Concessional loans have been a key source of
12
funding for the microfinance sector in Pakistan.
10
PPAF roughly owns 50% of all micro-credit given
10
Equity out in Pakistan. Most donor funds in Pakistan
8 are channeled through the PPAF with the
8 7 exception of a small percentage of donors who
loan out directly to various MFP.
6 5
Chart 14: PPAF Funding in Pakistan

4
10000
2
9000
8000
0 7000
2007 2008 2009 2010
PKR Bn 6000
Microcredit/Enterprise Development loans
Source: PMN – SBI, Microfinance 5000
Industry Funding Facility, Nov 2007 4000
3000
Another chief roadblock with for the prospect of 2000
1000
MFP’s to raise equity is the fact that the present
0
inflationary environment in Pakistan has led to a 2008 2007 2006 2005 2004 2003 2002
large degree of uncertainty in the microfinance Source: PPAF Annual Report

sector. Equity deals can happen in a negative

Donor funds are motivated by their own set of The following chart depicts the break-down of
principles and agendas and are therefore operating costs of a sample of MFPs21for the year
insulated from the short term effects of 2007.
inflation. However, it is widely believed that
donor funds in Pakistan will not keep pace with
the requirement of capital and MFPs will Chart 15: Break up of Operating Cost
increasingly shift focus from donor funding to
alternate sources of capital.
In addition to the above, the PPAF has recently

decided to peg its interest rates with the KIBOR.
This will affect MFPs availing concessional funds
especially during the current changing interest
rate scenario. Thus further loans taken from
PPAF will be impacted in a manner consistent
with the impact of inflation on commercial
loans. Interest rates charged by PPAF used to
vary between 6 to 10% per year. With these Source: MIX Market
loans now being pegged with the KIBOR (around
13% in August) this will greatly impact the cost Based on the above chart, it is evident that
of PPAF borrowing in Pakistan. personnel costs comprise the bulk of operating
costs.
7.2 Impact on the Cost of Operations The following table lists the inflation rates for
the categories that comprise operating costs as
The main operating cost drivers for MFPs are shown in the above chart. Inflation figures have
personnel costs, rent, utilities and been taken for the month of May 2008.
transportation.
Table 15: Inflation rate for operating cost components
Cost driver Inflation component Inflation Rate

Personnel Wage Rate 23%
Rent House Rent 2.4%
Utilities Utilities 32.2%
Transportation Fuel 9.5%
Others General Inflation 19.3%
Source: Inflation Monitor, June 2008
Assuming that all other variables (such as

increase in personnel, changes in internal
operations) that affect the cost of the above
components remain constant, the impact of
inflation on each of the components has been
calculated. The following chart projects the
annual cost of each of the components adjusted
for inflation rates as mentioned in the above
table.

Chart 16: Operating Cost Analysis However, there are many factors that will
influence growth of MFP’s in Pakistan. The
1,60,00,00,000
23%
2008 analysis of demand from a microfinance client’s
1,40,00,00,000
2007 perspective has been assessed in greater depth.
1,20,00,00,000
1,00,00,00,000
The demand drivers for microfinance clients are
80,00,00,000
60,00,00,000
19% mainly of the following types
40,00,00,000
2% 9.5%
20,00,00,000
32%
• Consumption led demand
0 • Demand led by productive activities
n
s
rs
t
l
ne
en
tio
e
iti
th
on
rta
til
O
U
rs
po
Consumption led demand

Pe
ns
a
Tr
As discussed in the above section, savings of

microfinance clients drop drastically due to the
As detailed in the above chart, personnel costs affects of rising impact. The following chart
have risen by 23%, rent by 2%, utilities by 32% depicts the total income and expenditures over
and transportation by 9.5% over the previous the last few years with the difference between
year. The overall impact results in an increase of them being savings of clients.
19% in the total operating costs for the year
2008. Chart 17: Impact of inflation on savings
(Figures in PKR)
In light of the current economic scenario, an
increase in the operating costs of MFPs seems 22,000
20,000
inevitable though the extent of increase can be 18,000
controlled through improving internal 16,000
14,000
operations. 12,000 Total Income
10,000
Total Expenditure
8,000
7.3 Client Impact 6,000
4,000
2,000
Rising inflation not only affects the costs of 0

PKR 2006 2007 2008
funds and operating costs of MFPs, it also affects

the demand for microfinance and the repayment Source: Intellecap Analysis
ability of microfinance loans. The impact of
inflation on each of these major heads is It is observed in Chart 17 above that both
discussed in detail below. income and expenditures have been steadily
increasing over the last few years. However, the
7.3.1 Impact on Client Demand expenditure basket experienced a significant rise
in 2008, which was not met by a corresponding
There are an estimated 5.6 million households in increase in income. Also, given the fact that such
Pakistan in need of microfinance services while clients comprise people from low income
the sector probably reaches out to less that 1% households, their margins to reduce
at the moment.22 With backing from the expenditures are limited.
government to increase outreach, micro-finance
in Pakistan has managed to grow at a Thus, in all probability there will be a substantial
substantial pace, reaching out to almost 1.5 increase in consumption oriented loans to meet
million borrowers in 2007. There is a basic consumption needs.
Government backed sector objective to reach 3
million borrowers by 2010.

Demand led by productive activities The following table aims to evaluate the effect of
The effect of inflation on each sector is unique. inflation on each of the microfinance client
The following chart depicts the active segments depicted above. Increases in prices in
microfinance borrowers per sector. 2008 over 2007 are taken against certain
acceptable proxies to determine the impact on
Chart 18: Active Borrowers by Sector the sector as a whole.
Source: Microwatch, PMN
Table 16: Demand by client segment
Increase in prices and Proxy

Client Segment Demand for Microfinance
Input costs Output costs
Demand: Very high

83% 22.5%
Cost of inputs for agricultural activities has
shot up drastically in 2008. While there has
Primary
Seeds and Government been a moderate increase in corresponding
Agricultural prices for agricultural produce, this in no way
fertilizers, support prices
activities matches the increase in input costs.
electricity (wheat)23
Therefore, it is expected that microfinance
clients engaged in primary agricultural
activities will need to avail more loans to
cover their rising input costs.
Demand: Moderate
Clearly, the impact of inflation on clients
engaged in agricultural and foodstuffs trading
is mitigated by the fact that those engaged in
34.02% 33.81% trading activities have greater leverage to
Agricultural & increase their selling price with respect to
their cost of purchase. However, those
Foodstuffs trade engaged in trading activities also have certain
WPI (Food) CPI (Food)
activities fixed
overheads to cover such as rent, utilities and
transport which have all seen substantial
increases due to inflation. Thus, there might
be a slight increase in demand for
microfinance loans to cover working capital
requirements of traders.

Demand: High
17.26% Clients engaged in livestock and poultry
Livestock and 22.39% related activities would also see a moderate
requirement of additional working capital to run
Poultry related CPI (egg, milk,
their businesses. It is understood that that
activities Animal Feed chicken, beef animal feed prices which are a key input cost
for these clients has risen by over 22%. An
and mutton)
analysis of the selling price of related items
shows that they do not keep pace with this
increase in input costs.
Demand: High
12.45% The non-agricultural trading sector has also
seen a large gap emerge between the input
22.39% costs and output prices for the trader. This
Non-Agricultural CPI basket as indicated is mostly non-essential
commodities which consumers can do without
trading WPI (apparel, in times of hardship. Thus, with demand from
24
(Manufactures) textile & the end consumer slowing down the flexibility
footwear & to raise prices to match input costs lessens
and these traders have to absorb a hit to their
household, margins. Thus, microfinance clients engaged
furniture & in this activity might see a need to borrow to
equipment) cover fixed overhead costs during this period.
Demand: High
Clients engaged in manufacturing and
services are presumed to be providing
nonessential products and services which at
Manufacturing the low income level will see demand from the
and services end consumer go down. This will mean that
most clients engaged in this line of work will
moderate production or service levels to an
acceptable market level thus containing costs.
They may still look for external loans to cover
any significant gaps in working capital outflow.
Source: News Articles, Federal Bureau of Statistics, Government of Pakistan
Thus, the effect of inflation on various sectors as rising inputs costs. However, there are inherent
well as various categories of microfinance clients risks attached to loans extended to clients,
is unique and influenced by a number of factors. depending on the purpose for which the loan is
availed. As discussed earlier, microfinance loans
7.3.2 Customer Risk are primarily disbursed for consumption
purposes or for income generation activities.
As discussed in the earlier section, demand for The following table analyzes the business risk
microfinance is expected to increase due to impact across microfinance client segments.

Table 17: Business Risk Impact across Client Segments
Client Segment Assessment of Associated Business Risk Risk Association
Typically, such loans are extended without collateral and are

extended to existing microfinance clients with a good track
record of repayment. However, in times of high inflation, even
Consumption such clients may face a difficulty in repaying loans. Thus,
consumption loans are inherently more risky than income
purposes generating loans. The demand for consumption loans is Extremely High
expected to increase over the next year. While part of this
demand will be met, it is also accompanied by a high risk if
inflation levels stay at current levels and therefore the
associated risk on such loans is believed to be extremely
high.
Income Generating Loans: Income generating loans are extended across a range of agricultural and non-agricultural activities.
The following table aims to identify the riskiness of microfinance loans extended to each of these sectors in greater detail.
The following factors influence the risk of this client segment:

• Strong demand for agricultural commodities which ensures a
steady income.
Primary • Adequate support from the Government in terms of
agriculture reasonable price guarantees adjusted for inflation. High
activities • However, input costs in the short run are still much higher
than output prices, which impacts savings of farmers and in
turn affect their ability to re-pay loans. Therefore, loans should
be structured in a manner that accounts for this short term
impact on farmers’ income.
Clients engaged in agriculture and foodstuffs trading have the
following advantages when compared to other clients.
Agricultural • Flexibility in terms of adjusting their portfolio in line with
trading expected market demand. Neutral
commodities • Demand for agricultural commodities is inelastic to a certain
extent and thus demand is expected to continue. Traders
therefore have the advantage of passing on the rise in input
costs to the end consumers.
With the exception of milk, demand for most other livestock
and poultry products is highly elastic and is expected to
decline due to rising prices. This affects the ability of clients
engaged in such activities to raise prices by a significant level.
Livestock and
Also, with increases in the price of animal feed (a
poultry related High
major input cost) not matched by a corresponding increase in
activities demand and the output price, this client segment is highly
affected by rising inflation.
Non-agricultural traders will observe a moderation in end

consumer demand as consumers will only purchase products
that they absolutely require during such times of high inflation.
Non-agricultural However, such clients (traders) have the Neutral
trade ability to adjust their portfolio based on market demand and
thus protect themselves from declining margins. Thus this
segment of clients is well positioned to mitigate the effects of
high inflation.
Manufacturing These clients are characterized by high capital and overhead
costs that require a steady cash flow to meet such expenses.
and services Thus, the impact of inflation on such a client segment is Extremely High
expected to be extremely high.

Customer risk affects the operations of Based on discussions with industry experts, it is
microfinance players in numerous ways. The considered that there will be a substantial rise in
value of Portfolio at Risk (PaR) is a valuable portfolio risk for microfinance players in
measure of the same. The following table details Pakistan. As depicted in the above table there is
the consolidated values of PaR for the sample an increase in estimates of all three risk
microfinance providers. PaR figures for both > parameters from the current figures, which
30days and > 90days and default rate calculated indicates an increase in the risk of loans in the
as the loan loss provision expense as a short run. However, the majority of this increase
percentage of total gross loan portfolio are in risk may be attributed to the prevailing
presented in the following table.25 macroeconomic conditions dominated by rising
Table 18: Key Risk Parameters for sample MFP’s
Source: Intellecap Research
inflation of essential items such as food and oil.

Therefore, the rise in risk parameters values is a
short term phenomenon and can be addressed
by risk mitigation strategies such as: loan
refinancing and portfolio shifting to less risky
client segments.

8. RECOMMENDATIONS
To mitigate the effects of inflation on the 8.1.1 Re-align Growth Objectives

microfinance sector a coordinated approach by
all stakeholders such as MFPs, Government and MFP’s in Pakistan have traditionally been
microfinance clients is required. The encouraged to achieve high growth targets.
recommendations are structured on the basis of Additionally this recent period of high growth in
who has responsibility to initiate action. Thus the Microfinance sector in Pakistan has been
these recommendations have been structured influenced by the high priority placed on the
as those that can be initiated by the MFPs and sector by the Government. However, with the
those that can be initiated by the Government. present inflationary scenario, it is imperative
that MFIs realign their existing growth oriented
The response tools that MFPs have at their strategies to focus on internal operations.
disposal to counter the effects of inflation are
broken down into the following; This would obviously result in a decrease in the
rate of growth in the number of borrowers in
1. Tactical counter measures the short term; however, it will allow MFPs to
2. Strategic counter measures improve their systems and processes to manage
the vast environmental risk that exists at the
Figure 2: Recommendations to MFPs moment. In order to reach the Government
backed target of 3 million borrowers by 2010 the
microfinance sector will need to grow
consistently at a rate of 27% per annum over the
next 3 years. However, this goal should be put
on the backburner for the moment and the
focus must shift internally to operations and
risk-management.
We believe based on our discussions with

industry experts and management of various
MFPs in Pakistan that the estimated growth rate
of the microfinance sector over the next 3 years
should slow down to 13% in 2008, rising
8.1 Tactical Counter Measures for moderately to 20% in 2009 and with efficient
MFP’s: systems and better market conditions rising to
27% in 2010 thereby reaching 2.5 million
Tactical counter measures are response tools borrowers by 2010. Based on the above
that MFPs should consider as immediate steps mentioned growth rates, the following table
to mitigate the inflationary impact on their details the projections of the total number of
business operations. The following are the key borrowers for each year until 2010.
tactical counter measure recommendations;
• Re-align Growth Objectives

• Manage Risk
• Increase Operating Efficiency
• Refinancing/ Restructuring of Loans
• Portfolio Shift
• Deposit Mobilization
• Loan Redesign

Table 19: Projections of the total number of borrowers
Year Current Growth Target Growth Estimated Growth

Figures in millions
13%(2008); 20%
43% 26% (2009); 27% (2010)
2008 2.2 1.9 1.7
2009 3.2 2.4 2.0
2010 4.6 3.0 2.5
Source: Pakistan Microfinance Network, Intellecap Analysis
The estimated growth in the number of Risk Management:

microfinance borrowers is lower than the The existing risk management practices in most
historical trend due to the following reasons; MFPs in Pakistan are not very well developed.
MIS and Internal Audit are two valuable tools to
• High levels of inflation in recent months. ensure adequate and well functioning internal
• Deliberate strategy of management to processes.
strengthen internal operations rather than
expand operations geographically. It is Management Information System:
recommended that MFIs realign the current MIS is an important tool as it enables MFPs to
emphasis from “only growth” to “growth with reach a greater number of clients more
building internal processes and systems”. effectively. A comprehensive MIS system helps
maintain the quality of the portfolio to ensure
This strategy does not call for a reduction in less drop outs and timely restructuring of loans
growth but for more emphasis on internal in order to reduce delinquency rates.
operations and efficiency of MFIs.
An example of an MFP that has successfully
8.1.2 Manage Risk implemented an MIS system is that of First
Microfinance Bank (FMFB). FMFB transformed
The Government has set a growth target of 3 its technology solution from a very basic system
million microfinance borrowers by 2010. While to one that is amongst the most advanced in the
the microfinance sector has been growing at a country with a full-fledged MIS for loans. Also,
CAGR of 47% since 1999, this rate was achieved its transformation from an NGO to a MFB posed
due to the limited number of existing a huge challenge to its existing MIS system as it
microfinance borrowers and to the backing of did not have any functionality related to
significant upfront investments. Historically, deposits, remittances, and insurance products
most MFPs have been solely growth oriented. that the bank envisaged to offer. The challenge
However, in the current scenario, with rapidly was addressed through the establishment of a
rising inflation, MFPs should consciously realign strong IT department and through the
their strategies to focus on the internal integration of an off-the -shelf application with
environment in addition to growth. its existing portfolio management system.
Increasing emphasis on internal processes and

procedures and adopting risk management
practices should be a high priority for all MFP’s.

An efficient MIS system ensures activities such Figure 3 – Operating Costs Mitigation –
as disbursements, repayments, deposits, Evaluation Framework
withdrawals, and money transfers are completed
faster, are better controlled, and are completed
with minimal errors. It also provides easy access
to accurate and up-to-date information on
customers and their activities.
Internal Audit:
Internal audits ensure proper transparency and
accountability across internal processes within
an organization. In order for internal audits to be
effective they should be carried out at regular
intervals (monthly or quarterly) with a system in
place to monitor the areas for improvement. A
robust internal audit system will ensure timely
correction and improvement of internal
procedures and processes thereby resulting in a
strong internal operational environment. This has been evaluated at 5 levels:
Regular internal audits ensure consensus on
good management practices within an 1 Loan Officer Level Strategies:
organization.
Remuneration:
For example; SKS Microfinance, a MFI based in Most MFPs have seen wages rise by over 20%
India is one of the first MFIs in the world to because of the effects of inflation. While
receive a certification for its 300-plus strong organizations should be empathetic to the
Internal Audit Department. SKS conducts concerns of their employees, MFPs could look to
rigorous audits every month across its 1,000 plus structure salaries in a manner that does not
branches across the country. inflate their wage bill. This can be achieved by
keeping fixed salaries at a lower level and
8.1.3 Cost of Operations: increasing the variable incentives. There is
ample empirical evidence that the introduction
Operating costs are incurred at various levels of the right loan officer incentive schemes can
and the strategies to bring down operating costs make positive contributions to loan officer
are varied and interlinked. Some of the key efficiency. Some of the most efficient Latin
measures that can be taken by MFPs to mitigate American MFIs with very high loan officer
the effects of inflation on operating costs are as productivity use financial incentive systems,
follows. including WWB Cali, Financiera Calpiá, CMAC,
Banco ADEMI, and Caja Los Andes. The BRI Unit
Desa, a high productivity lender in Indonesia,
uses a profit bonus system (based on unit
performance) to motivate staff, in addition to a
semi-annual contest for cash prizes.
Design and implementation of loan officer bonus

systems requires careful planning. One obvious
challenge is to ensure that the incentives are
properly aligned with the goals of the
organization.

Table 20: Number of active borrowers per staff and loan officer

Based on the above table, it is observed that the mentioned MFIs are comparable. However, it is
number of active borrowers per loan officer observed that the efficiency of personnel vary
across selected MFIs in Pakistan is significantly greatly between the MFIs of the two countries.
higher than the number of active borrowers per Thenumber of active borrowers per employee
employee of the MFI. Also, the percentage of varies significantly within Pakistan as well as in
loan officers to total employees varies from 58% comparison to countries such as India. The
to 80%. Thus, a sizeable chunk of the workforce number of active borrowers per staff is 126 in
is not directly involved in the core operation of Pakistan and 206 in India, which is about 60%
generating loans. This presents an opportunity more than in Pakistan. This gap represents a
for such MFIs to re-organize personnel and considerable opportunity for Pakistani MFPs to
allocate a greater percentage of staff as loan improve productivity of their personnel and
officers. This would result in better utilization of increase overall operational efficiency.
available staff and improved operational
efficiency. Therefore, MFPs in Pakistan can look to improve
productivity at the branch level by
There have also been cases where MFIs have
looked to reduce their operating costs by hiring a) Planning branch structures as per the
support staff on contractual bases. This by no requirements of the region
means is a best employment practice, however b) Striking the right balance between loan
it is useful as a short term mitigation strategy to officers and support staff
tide over uncertainty in the market place. c) Enhancing productivity of loan officers to
match levels seen in neighboring countries
The following table illustrates the personnel and
administrative expenses as a percentage of total
operating expenses for select MFIs in Pakistan
and India.
Table 21: Comparison of number of active borrowers per loan officer
Based on the above table, it is observed that

average personnel expenses constitute 60% of
operating expenses in Pakistan and 62% in India.
Similarly, administrative expenses constitute
40% and 38% of operating expenses for Pakistan
and India respectively. Thus, it can be deduced
that the operating expenses of the above

Head Office Measures Restructuring of loans is a good tool for MFIs to
Technology decisions, Loan Redesign, Branchless manage their portfolio in times of natural
Banking initiatives, Productivity of Loan disasters. Loan restructuring helps MFIs retain
officers are all measures driven by top good clients while also showing their sensitivity
management. These measures have been towards the crisis faced by their affected
discussed in greater detail in the following clientele.
sections. The right kind of rescheduling strategy can be a
8.1.4 Refinancing/ Restructuring of Loans useful short term solution for MFIs in light of the
current scenario of rising inflation. The following
The SBPs Prudential Regulations for MFB/ MFIs are the three types of rescheduling options
framed the following guidelines on rescheduling available to MFIs:
and restructuring of loans: • Client postpones payment of loan principal for
a specified period, while they are expected
“The MFB/ MFI shall reschedule/ restructure the to continue to make interest payments
Non Performing Loans (NPLs) as per the policy throughout the remaining contractual period.
approved by their Board of Directors. However, • Interest continues to accrue over the period of
these loans shall remain classified unless deferment of principal, but clients pay the
serviced regularly for 6 months. All NPLs shall be accumulated interest at a later date.
written off, one year after the default in • The MFI temporarily stops the clock on
performance. This shall, however, not extinguish interest accumulation during the period of
the MFI’s/ MFB’s right of recovery of such deferment of principal.
written off loans” The following highlights an example of a South
American MFI that adopted a comprehensive
disaster preparedness strategy.
Box 2: Example of an MFI in South America which restructures loans in case of disasters28
ACODEP in Nicaragua has developed a comprehensive disaster preparedness plan that includes modifications to the
delivery of their products and services during a disaster, as well as the introduction of emergency and recovery products.
In addition to a flexible credit policy for disaster emergency and recovery, ACODEP created a disaster loan fund to help the
institution prepare better for possible cash flows demands and to control credit and liquidity risks. The MFI stops collecting
payments during the emergency period, allows clients to withdraw compulsory savings deposits (which are used normally
as collateral), stops lending, and, on the basis of a field damage assessment, prepares loan restructuring and refinancing
plans. In addition,
in case of severe emergencies, it offers short-term loans of 1 or 2 months for household needs with special interest rates.
ACODEP loans are restructured when clients lose their homes, but not their productive assets. Loans are also restructured
for those clients that are severely injured. Loans may be refinanced when productive assets are completely lost. (Pantoja,
2002).

While the last form of rescheduling results in the repayment. Finally, the clients need to be aware
least burden to the client, it also results in the of the objective of the loan restructuring and
lowest return to the MFI. Considering that the not depend on the same as a long term solution.
present food crisis and rising inflation are not as
severe as is the case of natural disasters, the first Figure 4: Illustrative Loan Restructuring
method of rescheduling is most suitable in the Mechanism
Pakistan context. This has the least impact on an
MFI’s cash-flow while simultaneously providing
short term relief to MFI clients.
MFIs must adopt a customized approach

towards client assessment prior to extending the
facility of rescheduling loans. This service should
be extended only to those clients that have a
demonstrated repayment capability to avoid the
risk of further increases in loan defaults. The
effectiveness of this strategy depends on the
past client-MFI relationship. The established
clients generally have a higher repayment rate
on rescheduled loans than newer clients.
To ensure that clients do not misuse the relief

being provided by the MFP and for the MFP to 8.1.5 Portfolio Shift
keep a tab on its clients; MFPs need to develop
an efficient scanning and filtering system. A Microfinance players need to evaluate the
suggestive filter is explained in the following effects of inflation on their individual portfolios.
chart. Out of the total number of loans An efficient MIS system that allows microfinance
outstanding, the option of loan restructuring players to track clients by type, occupation and
would be extended only to micro entrepreneurs region will prove extremely useful in
who are accessing business loans (and not understanding certain client’s requirements and
consumption loans). The loan officer must carry the risk. As seen in the earlier section, clients
out due diligence to estimate the extent to engaged in certain activities see the
which the business is adversely affected by environment affecting them in different ways.
inflation and whether it needs additional The following table captures the demand risk
financial support. The client should at least be in matrix for the various types of microfinance
its 2nd loan cycle with a clear history of debt client segments.
Table 22: Demand Risk Matrix:

Given the above analysis, in the short run, MFPs 1. Higher interest rate on deposits:
could look to structure their portfolio in a MFBs may resort to increasing the rate of
manner that exposes them to the least risk. interest paid on deposits in order to mobilize
Demand across most client types are fairly greater deposits. The following table evaluates
strong and thus the risk profile of clients in the rationale behind the same.
certain sectors should be watched closely.
As shown in the above table, a typical MFP
The above analysis is generic in nature and is borrows at a rate of 13% (A) which is the cost of
assumed to hold true across Pakistan. This may commercial loans. The cost of deposit
not be the same across all regions and will have mobilization is 5.8% (B) and the interest paid on
to be explored in depth respective to each MFP, deposits amounts to 4% (C). This indicates that
though these factors broadly hold true. Thus, we MFBs have a reasonable margin to increase the
believe that MFPs will need to carry out client rate of interest paid on deposits by up to 3.2%
profiling across their loan products prior to (A-B-C).
extending loans. It will also be beneficial to
monitor those client segments that face a 2. Linkages with MFI/ NGOs:
greater threat due to rising inflation. While, MFBs are constrained by the time and
cost of raising substantial deposits, MFIs and
8.1.6 Deposit Mobilization NGOs are constrained by the fact that they are
unable to mobilize deposits from their vast pool
Deposit mobilizations are constrained by the of existing clients. Various linkages could be
time taken to mobilize such deposits. explored such as the business correspondence
In the context of rising costs of funds and model prevalent in India, to bridge this gap and
reduced availability of the same, MFBs could leverage each of the stakeholders’ advantages.
adopt certain measures to accelerate the From the perspective of an MFB, such a linkage
process of deposit mobilization. The following will enable them to mobilize deposits from a
are discussed in greater detail below. wider base of existing clients of MFIs and NGOs
Table 23: Interest paid on deposits
Interest paid on deposits Rate

Int. rate on borrowings (A) 13%
Cost of deposit mobilization (B) 5.80%
Current int. rate on deposits © 4%
and will significantly reduce the pressures of

raising funds. MFIs and NGOs will benefit by
providing their existing clients with an additional
product and may also provide them with a
higher rate of interest on the same. An
illustrative diagram of such a linkage is shown
below.

While, all Know Your Customer (KYC) norms Moreover, it has been assessed that
needs to be fulfilled and service channels and microfinance clients are not very sensitive to the
technology tie-ups need to be in place, the cost rate of interest charged as their requirement for
for the same might be far lesser than trying to funds is highly inelastic i.e. not greatly
raise and grow deposits organically in this influenced by the rate of interest charged on the
market environment. From the MFI perspective, funds.
this will result in offering their clients an added
service of deposit accounts and also a possibility However, from the perspective of an MFI, they
of leveraging their deposit accounts at the MFB risk passing on the additional interest burden on
to raise fund for their on-lending activities at a their clients at times where their clients are
far more favorable commercial rate. already squeezed for funds. This exposes the
MFI to a greater risk of loan default.
8.1.7 Loan Redesign
2. Increasing the loan size (B):
MFIs may face a liquidity crisis due to delayed This would result in a decrease in the transaction
repayments or increased defaults by clients. The costs associated with the loan. It is a viable
redesigning of existing loans and the option in times of steeply rising inflation as the
introduction of new loan products are effective real value of money falls. The demand for loans
mechanisms to overcome the liquidity crunch. will also increase as clients will need greater
The redesigning may take the form of any one or amounts to meet rising costs during inflationary
a combination of the following strategies: times. Thus, MFPs should evaluate the option of
increasing the loan size as it would help lower
1. Increasing the interest rate (A): their transaction costs and also address the
An increase in the interest rate on existing loans growing needs of their clients.
will enable MFIs to pass on a part of their
increased cost of funds to clients. MFPs in 3. Decreasing the frequency of repayment (C):
Pakistan have traditionally had lower interest This would allow for stricter monitoring and will
rates compared to their counterparts in other ensure greater compliance as well as a regular
South Asian countries. Recently NRSP raised its inflow of cash. While this does lead to an
interest rates by 400 bps. Kashf Foundation too increase in operating costs, it might be
has been evaluating a possible increase in the necessary with MFPs having to maintain a strict
rate change of 200 bps. Thus, most MFI’s are vigil over their portfolios.
actively looking to increase interest rates by
some degree to match the increase in their The following table illustrates an example of
financial and operating costs. how the above strategies may be adopted for a
loan of PKR 6,000 extended over a period of 12
months at a diminishing rate of 30%.
Table 24: Illustration of Loan Redesign Strategies

It is observed that as per the original terms and Figure 7: Interest Rate Swaps
conditions of the loan, the monthly installment
amounts to PKR 582. Under the various scenario
represented in the above table, the monthly
installments vary from PKR 582 to PKR 1,438
depending on the loan redesign strategies
adopted.
8.2 Strategic Countermeasures for

MFPs:
In addition to tactical counter measures

discussed above, MFIs would need to adopt
certain strategic counter measures in order to
safeguard themselves against the uncertain As illustrated above, the MFP receives fixed
economic environment characterized by rapidly payments from the microfinance clients and
rising inflation. The following are the key pays out fixed amounts to the counter party
strategic counter measure recommendations. depending on the agreed swap rates. The
obligation to the lending bank is met through
8.2.1 Interest rate risk mitigation using Interest floating payments received from the swap
Rate Swaps (IRS): counterparty.
While interest rate swaps are considered For instance, the MFP receives a 30% fixed rate
effective tools to counter inflationary trends in from the microfinance clients of which 18% is
the market, they are usually effective when kept by the MFP (to cover operational costs,
agreed upon before inflation hits the market. swap costs, and profit margin) and the
However, given that there is uncertainty in the remaining 12% is available for the swap
market, it might still be useful to consider IRS as agreement. Upon finalization of the swap
a strategy to counter potential future increase in agreement, the swap counterparty receives fixed
commercial costs of borrowing. The following rate (swap rate agreed upon) from the MFP (or
narrative illustrates the working of an interest through the swap facilitator) and pays out at a
rate swap: floating rate which goes to the lending bank
through the MFP (or swap facilitator). The swap
MFPs borrow funds on a floating rate basis from agreement is facilitated by an institution (could
commercial banks and financial institutions and be the lending bank itself) that has the pertinent
on-lend the same to their clients at a fixed rate. expertise in the underlying instrument (interest
Interest rate risk due to fluctuations in the rate rate swap). In the context of Pakistan, SBP can
of interest is inherent in all commercial support the establishment of the facilitator in
borrowings and the need to hedge this risk is a case the lending bank does not have the
pertinent concern for MFIs. IRS is an innovative expertise which will take care of all such
solution that may be used to mitigate this risk. transactions in the microfinance
The following chart illustrates the functioning of sector.
an IRS in the context of an MFP.

The swap agreement can be summarized as
follows:
Table 25: Swap Agreement summary
Normal Situation
Clients MFI/ MFB Lender
Pay Fixed Receive Fixed Receive Floating
Pay Floating
With Interest Rate Swap

Clients MFI/ MFB Swap Party Lender
Pay Fixed Receive Fixed Receive Fixed Receive Floating
Pay Fixed Pay Floating
Effect Expense goes from floating to fixed
8.2.2 Branchless Banking: The following infrastructural, logistical and

As per the Economic Survey of Pakistan 2006- target customer attributes favor setting up and
2007 there are 29.5 million people among the scaling a sustainable branchless banking model
transitory vulnerable (17.1 million) and in Pakistan;
transitory poor (12.4 million)29category that
constitute a large segment of the overall people • 625,000 shops (drink corners/ general stores)
suffering from poverty in Pakistan. This group in every vicinity
comprises the potential market for microfinance • 353,000 shops public call offices throughout
institutions. While the actual number of the country
microfinance clients in 2007 was 1.4 million,30 it is • 12,343 Postal Service Offices in all cities, towns
expected to reach 3 million clients by 2010. and villages
However, this still leaves tremendous • Oil Stations (3700 stations, 1200 POS enabled)
opportunity for microfinance to increase its on main roads only
outreach and serve large sections of the • 6 major telecom operators with a customer
un-banked. base of around 76 million subscribers
Branchless banking provides a platform to access Branchless banking is also beneficial to MFPs as
these large numbers of un-banked people. The it helps address two significant issues
bank led model and the non bank led model are pertaining to the cost of funds. Firstly, it
the two most prevalent models of branchless drastically reduces the costs related to setting up
banking. The SBP recently issued a set of branches, while at the same time it achieves the
guidelines for branchless banking, which allows objective of expanding geographical outreach.
for the bank led model to be set up in Pakistan. This also results in greater deposit mobilization
The bank led model can be implemented either of the un-banked population and provides an
by using agency arrangements or by creating a additional source of funds for MFPs. Secondly; it
joint venture between a bank and a non-bank, lowers the cost of handling low value
such as a telecommunications company.31 transactions. This is achieved through lower cost
Pakistan is favourably positioned to take of delivery associated with branchless banking.
advantage of the benefits of branchless banking. Also, additional costs to banks such as cost of
building and maintaining a delivery channel are
eliminated. The bank will have to invest in

technology to enhance service delivery and to time spent at each center, thus allowing them
manage risk; however this is estimated to be to become more productive and more efficient.
lower than the cost of organic expansion. Points of Sale” subject to a cash limit of
PKR. 10,000. This may impact the execution of
Tameer Bank in Pakistan estimates that, in the larger transactions.
Orangi slum of Karachi, the setup cost of a bank
branch would be 30 times more than the setup 8.2.3 Technology:
cost per agent, which is about USD 1,400.32 Technology can play a major role in enhancing
Monthly running costs average about USD the operational efficiency of MFPs. It also results
28,000 for a branch, compared with USD 300 for in time saving and prevents operational costs
an agent, as also, a much larger share of from increasing.
monthly running costs is variable for an agent
than for a branch. Even though MFPs have strong local knowledge,
product development acumen, and the ability to
However, there are certain concerns that manage small loans, most lack specialized
impede the scaling up of such a model: technical skills to implement technology or tap
into existing platforms. However, there are
• Capacity building due to issues pertaining to numerous examples of MFPs that have
regular power supply, wireless connectivity successfully implemented technology, which has
and liquidity constraints of small entrepreneurs resulted in an increase in their productivity.
scattered across the country.
• Efficiency issues due to institutional Case Study:
bureaucracy in government undertakings. SKS has automated microfinance through back
• Most MFIs lack stable core banking systems office and field technology.34 Rather than relying
and specialized technical skill to implement on manually-filled collection sheets and
branchless banking models. manually entering data in ledgers, SKS created
• The security of transactions made at various its own automated MIS that is incredibly user-
third party centers across the country is friendly. Field staff with only high school
another concern. Roles, responsibilities and education can independently manage the MIS.
liability of various stakeholders involved SKS’s MIS system has been key to its significant
should be clearly defined. growth as it has allowed growth while keeping
• The prudential regulations under the Banking an extremely tight control on business risks.
Companies Ordinance prohibit any cash Red-flags are immediately identified and dealt
payments outside bank branches with two with in a swift manner. SKS’s work in automation
exceptions: ATMs and withdrawals at and successfultechnology implementation has
“Authorized Merchant Establishments at various won the CGAP Pro-Poor Innovation Award, the
front, SKS introduced the “smart card” system Digital Partners SEL Award and the award for
that allows field officers to drastically reduce the Excellence in Information Integrity. On the field
Box 3: Case Study on Branchless Banking
Case Study FMFB-PO 33
In October 2007, FMFB and Pakistan Post entered into a partnership with the goal of poverty alleviation.
FMFB will use its 82 branches, combined with the 4,000 sub-offices of the Pakistan Post, to provide financial
services. The arrangement is such that recoveries and disbursements will be made through PPO outlets for a
fee charged on all such transactions. The services of postmen will be utilized for generating interest and client
background checks. All transactions will be initiated by an on-site MFO of the bank. Additionally, some rental
will also be paid to PPO for use of their premises. These will be treated as sub-branches. The participants
estimate that this partnership will result in disbursement of PKR 15 billion (USD 247 million) in the next three
to five years.

The following table details the time spent on
each activity.
Table 26: Gaining efficiencies with the Smart card system
Source: World Bank PovertyNet
The use of smart card solution enhanced SKS’s level of enthusiasm generated. But some of
loan officers’ productivity by up to 100%. these new approaches have already proved
Technology benefits forced SKS to make a few themselves and others will no doubt continue to
changes to their business model. To allow the emerge.
Smart card product to operate efficiently, SKS
had to limit its savings and loan products to five 8.2.4 Securitization of Loans:
with two loan repayment period options, instead Banks and Development Financial Institutions
of three. SKS had to customize its MIS system (DFI) in Pakistan have been allowed to securitize
(which took nearly 4 months) to ensure it was their assets under lease, mortgage, and
functioning with maximum accuracy and to infrastructure financing while other assets may
accommodate the smart card technology. also be securitized with prior approval of the
Despite this, the benefits of having this State Bank. The State Bank issued a
technology have allowed SKS to grow at a very comprehensive set of guidelines for asset
rapid rate. securitization in November 2002.
Creative new delivery channels and new Securitization in the context of the microfinance
information technology also hold promise for industry occurs when loans, either individual or
reducing risk and cutting delivery costs. MFPs group loans are transferred from the originator
are now exploring ways to piggyback financial of the loans or receivables to a Special Purpose
services delivery onto existing infrastructure, Vehicle (SPV), which is often formed as a trust.
such as retail shops, internet kiosks, post offices, The transferred loans are held with the SPV as
and even lottery outlets. Existing distribution collateral against which it issues securities that
systems may make it possible to provide can be bought and traded by potential investors.
financial services more cost effectively and, thus, However, these loans are serviced in accordance
to poorer and more sparsely populated areas. with the terms and conditions by the MFP.
On the technology side, companies in southern
Africa are developing low-cost, cell phone–based
banking services for poor clients. MFIs in Bolivia,
Mexico, India, and South Africa are also making
use of smart cards, fingerprint readers, and
personal digital assistants to improve efficiency
and expand into rural areas. Not surprisingly, the
actual performance of such new technologies
and strategies does not always match the initial

Box 4: Example of Securitization strategies adopted by various MFIs
In May of 2006, ProCredit Bank Bulgaria securitized 47.8 million1 of its Euro denominated
microfinance loans. Enhanced by guarantees provided by the European Investment Fund and
Germany’s KfW, a state-supported development bank, these securities received a BBB credit rating,
considered “investment grade,” from the global credit rating agency Fitch.
In July of 20061, the Bangladesh Rural Advancement Committee (BRAC) closed a deal to securitize
$180 million equivalent of local currency microfinance loans over a six-year period, with $15
million to be disbursed in the first six months. The issuance received the highest quality credit
rating (AAA) from a local rating agency, Credit Rating Agency of Bangladesh (CRAB), and succeeded
in attracting two local banks as key investors.
Securitization of loans has the following volatile. When loans are sold to an SPV, the
advantages; originator transfers the loans to the SPV and is
allowed to release the reserve capital supporting
• Additional Funding: It provides an avenue of those particular assets. Thus, securitization
additional funding to MFPs. successfully provides regulatory capital relief.
• Transfer of Risk: Securitization of loans allows
MFPs to transfer operational risks such The following disadvantages are associated with
as credit, interest rate and risk of prepayment to the securitization of loans:
the loans or defaults. In the case of
securitization of loans, MFPs often continue to • Costly and time consuming process:
service the portfolio but losses, if any, do Securitization of loans entails a high initial
not impact their financial statements. transaction cost. The cost of research and
• Addressing Capital Adequacy Requirements: drafting of legal documents are a time
Securitization of loans frees up capital consuming and expensive process.
that can be used to support new loans. Some • Upgrading of services: A successful
countries require regulated MFPs to hold securitization of loans calls for an upgrading of
more risk-weighted capital than local banks as client servicing and investor reporting processes.
microfinance loan portfolios are believed to be
Key Section Highlights

1 Securitization of microfinance loans on commercial banks’ balance sheets – so that it
frees up the banks’ balance sheets and gives way for more lending to the MFPs.
(Requires priority sector lending norms as are prevalent in India).
2 First loss/ equity tranche can be taken up by Government sponsored funds such as
PPAF providing confidence to the investors in the structure.
3 Setting up a transparent process to manage credit risk and monetize returns, it

8.2.5 Microfinance plus plus (MF++) MFPs need to be well established and mature in
The increasing economic uncertainty and rapidly their operations in order to maximize on the
changing external environment, compounded by benefits of such linkages. The introduction of
increasing competition within the microfinance new products and services serves as a challenge
sector, MFPs are forced to innovate new service to not only the front-line staff of an MFP but
offerings in order to differentiate themselves. also to its MIS and financial management
Microfinance is being packaged with other departments. Also, MFIs need to keep their
financial services and other credit services such mission in mind so as to avoid the possibility of
as savings, insurance and remittances. ‘Mission Drift’ wherein their focus shifts from
Microfinance is also being linked with the microfinance to the provision of an alternate
provision of basic amenities and has made product or service.
progress in sectors such as health, education,
water, sanitation, agriculture, finance and 8.3 Recommendations to the
livelihoods. This additional component helps Government/ SBP:
MFPs in generating additional revenues and also
provides clients with a greater variety of The following measures are recommended to
products and services. the State Bank of Pakistan to contain the impact
of inflation on the microfinance industry in
MFPs have often partnered with private Pakistan. These recommendations have been
companies to expand their outreach and also made keeping in mind the role of the SBP with
provide an additional product or service offering respect to the microfinance sector in particular.
to their clients. Examples of such partnerships Thus, the recommendations should be treated in
are prevalent in all parts of the globe. A notable light of the larger overall economic policy
example is the partnership between Grameen objective of the SBP. The following are the key
Bank and Dannon Foods35 to develop low cost recommendations to the SBP.
manufacturing units. Hindustan Unilever Ltd
(HUL) has been looking to use microfinance 8.3.1 Encourage Commercial Lending
delivery channels to position a number of their The outreach target for MFPs is 3 million
products targeted at the low income client borrowers by 2010.36 According to an estimate by
segment. Such partnerships are generally cost- Shorebank International,37 the future capital
revenue sharing agreements between the MFI structure for the industry is expected to appear
and the organization. as follows:
In the context of Pakistan, the micro insurance Chart 19: Future Capital Structure of the
industry poses a huge opportunity for the Pakistan Microfinance Industry
linkage with microfinance providers. For MFP’s
this could be an avenue to diversify their risk
while adding revenues and lowering the costs of
their operations. Mainstream insurance
companies are focusing on rural and low income
segments. MFPs such as Kashf and NRSP
currently offer micro insurance products to their
clients. Kashf offers a compulsory life/ accident
insurance policy for the duration of the loan.
NRSP offers a voluntary health insurance scheme
which was introduced in October 2005.
Source: PMN – SBI, Microfinance

The above chart indicates that the capital Poverty Alleviation Fund’s) program PRISM has
requirement for the industry in 2010 would be tried to address the need for the same by
around PKR 69 billion (approx USD 1 billion). promising funds to the tune of PKR 2.145 billion
Commercial loans and savings are expected to there still remains the need for close to 19
be the major sources of capital for most MFPs by billion in funds from commercial sources.
2010 as they would not be able to access equity Government support is much needed if this
and the amount of concessional loans (apex funding gap is to be met. This can be met
debt) is expected to stagnate. Since commercial through channelizing funds from commercial
borrowings are expected to become a major banks by incentivizing them in the following two
source of capital for MFPs, it is imperative for ways:
the SBP to encourage commercial banks to lend
out to MFPs. The current and expected situation • Increasing onus on PRISM to act as a guarantor
and requirements is explained with the help of to commercial banks on behalf of the
the following table. MFPs.
Table 27: Pakistan Microfinance Industry Scenario
Sources: PMN-SBI, PPAF
From the above table, it is observed that there is • MFI lending to be included in the framework of
a huge gap between the demand and supply of the priority sector lending, as is the
commercial debt. Though the PPAF’s (Pakistan situation in India.39
Box 5: Microfinance Sector Lending
Microfinance: Sector Lending

As part of the incentive provided to commercial banks, SBP can formulate minimum requirements for a bank
to lend to the MFPs similar to the Agriculture Finance requirements. Under Section-8(3) of the State Bank of
Pakistan Act1, 1956 SBP has created a special Agricultural Credit Department providing credit facility for
agriculture, both through the development of credit institutions as well as through providing credit lines to
the development banks and incentives to Commercial Banks. This was done as part of the Banking sector
reforms in 1972 prior to which the lending to the sector was primarily from Agriculture Development Bank of
Pakistan and commercial lending was minimal.
The MF sector saw its development after year 2002. The Government should consider including this sector
under the domain of sector-specific lending. Rural Finance and Financial Inclusion is increasingly being
recognized as a tool for poverty alleviation but without adequate funds it is unable to achieve its objectives.
Direct lending to the poor and marginalized is found to be difficult because of due diligence and repayment
issues. Directed credit programmes are more effective when channeled through specialized financial
institutions thus; financing MFPs is known to be a feasible and sustainable option. China has been
experimenting with switching from lending quotas for State-owned Banks to micro financing actively since
2000.

However, the effective implementation of the 8.4 Recommendations Overview:
above recommendation requires MFP lending to
be included in the framework of the priority The recommendations mentioned above are all
sector lending, as is the situation in India (which looked at in isolation, however they are
requires banks to compulsorily lend 40% of their interlinked and MFPs should look at how they
gross portfolio to the priority sector). can adopt these measures in a manner that best
suits their individual needs. At a generic level,
8.3.2 External Commercial Borrowings: MFPs can look at adopting a structure that is
Looking at the dearth of funds and their cost, both stable and scaleable. MFPs need to look at
MFPs are exploring alternate sources of funds various avenues such as deposit mobilization
such as External Commercial Borrowings (ECB), and capitalmarkets for acquiring funds to sustain
which is not currently allowed in Pakistan. ECBs their growth targets and operations. In such a
have proven to be a vital source of funds for scenario, MFPs need to establish their
MFIs in countries such as India, which has operations and build trust among investors and
recently allowed ECBs up to USD 5 million in depositors. To claim this confidence, they need
NGOs engaged in microfinance activities. The to follow a systematic approach towards
key concerns while framing regulations for ECB strengthening their microfinance operations.
are the tax implications for the NGO-MFI and the
potential foreign exchange risk that they might This framework is designed to highlight what
be exposed to. Also, considering the lower cost could be the key priority areas for an MFP and
of funds available in the international market, it what kind of support and help they would need
is necessary that appropriate legislation be from various stakeholders at different levels. The
introduced to facilitate their flow.40 following chart describes the various stages of
an MFP, its requirements and the role that SBP
8.3.3 Establishment of Credit Bureaus can play at each stage.
An accredited credit bureau provides
information pertaining to the credit history of Figure 8: Recommendations Overview
clients and also provides a platform for lenders
to share information with each other in order to
avoid multiple lending to borrowers with a
history of default. Credit bureaus could be
established by a formal agency like the
Government or informally by industry players.
The establishment of credit bureaus will

considerably reduce the quantum of capital
investment dedicated to technology and its
application for KYC strategies for MFPs. This
would be beneficial to MFPs operating in urban
areas, where the proportion of individual loans
is significant when compared to group lending.
Box 6: Credit Information Bureau of India Limited (CIBIL)
Credit Information Bureau of India Limited (CIBIL) is a relevant example in this context. CIBIL
was established in 2004 and holds a database of the credit history of more than 4 million
borrowers1 across the country. CIBIL provides this information in the form of credit information
reports to its members who comprise of Banks, Financial Institutions, State Financial Corporations,
Non-Banking Financial Companies, Housing Finance Companies and Credit Card Companies.
Tighter credit checks have reduced bad loans to 3.4% of total credit as on June 2006 from 5.1% in
2005.

In the present context, most MFPs should focus could start pulling in the capital required to
on improving their internal operations and achieve significant scale.
monitoring operating costs while striving to
generate profits to fund growth targets. MFPs Once the systems are established and the
should also build and streamline their MIS operations are sustained, the MFP needs to shift
systems to achieve greater operational focus on expansion and growth in terms of
efficiency, to lower costs and to save time. Once outreach. At this stage they need to look for
the foundation is laid, the MFP can focus on various sources of funds both commercial and
expanding operations in terms of outreach. grants/ donations. This is the time when the
MFP has to leverage the capital markets for
As things stand currently, most MFPs in Pakistan raising equity as well as commercial debt
have to begin their focus internally and look to financing.
break-even in their operations and start
generating profits to fund their growth. Once an The next important stage is deposit mobilization
MFP starts generating profits, the next focus where they need to comply with various
should be on building efficiency in operations by regulations to be able to accept deposits from
establishing transparent and systematic clients. The biggest obstacle at this stage is the
processes, thus building a Management operational costs involved in mobilizing
Information System (MIS). At this stage the MFP deposits. Hence they need to find cost effective
starts proving their investment worthiness and ways of raising deposits. The following case on
Kashf Foundation explains this in greater detail.
Kashf Foundation in Stage 4

Kashf is at stage four of the above mentioned growth path. In addition to their existing structure of
a foundation they are in the process of setting up a microfinance bank. The biggest challenge at
this stage (i.e. accepting deposits) is to keep transaction costs at a minimum. In order to lower the
cost of raising deposits, Kashf is planning to implement a branchless banking model to mobilize
deposits.
The final stage involves offering a wide range of

financial services to the microfinance clients
thereby building the local economies through
livelihood promotion and job creation.

9. CONCLUSION:
In conclusion, this study focused on the global With the objective of analyzing the impact of
inflationary situation with a special emphasis on rising inflation on the operations of MFPs in
food and oil inflation and the factors that Pakistan, the paper endeavored to bring to light
contributed to these. Against this back drop, the the roles and impact of various stakeholders
current inflationary situation in Pakistan was involved in the microfinance industry. Various
studied to establish linkages with the global impact centers such as client specific,
market place and isolate Pakistan-specific factors institutional, and regulatory were identified and
that contributed to the inflationary trend. ranked based on impact (both real and
perceived) experienced due to rising inflation. It
With the specific objective of analyzing the is also evident that there is no one
impact on the Microfinance Providers, the paper recommendation to safeguard the industry from
has tried to bring to light many finer points like the ill effects of high inflation. A collaborative
differentiating riskier clients from safer clients effort of all stakeholders involved is needed to
depending on the purpose of the loans. The face the challenge. MFPs are required to
paper establishes that MFIs have not been improve their operational efficiency by reducing
insulated from the global macroeconomic cost and increasing efficiency, while the
turmoil and the repercussions are seen at all assistance of the SBP in terms of favorable
levels- client, institutional, and regulatory. policies cannot be underestimated.
Therefore, it is the collaborative effort of all of
them. The MFPs need to undertake some
immediate steps to prevent defaults and then to
improve their operational efficiency and build
institutional capacities. The MFPs would not be
able to achieve many of the targets if the
regulatory environment is not supportive. Many
of the recommendations made to MFPs in this
paper are dependent on the enabling role of the
regulators like SBP and Government assistance.
The networking organizations like the Pakistan
Microfinance Network must play a productive
role in bridging the gap among the regulators
and the MFPs.

10. ANNEXURE
10.1 Annexure 1: Key Inflation Indices
10.2 Annexure 2: List of Abbreviations

on microfinance
CONTACT INFORMATION
Pakistan Microfinance Network

132, Street # 40, F-10/4,
Islamabad, Pakistan.
Tel: +92 51 2292231, +92 51 2292270,
Fax: +92 51 2292230,
Email: info@pmn.org.pk
www.microfinanceconnect.info
Copyright © 2009 Pakistan Microfinance Network, All Rights reserved.

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Study on “Impact of food

inflation and monetary policy

Study on “Impact of food inflation and monetary policy

Copyright © 2008 Pakistan Microfinance Network,

All Rights reserved.

Authorized by Sara Saeed Khan

Impact Of Food Inflation 01

Inflation is a crucial macroeconomic variable Inflation’s co-relation to microfinance could be

Periods of excessive inflation often have a

02 Impact Of Food Inflation

Inflation around the world 2001-07 16

China Russia Brazil 2001 02 03 04 05 06 07

14.0 India Pakistan

Impact Of Food Inflation 03

Source: World Economic Outlook, IMF, April 2008

increased significantly from 37% to 67% in the

Table 2: Global price rise of wheat and rice

Commodities 2005 2006 2007* 2007 2007 2008T 2008

Wheat 100 125.8 167.4 180.3 224.3 269.9 227.3

Source: Commodity Research Bureau

04 Impact Of Food Inflation

Table 3: Demand and Supply factors affecting global food prices

Demand Factors Supply Factors

Increasing demand: Curbing exports and high export taxes:

Unseasonable Droughts & Natural Disasters:

demand and supply factors as listed in the table 80

In addition to rising food prices, rising oil prices 0

have played a part in the increase of inflation

Impact Of Food Inflation 05

Demand Factors Supply Factors

The following table lists the global oil production

Table 5: Global Oil Overview

Year Production Consumption Deficit

Source: British Petroleum

06 Impact Of Food Inflation

4.1 Pakistan Economy: Overview respectively) and the dismal performance of

7 month of July 2008. The following chart depicts

2003 2004 2005 2006 Chart 6: Inflation in Pakistan

Pakistan; political instability lead by the judicial 0

Impact Of Food Inflation 07

statistics, 38% of Pakistanis are food insecure i.e. 0 0%

intake of 2,350 kcal per day. The United Nation’s

Source: SBP Monetary Policy Statement,

Prices for key food items have seen a drastic

08 Impact Of Food Inflation

Table 6: Demand and Supply factors affecting food prices in Pakistan

Demand Factors Supply Factors

- Atta smuggling to Afghanistan though - The oil-driven economy of Pakistan is facing a

Tackling the food crisis and its resultant inflation

Impact Of Food Inflation

Table 7: Recent SBP Policy Measures

Impact Of Food Inflation

among the largest potential microfinance 6.20

markets in the world with an estimated size of Commercial

Pakistan made microfinance an explicit priority

2004 2005 2006 2007 2008 2009 2010

By the year 2010, it is expected that debt will

12 Impact Of Food Inflation

Pakistan Poverty Alleviation Fund (PPAF)

Table 1: Contribution of food and energy inflation to headline inflation

Type of Institutions Number of Active Borrowers

Source: World Economic Outlook, IMF, April 2008