The country is living beyond its means. There are persistent twin deficits. Real terms interest rates are negative and have been for an extended period of time, as inflation remains stubbornly high. A leading rating agency has voiced concerns about the country's fiscal outlook and the Finance Minister has publically said "there is no need to panic". And yet there is policy gridlock.

This could be Britain. Or the US. Or France. Or one of several other G20 countries. But it is true in India also – and has been for a long time. But I think India is different.

First, inflation has been persistently high because of structural supply-side problems and steep falls in the rupee – a 16 per cent fall in 2011, and more than 4 per cent in 2012. This has widened the current account deficit and eaten in foreign exchange reserves, which are the poorest in the BRIC nations. India has foreign currency reserves to cover only about six months of current account payments, down from eight months in 2009. Second, growth is slowing and green shoots are not evident. Economic growth in 2012 was the slowest for a decade and Credit Agricole CIB thinks financial markets are pricing in an increasing likelihood that India's credit rating will soon be downgraded to junk. Third, add in state deficits to the central government figures, and the problem is not only worse, but clearly perennial. Fourth, political gridlock has hampered progress. Divestment policies, or those that encourage investment in the private sector, or raise revenue such as a general sales tax, are being blocked by the compulsions of a coalition government.

The fourth point underpins the others. According to the watchdog PRS Legislative Research, 30 per cent of Parliament's time in 2011 was lost due to disruptions. In 2012, Parliament has behaved itself better, but only just – I watched much of the session of Parliament where Bahujan Samajwadi Party (BSP) leader Mayawati did a volte face with her support of the government's FDI in multi-brand retail bill, and it provided more drama than a Hitchcock movie. But this isn't new – Kapur and Mehta of the UN Research Institute for Social Development, writing in 2006, with data to 2002, found that historically "much of Parliament's time is wasted on rowdiness and disorder and theatrics".

But let's be clear. India is doing poorly, but this could be Britain, US, France or one of several other G20 countries. In Britain, Gordon Brown's Golden Rule of fiscal policy was all but abandoned in 2005, eight years after introduction. The eurozone crisis probably would not have happened had France, Germany and Italy not deliberately reneged on their own Stability and Growth Pact such that the pact all but died, again, in 2005, aged eight.

In the US, Congress is in the position of wanting to do lots of things but without being willing to spend the money required to do so. The Bush tax cuts, extended by President Barack Obama, did almost as much to add to the deficit in the period 2001-12, as the Iraq and Afghanistan wars (both figures are almost exactly equal to the amount the fiscal cliff requires the federal government to cut spending).

Let's be further clear. Britain's economy may well see a triple-dip recession. The Economist declared of Europe and America just this month: "American turns European: A broken system, a lousy deal and no end in sight..."

In India, the end is more in sight. Unusually, gold accounts for 80 per cent of the current-account deficit, according to Reserve Bank of India deputy governor Subir Gokarn. After the Fiscal Responsibility and Budget Management Act (FRBM) was passed in Parliament in 2004 (which capped the deficit at 3 per cent and zero deficit to finance current expenditure by 2008/09) the budget deficit was around 3.5 per cent of GDP for several years. After shooting up to 7.8 per cent in 2009, it has fallen to 6.9 per cent, 5.1 per cent and 4.6 per cent in subsequent years. Once the cyclical proportion of this is corrected, a structural deficit will remain, driven by the 2.5 per cent of GDP that are handed out in subsidies. But given the election countdown timer has started, this is unlikely to be cut. This and a multitude of moral hazard issues in the political system mean the central government and states will never realistically balance their budgets.

"India is all about homegrown, self-inflicted injuries," said Rajeev Malik, senior economist in Singapore with CLSA Asia-Pacific Markets.

But consider this. Tim Harford says that Frances Zelazny of the Center for Global Development estimated an iris-scanning system in Andhra Pradesh paid for itself in merely a month after reducing fraudulent poverty reduction payouts. The influential economics blog Marginal Revolution says the Aadhar scheme is the "most important economic policy in the world". Imagine the positive impact Aadhar, the introduction of a general sales tax, lower subsidies and welcoming more foreign investment could have on all the red ink above.

Pratik Dattani is managing director of EPG Economic and Strategy Consulting and also runs a large not-for-profit organisation with strong links to India. He is an economist whose work focuses on helping organisations and investors understand social returns and impact investments.

More info: www.economicpolicygroup.com

The recently held Microfinance India Summit 2012 (http://microfinanceindia.org), started with an insightful valedictory speech delivered by the Indian minister of rural development, Jairam Ramesh. He extensively discussed why “microfinance in India has been discredited” and how it “raised many more questions recently than it answered”.

As commendable as the minister’s knowledge is about the past and current conduct of microfinance in India, in particular that of Andhra Pradesh, his views only represent half of the story.

Financial inclusion, poverty alleviation, or both?

The other half of truth lies in understanding what purpose microfinance is meant to serve and how well it was able to deliver so far in serving its original intentions.

At the end of the day, a majority of the MFIs (Microfinance Institutions) – at least when it comes to outreach (i.e. the number of people it has managed to involve) – are NBFCs (Non-Banking Financial Companies); they are privately-owned commercial outfits, led by highly-skilled banking professionals. Thus one would assume that they share the same standards of operation as any other company within India Inc, regardless of industry or sector.

By this we mean that there is robust technology to assist efficiency and accountability, there is highly-skilled second-tier management and board of directors and, most importantly, a total focus on the customer’s needs, including client protection.

When it comes to strategic focus or with a less popular expression, the development goals (double bottom line), microfinance was meant to ensure financial inclusion. While this term intrinsically suggests that the aim is to deliver financial services to those segments of the society that were not and will not be served by traditional financial institutions, many freely substitute the term financial inclusion with poverty alleviation. This is where all the problems start because it provides us with an elusive territory, which can swallow everything from doing good to establishing social businesses, from fostering grassroots entrepreneurship to accelerating economic growth.

In theory, and unfortunately often in practice, many practitioners and authors borrow the term microfinance to gain their brownie points in the development sector.

Defining indicators of success – who is ‘included’ and ‘empowered’?

One potential analogy of social indicators and how misleading the achievements of the microfinance sector could be is the measurement of literacy rates across India. Literacy is given a definition by policymakers by the ability to communicate in reading and writing in any language. The statistics show that since the British rule, India’s literacy rate increased six-fold from 12 per cent to 74 per cent (2011). This is indeed commendable, provided that acknowledging literacy doesn’t stop at one’s ability to write his/her own name at the age of seven.

Similarly in microfinance, the outreach numbers show 35 per cent (MCRIL Microfinance Review 2012) of those who are potential customers of the sector once in their lifetime received a loan, or were members of an microfinance entity and successfully repaid their loans. Leave alone those cases when eight institutions lend to the same group of women in a given village. Does financial inclusion really exhaust itself in getting or accepting a loan? Is borrowing from the moneylender also part of financial inclusion? What about encouraging savings and the ability to deposit it somewhere other than under the mattress or the saree of the women entrepreneurs? Were we able to provide for the latter in the past 20 years?

India’s contribution to the global microfinance sector – where to go from here?

Local governments would argue that by all means with the Self Help Group (SHG) – Bank linkage program (the truly remarkable community development tool of National Bank of Agriculture and Rural Development or NABARD, which aimed at fostering women empowerment and providing a platform for social and financial inclusion, lived up to its promise and performed so well that it is worth spending another Rs 15,000 crores on it next year. (Reference: The Indian environment minister’s speech on the MF Summit)

Although the SHG programs have contributed a great deal to spreading microfinance in India and around the world, they failed to achieve what the commercial MFIs and for that matter the local moneylenders also provided – quick access to reasonable amounts of cash for running businesses. Was it able to serve as a platform or distribution channel to participate in India’s economic success?

Take for instance a woman entrepreneur who runs a jewellery-making business versus one who farms goats. While they are both small entrepreneurs from the same social strata their cash flow and manpower needs are very different along with their income seasonality. As MFIs in most cases provide one type of product, which they call a “business loan”, even if it is often used for other purposes, it is a standardised loan for the sake of organisational efficiency. Hence do not focus on the cash flow needs of the businesses or the households. This leads to the small enterpreneurs borrowing from multiple resources, and if they are financially literate one would only hope that they can estimate how many such loans their households will be able to absorb without burdening their monthly budget.

In many cases, unfortunately, they aren’t able to decide on this. Similarly, the lack of assurance that they fully understand the terms of their loan contract or their vulnerability to repay in case of any emergency is a logical and obvious recipe for a sectoral disaster. Even more so, if we approach the issue from the MFI’s angle.

Are MFIs built to last?

It quickly becomes clear that neither the long-awaited Microfinance Bill 2012 (draft is ready and scheduled to be discussed in the Indian Parliament) nor the expectations of their investors will pave the way for successful and sustainable financial inclusion. Many institutions and policymakers believe that simply by passing the bill the anomalies of the sector will suddenly disappear. Investors also tend to believe that making quick bucks as it was the case between 2007 and 2010 is still feasible as the market is not yet well penetrated.

Unless, the necessary professionalisation, increased governance standards, high-end technology, and, most importantly, reasonably targeted profit numbers are put in place, it is the poor who will need to pay the highest price and will remain financially excluded.

Video: http://www.facebook.com/photo.php?v=10151274701719728&set=vb.832549727&type=3&theater

(This article is the first in a series discussing the perils of the Indian microfinance sector, and attempts to suggest ways to improve its performance.)

Neishaa Gharat is the voluntary director of Project Crayons UK – a UK charity that supports children, young people and women in India through knowledge sharing, enabling partnerships, collaborations, fundraising and volunteering opportunities. In this regular Shades of Money column, she will be exploring aspects of socially viable growth prospects in an increasingly globalised world.

She invited Anna Somos Krishnan to share her thinking about microfinance in India through a series of thought provoking articles. Anna is currently an independent economic and social development consultant based out of Hungary and India. She has assisted the operations one of Hungary’s first microfinance establishment and headed their strategic unit between 2010 and 2012. Prior to this she worked extensively in the Indian microfinance sector as the executive director of Planet Finance India, an independent development consultancy firm.

Contact:  This e-mail address is being protected from spambots. You need JavaScript enabled to view it  and This e-mail address is being protected from spambots. You need JavaScript enabled to view it to share your views

projectcrayonsindia.org / neishaagharat.com

Social Enterprise – can it mean different things in India and Britain?

According to the Indian ministry of corporate affairs, there are 2,487 registered social enterprises in the country (2011). That is one for every 500,000 people in India.

According to the UK's Department for Business, Innovation and Skills (BIS), there are 68,000 social enterprises in Britain (2008). That is one for every 890 people in Britain.

According to Social Enterprise UK, a social enterprise is a business that trades specifically to "make a difference" and has a social and/or environmental purpose, earns money through income (rather than grants or donations), and reinvests the majority of its profits.

It is clear India has far greater social issues that these companies could address than Britain – 53 per cent of India's employment is in agriculture, compared to only 19 per cent of its GDP; 41 per cent of the population lives below the poverty line of $1.25 per day. Adult literacy rate is 63 per cent. In fact mortality is 50 in 1,000 births. So, why the difference?

At least part of this is to do with methodolical differences – in Britain, there are a number of legal and group hybrid structures. Managing director of the Social Enterprise Mark (SEM), Lucy Findlay, believes many organisations may claim to be social enterprises, but may simply not understand what that really means. But because the term is the new "in" thing, they err on the side of claiming it, rather than not. In reality, some organisations may not understand what the SEM means by social enterprise, given that qualifying for its very specific definition often depends more on a clever accountant, than a social purpose.

In India, while there aren't the myriad of structures, what is present is sufficiently complex. An Indian accountant would call social enterprises "Section 25" companies, per the Companies Act 1956. These are companies which are incorporated for promoting art, commerce, science, religion or any other charitable object. They need a minimum authorised share capital of Rs 100,000 and all profit must be reinvested for the promotion of its objects (SEM requires more than 50 per cent). The regulatory structure is lighter touch than for for-profit companies but offers better transparency than a trust or society structure. It may receive donations from its members (SEM says these need to be less than 50 per cent).

However, the government has the right to revoke the Section 25 license and force the enterprise to become an ordinary company. An ordinary private or public limited company can apply for a license to be a Section 25 company, but not the other way around. It cannot distribute profits as dividends to members, whereas certain types of social enterprises in Britain can. Closing a Section 25 company can often take up to two years.

These legal complications rather obfuscate the real purpose behind social enterprises. As I've argued in the past, or as the Asian Development Bank (ADB) outlines in its report on India's Social Enterprise Landscape earlier this year, social enterprises should more simply be defined as: organisations with a triple bottom line, in that they address social and environmental needs and have a sustainable revenue model (or plan to have one in the near future). The ADB emphasises that a focus on legal structure complicates, and limits, the sector.

In a Financial Times article on social entrepreneurship in India earlier this year, the definition was closer to that of the ADB: doing something socially relevant, not simply a charity, and for-profit. Smart young Indians from business schools who want to tackle India's monumental development problems, but make money too, are finding this kind of definition particularly appealing.

Google Trends shows that the term "social enterprise" has entered the psyche in recent years in particularly the southern states in India, namely Karnataka and Andhra Pradesh, with a similar trend followed by "social impact" and "Section 25 companies", although there is far richer data on the increasing awareness of social impact in North India, particularly in Uttar Pradesh, Madhya Pradesh and Rajasthan.

The sector press in Britain argues about what it all means on a regular basis, in a battle between purists like Lucy Findlay and entrepreneurs not wanting to be encumbered by definitions. In India, from the 50-year-old FabIndia, to Shahrukh Khan's engineering feats in the film Swades, to modern day jugaad innovators like Husk Power Systems, marrying entrepreneurship with social purpose has been part of life. The current draft of the Companies Bill 2011, scheduled for introduction in the current Winter Session of Parliament, will clear many of the cobwebs in the Companies Act 1956. Amongst this may be new norms around company spend on Corporate Social Responsibility (CSR). This may well bring social enterprises and worthwhile causes even further into the national psyche.

Pratik Dattani is managing director of EPG Economic and Strategy Consulting and also runs a large not-for-profit organisation with strong links to India. He is an economist whose work focuses on helping organisations and investors understand social returns and impact investments.

More info: www.economicpolicygroup.com

  Guest Column  

Gujarat - Beyond the hype

by Shiv Morjaria

A panoramic view of the Modi growth story.