Govt. & Taxes, Philippines

Saturday, October 28, 2006

Micro-credit with zero government support

Informal credits arise because of unavailability of formal credit institutions to reach out to small borrowers like farmers, fisherfolks and street vendors. In a way, these are still market solutions to credit supply-demand imbalance. The higher than usual interest rates charged by informal credit lenders compensate for their innovation and risks for lending to small borrowers with zero paper work. After all, a 100% per annum (p.a.) interest rate for a loan is better than 10% p.a. interest rate but is not available to prospective borrowers.

One such variety of informal credits practiced in rural Philippines is called "tampa" system. It is practiced in some towns in Pangasinan province, I do not know where else. The system goes like this: for every P1,000 loan, a farmer pays back 3 cavans of "palay" or unmilled rice at the end of the harvest season which is 4 months. Depending on the lender, a cavan would be 46 to 50 kilos or more. Friendly lenders charge only 46-48 kilos x 3 cavans of palay, average lenders charge 50 kilos x 3 cavans, while notorious lenders charge more than 50 kilos x 3 cavans.

The lenders normally are just neighbors of the farmers, those who have enough savings, or those who have at least one household member working abroad (overseas Filipino workers or OFWs), or other sources of income aside from rice farming.

Interest earning by the lenders depend on what month they would sell the palay paid to them by the farmer-borrowers. The bulk of palay harvest is during the “ber” months (September to December) harvest period. Where supply is high relative to demand, price is low, around P8-P10/kilo. So many lenders get the palay, stock it either in their own house storage, or pay storage fee of P5/cavan somewhere, regardless of how many months the palay will be stored. When harvest is lean (during the months of March to July), palay price is high, from P12 to P15 per kilo, then they sell the palay or mill it and sell it as rice.

Effective interest rates: If the lender sells the palay during peak harvest season ("ber" months), revenue would be (assuming a 50 kilos/cavan, the predominant rate):

P8/kilo x 50 kilos/cavan x 3 cavans
= P1,200 or 20% interest over 4 months, roughly 5% per month.

If the lender waits for a higher price of P12-P15/kilo during lean harvest months (especially June-July), just stock the palay in storage for 9 months (October to June), interest rate would be (taking a mid-price of P13.50 a kilo):

P13.50/kilo x 50 kilos/cavan x 3 cavans
= P2,025 or 102.5% interest over 13 months
(4 months planting period + 9 months storage) or 7.9% per month.

Repayment rate is generally high, from 90% to 100%. In cases where super-typhoons would wipe out the harvestable rice, then payment will be postponed for the next cropping season. Or if the farmer encounters deep personal financial problems, say one family member would get sick and medical/hospital bill is high. For persistent lenders who demand prompt payment of the loan despite said misfortunes, some substitutes are accepted like farm animals (cow, carabao, pigs, chicken, goats).

Is the system effective?
I say YES, because of the following reasons:
(a) High repayment rate, unless natural calamities or personal tragedies would occur. The risk of being “black-listed” by other neighbor-lenders, plus bad reputation as someone who does not pay borrowed money, is enough factor for farmers to pay back the loan on time.

(b) No taxpayers money is spent and no government bureaucracy is involved. Usually there is “moral hazards” problem when farmers know that credit is from government, many usually don't pay back, they come up with various reasons and alibis for not paying.

(c) Lenders (neighbors) can easily determine credit-worthiness of farmer-borrowers. So information gathering is cheap if not free.

One may argue that the system is not effective since effective interest rates are still high and hence, detrimental to farmer borrowers. This is somehow true but as mentioned above, a 100% p.a. interest rate but available loan is better than a 10% p.a. interest rate but unavailable loan. The key is to expand competition. Individuals, whether within or outside the village (the "barangay") with surplus savings can help by joining the credit-supply competition. Getting even just 2% interest rate per month (24% p.a.) is actually higher than usual bank savings interest rate of 1-3% p.a., minus government's 20% withholding tax on interest earnings.

By the way, why would the (Philippine) government get 1/5 of interest earnings of an already small savings interest rate? Not only that government implicitly discourages hard work (through "progressive" personal income tax system) but also discourages personal savings in banks.