Once relatively insulated from the world’s financial system, the microfinance industry is finding itself more closely tied to the capital markets than ever before. As a result, it is far from being immune to the current financial crisis, and some microfinance institutions (MFIs) are beginning to see their cost of borrowing go up as a consequence of the global credit crunch.
One reason for the higher cost is the lack of liquidity in both domestic and international capital markets. The global flight to quality has hurt developing economies, making it much more difficult for the governments of these countries to raise money. Since September, spreads on sovereign credit default swaps – widely accepted as an indicator of the market’s perception of the credit quality of sovereign debt – have risen across the board. Among the hardest hit are countries with a substantial amount of microfinance activity, including Argentina, Russia, Indonesia, Ukraine, Ecuador, Peru, Egypt, South Africa, Kazakhstan, Turkey, Romania and Bulgaria. Given the higher spreads, MFIs in these and other countries can expect a tougher time accessing domestic sources of capital in the coming months.
Another reason is market volatility, which increases the cost of hedging foreign exchange risk. MFIs that tap the international capital markets will have to pay more for local currency loans. Take the example of Peru. Three months ago, a microfinance investment vehicle (MIV) could charge an MFI roughly 11.3 percent for a one-year loan in PEN in order to achieve the equivalent of a 10 percent return in USD. Now, in order to achieve the same rate of USD return, the MIV would have to charge over 15 percent.
In the past, MFIs have avoided the cost of hedging by borrowing in hard currency (indeed, many were able to benefit from a steadily depreciating USD over the past five years), but hard currency loans are essentially ticking time bombs, especially in the current environment. Recently, the Brazilian real and Mexican peso have depreciated very rapidly, with the USD-BRL exchange rate rising more than 40 percent since the beginning of September. Other currencies like the Colombian peso and Romanian leu have depreciated significantly as well, albeit over slightly longer periods of time.
Given these challenging conditions, we anticipate MFIs will have to pay substantially higher rates in order to borrow both domestically and internationally in the coming weeks and possibly months. Exactly how these higher rates and general lack of liquidity in the global capital market will affect end borrowers remains to be seen.
Konstantin Andreev and Pamela Young, Cygma
Since January 2008, Cygma has been advising microfinance and SME (small and medium enterprise) investment vehicles and microfinance institutions on all aspects of foreign exchange risk in emerging market currencies. Cygma developed out of the collaborative efforts of Chatham Financial – a capital markets consulting firm specializing in interest rate and foreign exchange hedging – and other microfinance players, including responsAbility, Opportunity International and MicroVest. For more information, call +1 484 731 0199.
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In the past, MFIs have avoided the cost of hedging by borrowing in hard currency (indeed, many were able to benefit from a steadily depreciating USD over the past five years), but hard currency loans are essentially ticking time bombs, especially in the current environment. Recently, the Brazilian real and Mexican peso have depreciated very rapidly, with the USD-BRL exchange rate rising more than 40 percent since the beginning of September. Other currencies like the Colombian peso and Romanian leu have depreciated significantly as well, albeit over slightly longer periods of time.