MICROFINANCE MATTERS - Report from the Field: Microfinance Plays Strong Role in Mongolia's Poverty Reduction Strategy

With the economic transition of the early 1990s, Mongolia launched ambitious reforms to restructure the banking system for participation in a free-market economy. However, the rapid nature of the transition, and low financial literacy among Mongolian clients led to a mid-1990s banking crisis with the rate of non-performing loans reaching 47% and a wave of major bank insolvencies.[1] In the years that followed, the banking system was dramatically reformed with critical revisions to the legal environment as well as substantial assistance from international organizations. It was during this period that microfinance in Mongolia was born. Both as a direct financing methodology for poor people and as an alternative to traditional banking strategies, microfinance has quickly become one of the leading approaches for reducing the considerable national poverty rate of 36%.[2]

According to the most recent Sub-Sector Review of Microfinance in Mongolia published by the United Nations Development Programme (UNDP), the past seven years have seen significant growth in the microfinance sector. There are now over 1,600 formal financial intermediaries in Mongolia, which is approximately one for every 366 families.[3] Loan outreach has increased, with 26% of all households now accessing some form of microcredit, up from only 1% in 1998. Likewise, savings has also increased, with an increase in the Deposit-to-GDP ratio from 19.9% to 42.0% in just the last four years. There have also been noticeable improvements in credit discipline, product demand, and consumer confidence in the finance sector.

The Economy and the National Poverty Reduction Strategy

As the financial sector has recovered, so has the growth of Mongolia's economy as a whole. After volatile GDP growth in the late 1990s and early 2000s, (due to commodity price fluctuations and a currency crisis in Russia), Mongolia's GDP has rebounded to an astounding 10.5% growth rate in 2004. While much of the value of the economy is in larger agricultural and industrial sectors, 96.1% of all registered businesses are microenterprises and small- and medium sized enterprises (SMEs), which provide over 80% of national employment.[4] As the private sector and the role of microenterprises and SMEs have grown, the growth strategy for the Government of Mongolia as well as donors has broadened from sectoral development to include the creation of an enabling business environment and support for the robust growth of SMEs.

This has also become a natural foundation for Mongolia's poverty reduction strategy. With the formal adoption of its own Millennium Development Goals (MDGs) for attainment by 2015, the Government of Mongolia sought a pro-poor, pro-growth economic solution. Accordingly, the Mongolian Economic Growth Support and Poverty Reduction Strategy (EGSPRS), released in September 2003, was developed with a clear target to support the growth of SMEs in order to spread economic development across the majority of the population. Moreover, in line with the increasing focus on private sector development, the EGSPRS places a special emphasis on microfinance, stating that "maturing markets, growing business incomes and profits, operating non-agricultural small and middle-size enterprises, and shrinking flows of rural-to-urban migration are impossible without accessible financial services." As such, microfinance is likely to become key to both future economic growth and poverty reduction.

The EGSPRS and Microfinance

Regarding microfinance, the EGSPRS focuses on improving the legal and regulatory environment, developing competition, and increasing outreach (especially to rural areas). In terms of the legal and regulatory environment, the EGSPRS encourages the "intensification of structural reforms" that build off of the financial sector reform laws of the late 1990s and early 2000s. This includes further privatization of state owned commercial banks, as well as strengthening laws concerning the pursuit of collateral claims, while reducing licensing and registering laws for business creation.

A further change to the business environment was suggested by encouraging competition among financial intermediaries as a way to extend its outreach to rural areas and SMEs. The EGSPRS is also explicit in its position that the expansion of financial services is most effective through increased competition, and as such, there is a clear focus on increasing the role of non-bank financial institutions (NBFIs) and Savings and Loans Cooperatives through changes in financial sector policy. Moreover, laws regarding securities markets, savings, and insurance were proposed to expand the scope of potential financial products and services.

Finally, the EGSPRS encourages the government to re-orient policy priorities towards those population groups most affected by natural disasters through expanding financial and banking services in rural areas, and "developing small and middle-size enterprises". This is a tone that is prevalent throughout the document where the microfinance sector is directed to diversify loans and other products (e.g.., insurance)) for the direct benefit of herders and other rural SME owners. Reaching out to the most vulnerable poor, those farthest from urban financial centers, is central to the poverty reduction strategy.

Development of the EGSPRS

To incorporate microfinance into the EGSPRS, Mongolia took an intensive, participatory approach. The Government of Mongolia set up a working group consisting of multiple stakeholders including all concerned ministries, leaders of major financial institutions, and others. Interestingly, this overall development strategy was mainly the scope of the Ministry of Industry and Trade, but the Ministry of Social Welfare and Labor took an active role in bringing SMEs to the table and addressing issues such as microfinance and employment. Together, the heads of the two ministries collaborated to develop a strategy that utilized small businesses in developing a macroeconomic approach to poverty reduction. Additionally, the Bank of Mongolia exercised its leadership to make recommendations for the legal and regulatory environment which were also incorporated by the policy makers.

In formulating these strategies, however, a few key challenges have emerged. The increased focus on competition between financial intermediaries might lead to a near-saturation point in the market at some point and could potentially overheat the sector. Some officials in the banking sector argue that excessive competition is decreasing the profitability necessary to reinvest into new product offerings. Another challenge relates to the enforcement of legal reforms. Although new laws have theoretically strengthened financial institutions, the inability of the judicial system to adequately enforce contracts and pursue offenders is inhibiting the full positive effects of these laws on the microfinance system. Ultimately, further reforms may be needed to develop a legal apparatus that will support the steady growth of microfinance in Mongolia.

Implementation of the EGSPRS

Mongolia has been quite aggressive in addressing these issues and supporting microfinance's role in SME development and resulting poverty alleviation through the implementation of the EGSPRS. Many legal reforms regarding NBFI registration, legal claims to collateral, and business licensing have made it on the books with tangible results. In addition, the newly developed National Coordinating Committee of the International Year of Microcredit and UNDP has jointly organized a "National Summit on Microcredit and Entrepreneurship" in tandem with the global launch of the Year. This event attracted nationwide interest, and was attended by over 1,400 national and international participants. In addition, the Summit created strong momentum to strengthen microfinance and entrepreneurship for poverty alleviation. Consequently, the government of Mongolia declared 2005 the National Year of Promotion of Microfinance and Entrepreneurship and launched a new National Programme in support of SMEs. These positive steps forward continue to strengthen the role of microfinance in poverty reduction.

Lessons Learned

All stakeholders in the EGPRSP process, regardless of background and interests, acknowledged the importance of microfinance in poverty alleviation. Observing the achievements of microfinance in Mongolia, participants agreed to focus not only on the financial issues of the sector but to broaden the potential for microfinance to succeed in various aspects of private sector development. The further success of microfinance and the attainment of goal 1 of the MDGs, poverty alleviation, will depend on the cooperation among all these stakeholders.

Issues for the Next EGSPRS

The current EGSPRS will expire in 2006, which will require a new vision for poverty reduction in Mongolia. In order to craft this vision, there is a distinct need to ascertain the impact of microfinance on poverty alleviation. Currently there is no quantifiable data on the role of microfinance, although there is a wealth of client success stories that support microfinance's success. This is especially important since some poverty rate indices show slight increases in poverty in Mongolia over the past five years. Thus it is necessary to understand how credit is being used (i.e., consumption vs. enterprise improvements) in order to assess types of reforms or incentives that might be needed to better utilize credit for poverty reduction.

Another future consideration for the EGSPRS should be reforms that reduce the cost of doing business for Mongolian microentrepreneurs. While there has been some policy success with issues like business licensing, there can be more advances in registering property, starting and closing a business, and in labor relations that will reduce these costs. Currently UNDP and the Government of Mongolia have launched the Enterprise Mongolia programmme which is a series of initiatives that develop capacity for local entrepreneurs, and identify policy issues that can improve the environment for microenterprises and SMEs. Through this programme and others, further additions to the new EGSPRS can be made to empower entrepreneurs and better utilize tools like microfinance to reduce poverty in Mongolia.

(1) Country Profile: Mongolia 2004, World Bank.

(2) Living Standards Measurement Survey, 1998, Mongolian National Statistical Office.

(3) Sub-Sector Review of Microfinance in Mongolia, 2005, UNDP Mongolia.

(4) Statistical Yearbook, 2004, Mongolian National Statistical Office.