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Microfinance and SMEs in Tanzanias economy

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INTRODUCTION

This essay analyses the influence of microfinance to the growth of SMEs in Tanzania. In most of emerging economies small and medium enterprises (SME`s) are considered important for creating employment and contribution to private sector development they are recognized as they continue to play an important role in economic development of any country due to their ability to raise incomes and creation of jobs in environments with scarce economic opportunities.

These SME can either be in a form of business operations - selling goods or services or investments i.e. poultry and small manufacturing industries.

Furthermore they are considered to be a very important resource for their contribution to eliminate poverty and creating jobs. Davies, et al (2002) states that, the immediate goal for any small to medium-sized enterprise (SME) is to survive and maintain its independence. But, sooner or later, a small company will probably want to expand. Growth means entering the market in a wide coverage.

The aim of this paper is to examine the growth strategies and problem facing most of SMEs, and will investigate the role of strategies on which can be improve growth performance of SMEs.

Among the problems they face is inability to grow. SMEs growth depend to a large extent on the financial assistance obtained internally or externally, internal sources of funds are generated from business operations or fund from owner themselves, due to the fact that most of the time these funds are not enough external finance become important, external sources include, funds from family members or friends, debts financing from financial institutions such as Microfinance institutions. .

Currently In Tanzania there is a number of microfinance institutions these are financial NGOs, i.e FINCA, PRIDE, SEDA and others , also banks do provide microfinance services i.e ACB,CRDB,NBC apart from them government institutions i.e RFSP,SELF work jointly in providing microfinance loans to SMEs

It is triggered by the thinking that lack of enough fund is one of the hindrance to the growth of SME'sThe role of microfinance institutions is to fund economic activities through the SMEs established by Tanzanians to generate funds that reduce the poverty among Tanzanians.

The question explored in the study was to look into the influence of microfinance to the growth of SME in Tanzania. More specifically the hypothesis of the study was to see whether the growth of SME in Tanzania is directly related to the services they obtained from SME's.

As the tools for the study; various framework, theories and models regarding the concept of SME and microfinance are explored, analyzed and conclusion drawn.

1.1 Background

Tanzania government has opted to achieve the Millenium Development goal through microfinance. For that reason microfinance has been viewed / considered to be one of the ways in which poverty can be reduced in poor countries, where by poor people will be able to get financial services to satisfy their unmet needs. In Tanzania, much progress has been made in developing a viable, commercial microfinance sector in the last few decades as a solution to the problem of poverty, (Millennium development goal).

Literatures has been indicated that micro finance is potential tool to contribute considerably to the economic development of the country, Tanzania is like many other developing countries and is classified as the poorest nation . according to household budget survey (HBS), the most commonly measure for poverty analysis , depicted that in year 2001/2 about 34% of the population was considered to be poor and 82% of the poor were in rural areas, (poverty eradication paper, 2002). Therefore by extending credit to SMEs will offer so many benefits i.e. creation of employment, expanding business, improving standard of living, capacities in investing as well as saving to the people in the country hence development of the nation.

CONCEPTUAL FRAMEWORK

Meaning of micro finance

Microfinance refers to the extension of small amounts of collateral free institutional loans to jointly liable poor group members for the self employment and income generation (Rahman, 2001).

"Microfinance is bringing credit, savings and other necessary financial services inside the reach of people who are too poor to be served with normal banks, as they are unable to provide adequate collateral.

Generally, banks are for those who have money and not for the people who are without money. (Gert van Maanen, Microcredit: Sound Business or Development Instrument, Oikocredit , 2004)

"Microfinance is based on the idea that poor people have expertise which is unutilized or underutilized. The lack of skills is not what makes people poor. Aid is not the e answer to poverty, but only it helps poverty to continue. It makes dependency and takes away the people's initiatives to break through poverty. Unleash of creativity and energy in human being is the answer to poverty." (Muhammad Yunus, Expanding Microcredit outreach to reach the Millennium Development Goals, International Seminar on attacking Poverty with Microcredit, Dhaka, Bangladesh January, 2003)

Micro finance institutions.

Mayoy (1999) has defined MFIs as a sector of formal and informal financial institutions provide financial services to micro economic units. The terms are used as umbrella terms to refer to the range of services such as credits, savings and other financial services like pension and insurance.

The World Bank (1998), defines MFIs as agents and organizations that engage in relatively small financial transactions using specialized as well as character based methodologies to serve lower income households, micro enterprises, small farmers and others who lack access to the bank's system. They may be informal, semi formal (that is legal registered but not under central bank regulations), or formal financial intermediaries.

Micro and Small Enterprises.

URT (20002), defined small and micro enterprises as those lacking access to financial services from mainstream financial institutions. Generally the definition of micro-small business enterprises is extremely diversified in such a way that definition used depends on various measure of size; depend on the purpose and the reasons. Doing the measuring for instance, in United Kingdom the definition of for small could be range from 5 to 2000 employees depending on the industrial

sector, (Kibera 1996)

In Tanzania context, small and medium enterprises are those which consist up to four people in many cases family members, The popularity of small and medium enterprise are in informal sector, they are mostly formed by engaging between 5 and 49 employees with the employing capital of 4M to 200M to 800M. (SME Policy 2003).

2.1 Microfinance development in Tanzania

In Tanzania micro finance is in its infancy, but growing fast, in late 1960s after the Arusha declaration, Tanzania government establish financial institutions to assist the poor farmers and small scale enterprises they were NBC and CRDB. Before restructuring, statistics indicates that the informal sector accounted for 80% of non farm employment, (Rutashobya 1991), only 0.4% or about 8000 people obtained their credit from formal banks, those who obtained their credits from cooperative societies or saving and credit cooperative organisations. and also due to the recognition of the role of the private sector including the dynamic role of micro and small enterprises (Chijoriga 2001).

Micro financing institutions such as credit granting, provide micro or small loans without collateral at market interest rates or slightly above them to small scale clientele, mostly non farm enterprises, typically, the MFIs enable to extend loans based on the borrower's cash flow and to tailor-fit the loan repayments in accordance with cash flows. It follows the simplest documentation leading mechanisms such us peer pressure, and joint liability groups to ensure borrower discipline, incentives to motivate clients' good behavior, good loan offers, and threat of cancellation of future loans for defaulting borrowers, among others, (Liento 2003)

Micro finance institutions currently found in Tanzania

According to currently literatures, micro finance business emerged in Tanzania either as micro finance institutions or financial NGOs, i.e. FINCA, PRIDE SEDA, and others, also some of the banks do provide micro finance services i.e. CRDB, NBC, ACB and others, apart from them institutions the government also is no left behind on this war against poverty eradication, its provide micro finance loans to its people i.e. through TASAF, SELF, RFSP, all these institutions and various government programs work jointly so that to eradicate poverty.

Despite the establishment of number of Microfinance institutions in Tanzania, the poverty burden continues to weight heavily on Tanzanians and more specially those living in the rural areas (Fraser and Kazi 2004). The above statement leads us to a question why poverty rate increase despite of the increase in number of MFI's. the question rise from the above statement is that is microfinance solution to the growth of SMEs?

2.2 The role of microfinance in Tanzania

Nowadays, micro finance is seen as one of the alternative tools in poverty alleviation, i.e. more than just pure banking business. However, the different players in the micro finance field (NGO's, co-operatives and financial institutions) have their own emphasis and not all of them have poverty reduction and the advancement of freedom as an ultimate goal. Micro finance non-governmental organizations (micro finance NGO's) in this sense are very interesting research objects since they are supposed to have a double mission: on one hand, NGO's are actors of the civil society with social goals and their mission is not to make profit unlike commercial enterprises. On the other hand, the financial performance, especially financial sustainability, is important for micro finance institutions to survive in the long run.

Some Micro finance institutions borrow money from banks with high interest rates of which they have to charge also high interest rates to their clients to break even. Others use savings of the borrowers to offer credit to their clients (Ministry of Finance, 2000). The Bank of Tanzania as a regulator of these institutions does not allow this system. Some MFI's have designed a system, which does not involve the use of borrowers' money of which they use Loan insurance funds as savings.

THEORETICAL FRAMEWORK FOR SMALL BUSINESS DEVELOPMENT

Over the last few years, many African countries have moved or are in the process of moving toward western type political democracies with their economies from socialist based to capitalist/free market oriented economies. These transitions however, are not smooth. They are associated with painful economic and social consequences. People in third world, most of the time carry the burden of these transitions' consequences. People, i.e. impact of structural adjustment programme (SAP).

In this regard the informal sector through the small businesses will be the ones to create the needed jobs for their ever growing population and hence to take advantage of the situation. To get the economies moving on the road to sustainable growth with equity, African countries need to take critical look at the past experience, present constraints and future prospects for small and medium business development. (URT, 2001).

3.1 The Role SMEs in the Economy.

SMEs are considered to have great potential for making the highest contribution to employment growth through labour intensive technologies to reveal an immediate impact on the employment generation (ILO, 1993 and Kitine 2000). SMEs contribution is to increase income, saving and encouragement to business ownership and management at enterprise level. About 70%of people in sub Saharan Africa rely on the small enterprises for their livelihood, (Rutashobya 1995, Masawe 2000).

In Tanzania, small and medium business contributes substantially to the country's GNP and employment in the country (Olomi 2001, URT 2001). However SMEs about 1/3 of the GDP of the country and that about 20% of the labour force is employed by the sector (URT, 2001). However SME sector in Tanzania is not centrally documented to find reliable data on the stated estimates (word bank, 2000).

3.2 Importance of SMEs in Economy.

SMEs tend to be more effective in the utilization of local resources using simple and affordable technology, by so doing they add value to local resources, Tanzania is endowed with abundant of natural resources which are yet to be fully tapped, on the other hand , development of SMEs facilitates distribution of economic activities within the economy and that fosters equitable income distribution .that means SMEs are used as engine of producing indigenous people in the business, and therefore they used to distribute wealth among indigenous people (ACS and Audtresch, 1990)

The importance of SMEs to world economies is well documented .SMEs (firms with 200 or less employees) make up the largest business sector in every world economy ( Wang, c. et al 2000), and governments around the globe are increasingly promoting and supporting SME growth as part of their overall national development strategy. While they dominate in terms of absolute numbers, SMEs are also important because they are key drivers of employment and economic growth. At a macro level, SMEs have created the majority of new jobs in OECD countries since the 1970s (Robertson, 2003) and their collective contributions to respective GDPs.

3.3 Relationship between financial institutions business operations

The role of small business in poverty alleviation and economic growth has emerged strongly but being assisted financially by financial institutions. Poverty cannot be alleviated without Tanzanians´ entrepreneurial knowledge of establishing business operations generating funds to cover their survival needs. However, these business operations cannot exist without the availability of funds issued mostly by financial institutions. Impliedly, we can say that Tanzanians establishing business operations, outsourcing funds for business operations end up with alleviating poverty among Tanzanians.

FINANCIAL REFORMS.

In Tanzania the banking and financial institution act 1991, marked the beginning of the on going financial reforms, the law among other things permitted entry of private banks and provided the supervision and regulation framework for the financial sector. (Llwiza and Nwako, 2002).

A large body suggest that financial development contributes significantly to growth of the economy, (word development report, 20002). Microfinance Institutions schemes were intercede to meet different objectives. The most commonly mentioned objectives include: poverty alleviation and improved life standards, offering finance to the poor (Harper et all 1999). Women's empowerment and the development of the business sector as a means of achieving high standards and reducing market failure (Chijoriga and Cassimon 1999).

Microfinance institutes are ambling/empowering small and medium entrepreneurs, though provision of Loans, with few conditions. (Kahama, C.G; 2004;(The cooperative society's rules; 2004" - ACT NO.20 of 2003).

The existing MFI's in the country have different legal forms namely; Non Governmental MFI's, Community and Village banks, Government programmed and cooperative societies (SACCOS), Commercial Banks and traditional financial providers (Kazi, 2003).Savings and credit organizations, financial cooperatives, microfinance and cooperative banks whose primary activities are to mobilize savings and furnish secured and unsecured Loans or credit to household small holder producers and market entrepreneurs, micro-enterprises in rural and urban areas

CONCEPT OF BUSINESS GROWTH.

The term of business growth is used in ordinary language to mean two different connotations. Sometimes it meanly means increase in amount ie sales or export. At other times, it is used in its primary meaning implying increase in size, improvement of quality as a result of a process of development (Penrose, 1959).

The business economic performance will reflect its value in the society. The length of the business has been performing in the market can predict its growth stage as indicated in the product life cycle theory (Kotler, 1997). There are two types of growth, qualitative and quantitative growth. (Olomi 2002).qualitative growth can occur through change or sophistication in the firm and its owner, quantitative growth has to do with changes that are readily measurable, such as work force size, sales revenue, profitability, total investment, product mix etc.

4.1 Access and outreach of MFIs for SMEs.

0utreach refers to the to the extent to which all segments of population including low income people have access to financial institutions and their services .if micro finance is to have a significant impact on alleviating poverty and stimulating the business sector, it has to have wider outreach (Oyer and Levisky, 1999).the emphasis on the accessibility and outreach is highly relevant as far as the question of economic growth is concerned.

According to the research done by Chijoriga (2000) in Tanzania, most of MFIs operate only in the municipalities, cities and towns in which they are registered, showing high concentration in the urban areas; few of these schemes reach rural people. The gap of financing is therefore there, especially for the agricultural sector and in particular for small farmers.

Here below are some of MFIs providing financial services to lower income earners in order to reduce/alleviate poverty among Tanzanians.

4.2. National Microfinance Bank (NMB)

NMB's specific strategy towards microfinance is unique in that they link large corporate customers to microfinance loan customers NMB encourages and expands microfinance in three ways:

The first way is to offer loans to micro and small enterprises for the purchase and inventory and supply of goods, second way is through collection and payment services to large corporate clients to/from micro and small enterprises and lastly to do add-on services such as money transfers and payroll services to both the large corporate clients and micro and small enterprises

AKIBA Bank

The microfinance products offered at AKIBA are savings deposits, group and individual micro enterprise loans. It is the first commercial bank to pioneer microfinance in Tanzania and have seen a great amount of success with current outstanding loans at Tsh. 18 billion (13.7 million USD), 4 billion of those being individual micro loans and the remainder being loans to groups or businesses.

(http://en.wikipedia.org/wiki/Microfinance_in_Tanzania)

CRDB Ltd.

CRDB is different from the other two national banks in that it primarily provides loans to microfinance institutions such as SACCOS (the largest type of MFI in this program). CRDB as a more conservative bank has taken this approach in order to reduce their risks in microfinance by loaning to groups such as SACCOs instead of micro and small enterprise borrowers.

http://en.wikipedia.org/wiki/Microfinance_in_Tanzania

4.3. Tanzania Postal Bank

The Tanzanian Postal Bank also offers various types of loans ranging from personal, installments, short-term and micro-credit (offered to groups). TPB's loan portfolio mainly consists of "working capital financing, bridging finance, commercial transport loans, crop financing, export-import financing, guarantees and bonds, direct personal loans, employer collective guarantee scheme and group-based loans." The number of loans approved has also grown in 2001 from 69 in the year 2000 to 356 loans the year after. A problem with increasing loan portfolios is the definite risk involved. Contributing to this risk are issues such as "weaknesses in the legal system regarding contract enforcement, weaknesses and time-consuming title deeds registration procedures, lack of credit reference bureaus, and past history of non-performing loans (examples from other banks).

(http://en.wikipedia.org/wiki/Microfinance_in_Tanzania)

FINCA

4.4. Mission and focus on women

The mission of FINCA International is to provide financial services to the world's lowest-income entrepreneurs so they can create jobs, build assets, and improve their standard of living. Today, FINCA's mission reaches out to over 740,000 clients worldwide. In an ambitious push forward, it aims to expand its outreach to over one million clients by the end of 2010.

The premise of its mission is to have a systematic and generational impact on poverty by making business loans available to poor women on a massive scale. According to Rupert Scofield, FINCA's President and CEO, "women have historically proved to be better credit risks, as they tend to be more responsible, perhaps from having to take care of the children. And frankly, they tend to be more creative and risk-taking than the men. Because they manage the household money, they know where the returns are in the marketplace on any given day."

In the microfinance industry, FINCA is known for reaching the very poorest market segments, particularly women. As of December 2008, women comprised 70 percent of its small loan clients.

"Women as a disadvantaged group in developing economies are the normal focus of the gender factor in view of their unique role as a productive force severely constrained by limitations in their accessibility to key production assets including capital, education and skills."

(National Trade Policy pp. 31-32)

4.5. Some of the Problem facing SMEs in accessing credits

Financing has been identified in many business survey as the most important factor determining the survival and growth of medium and sized enterprises in both developing and developed countries access to finance allows SMEs to undertake productive investment to expand their businesses and to acquire the latest technology thus insuring their competitiveness and that of the national as a whole. Poorly financial systems can seriously undermine the microeconomic fundamentals of a country, resulting in lower growth in income and employment. Chijoriga (2002)

Despite their dominant number importance in job creation, SMEs traditionally have faced difficulty in obtaining formal credit. I.e. maturities of commercial banks loans extended to SMEs are often limited to a period which is very short to pay off sizeable investment, mean while access to competitive investment is reserved for only few selected blue-chip companies while loan interest rates offered to SMEs remain high. Chijoriga, (2000).

According to Chijoriga, (2000) traditionally commercial banks and investors have been reluctant to service SMEs, for a number of well known reasons some are,

 SMEs are regarded by investors as high risk borrowers due to insufficient assets and low capitalization, vulnerability to market fluctuations and high mortality rates.

 information asymmetry arising from SMEs, lack of accounting records, in adequate financial statements or business plan make it difficult for creditors and investors to assess the credit worthiness of potential SMEs proposals.

 High administrative/transaction costs of lending or investing small amounts do not make SMEs financing profitably business Chijoriga, (2000) .as a results commercial banks are generally biased toward large corporate borrowers who provide better business plains, have credit ratings, more reliable financial information, better chances of success and higher profitability for banks. When banks do lend to SMEs, they tend to charge them a commission for assuming risk and apply tougher screening measures which drive up costs on all sides.

The main contributor to the critical role of the managerial factor is the use of external advisors, focus on strategy formulation and implementation rather than focusing on operational bits and pieces, aiming for long term competitive advantages rather than short-term profits, and developing strong interest for non-financial benefits such as need for achievement and recognition Visagie, J.C. (1997). Most SMEs in developing economies lack strategic orientation and long-term vision. They put greater emphasis on short-term profits rather than building long-term competitive potential.

CONCLUSION

SMEs continue to play an important role in the development of world economies however they continue to face enormous challenges to grow and develop as compared to rival bigger firms. But it is pleasing to note that of late major financing institutions like the EU and World Bank etc and mostly developing countries are coming up with deliberate policy that will fuel the development and growth of SMEs as their existence has proved worthwhile to the development of various economies through poverty reduction as they continue to be a major source of employment.

FURTHER DISCUSSION

The contribution of MFIs in alleviating poverty among Tanzanians is very important. In Tanzania majority of them need financial support in order to start up their business or make investments. Microfinance does not only cover financial services but also non-financial assistance such as training and business advice. In Tanzania, the majority of people live in rural areas where poverty is more prevalent than in urban areas. About 60% of the people who live in rural areas compared with 39% in urban areas live in abject poverty. According to United Republic of Tanzania (2001), about 90% of the poorest of the poor live in rural areas. This is despite the long history of poverty eradication initiatives. (URT2005)

Therefore, poverty is alleviated by the contribution of business establishments that generate funds and business performance and growth cannot stand without the contribution of financial institutions that provides funds.

Further discussion the challenges of Microfinance Institutions will be on

Why Tanzanians are still poor despite the establishment of the number of microfinance institutions, especially those who live in rural areas,

Is microfinance solution to poverty?

Why MFIs interest rate so high,

Why so many microfinance institutions focus on women?


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