The Resource Curse for the Poor: Commodity Price Shocks Impact on Microfinance Institutions

Abstract

Although developing nations have historically looked to export revenue as a means of improving their economies, many have instead been subverted by these commodities’ associated volatility. This paper expands upon the existing research about the repercussions of commodity dependency on the formal financial sector by testing changes in a country-specific commodity-weighted price index on Microfinance Institution’s (MFI's) financial outcomes.

Unlike formal sector banks, Microfinance Institutions (MFIs) intend to help alleviate poverty by targeting lower-income borrowers who have limited access to external credit. Due to their more isolated clientele and lower foreign asset exposure, I hypothesized that commodity price shocks and price index volatility to not be significantly correlated with MFIs' measures of credit quality, client outreach, and institutional sustainability. If MFIs continue to extend credit under price volatility, they could step in where formal sector banks fail. As they serve to provide capital to those most vulnerable to the Resource Curse and allocate credit to micro-entrepreneurs to start small businesses, MFIs could play a fundamental role in diversifying capital in countries with high capital concentration. To test if MFIs remain resilient to commodity price changes, this paper uses Blundell-Bond methodology to regress positive price shocks, negative prices shocks, and price index volatility on key financial metrics of MFIs.

Results prove that only one of my hypotheses is true: a positive price shock in the country-commodity price index shows no correlation with institutional outcomes and borrower behavior. On the other hand, when the price index falls by more than 15\%, a negative price shock, MFIs extend fewer loans to fewer clients and charge a higher interest rate on those loans to cover costs. When the index displays greater volatility, MFIs supply loans to fewer borrowers but cover costs by increasing the size of their loans rather than the interest rate that's charged. Diminished credit outreach following negative price shocks and price index volatility undermines the Microfinance Industry’s initial mission to aid marginalized poor and female borrowers. The commodity price changes permeate deeper into credit markets and income brackets than previously considered in the literature. This means MFIs aren’t a perfect hedge against formal credit markets and poor borrowers aren’t benefiting from credit at times when they need it most. MFIs, in sum, demonstrate a preference for maintaining financial measures of sustainability over outcomes for their borrowers as a result of exogenous economic shocks.