Commodities and currencies
2015 was a challenging year. The general economic picture was marked by two important trends: plummeting commodity prices (including oil) and tightening financial conditions. Overall, global growth declined in 2015, reflecting a further slowdown in emerging markets and a weaker recovery in advanced economies1.
Whereas the US economy continued to grow and the European economy only slowly picked up steam, China, Russia, Brazil and many other emerging economies suffered. During the summer, financial market volatility increased in the wake of a depreciation of the Chinese yuan. This resulted in increased risk aversion, a sharp correction in equity prices worldwide and weakening currencies for many emerging economies. The appreciation of the US dollar, resulting from the ongoing economic growth and the rate hike by the Federal Reserve (expected in September, actual in December), amongst others, contributed to declining capital flows to emerging countries and thus tighter financial conditions.
1 Source: IMF, World Economic Outlook, October 2015.
Adverse developments in Central Asia
In Central Asia, the oil-exporting countries and countries with economies that have close ties to the slowing Russian economy were severely hit. The Azerbaijan manat, for example, devalued by 43.6% against the euro in 2015, whereas the Kazakhstani tenge reached a record low in the wake of the devaluation of the Russian ruble. As a result, many countries in this region face an economic slowdown. An additional problem for most countries in the region is the decrease in remittances from migrant workers in Russia to their families at home.
Against the backdrop of a recession in Central Asia, low oil prices and subsequent strong volatility on the foreign exchange markets, the fund nevertheless continued to grow its assets and was able to enter promising new markets in Bolivia, China, Myanmar, Panama and South Africa.
Weaker growth outlook
Given the developments described earlier, the downside risks to the outlook have increased, particularly for emerging and developing economies. Even if the growth prospects vary across countries and regions, the outlook for developing countries is generally weakening, with growth projected to decline for the fifth year in a row. This weaker outlook is due to a combination of factors: the slowdown in China as a result of that country’s transformation into a more services-oriented economy; the adjustment in the aftermath of the credit and investment booms of recent years; the weaker outlook for exporters of commodities, including those in Latin America, following the enormous decline in prices (including oil) and, lastly, the geopolitical tensions and domestic conflicts in a number of countries. In these circumstances, Triodos Microfinance Fund expects to direct more capital towards emerging markets that demonstrate greater resilience to the impact of higher interest rates, have strongly developing domestic economies and offer above-average market potential for financial inclusion, particularly in Asia and Africa.
Financial inclusion market
The provision of a broader range of financial services is the key to financial inclusion. However, this should come with an enabling environment shaped by a set of policies, regulations, and institutional structures. The most recent EIU Microscope Index2, based on 55 countries, shows that in 2015 the environment for financial inclusion was moving in the right direction, albeit slowly, with improvements that are not uniform from country to country. Overall, efforts to increase financial inclusion have been stepped up, yet some essential elements, such as consumer protection and financial literacy, are still insufficiently addressed.
From a macro-economic perspective the outlook may not be entirely positive; from a structural perspective; however, the potential for growth across most microfinance markets is considerable, as financial exclusion remains widespread. The rate of financial inclusion has generally grown rapidly over the past few years, but the gap between developed and emerging economies remains large.
In the past, markets in Latin America and Central Asia were the drivers for the microfinance industry. For different reasons, they started to slow down in 2015 and are expected to continue doing so in 2016. After years of strong expansion, South American markets are maturing, which is limiting growth opportunities in the traditional microfinance segment. In addition, lending growth may slow down in the wake of the macroeconomic adjustment that commodity exporters are going through due to the decline in prices.
The trend in Central American economies is different, however, as most are benefitting from the current fall in oil prices because they are net energy importers. In addition, the recovery of the US economy is providing a strong boost via increased trade and remittances.
Prospects are stronger for markets in Asia Pacific and Sub-Saharan Africa, as they are expected to register above-average rates of growth this year. Growth fundamentals in the main financial inclusion markets in Asia Pacific are relatively solid, with the exception of Mongolia, which will be affected by the end of the commodity super cycle and the downturn in China. Microfinance markets in India and Cambodia are expected to expand at their current pace; India in particular may benefit from higher growth potential as well as a more favourable regulatory environment. Sub-Saharan microfinance markets are expected to continue expanding as the penetration remains relatively low. The expansion of technology-driven solutions will further support the development of the microfinance markets in the region, especially in Eastern Africa.
Altogether, the microfinance sector is expected to grow by 10-15% in 20163, which is only slightly lower than in previous years.
2 Source: Global Microscope 2015 by The Economist Intelligence Unit, published in December 2015.
3 Source: responsAbility - Microfinance Market Outlook 2016
Decisive trends – technological development and regulatory reform
Sector players see mobile money, branchless banking and a broader spectrum of services as the most important trends within the microfinance sector. Clients’ needs are evolving rapidly and with them the services that MFIs need to offer. In addition to access to credit, MFI clients want to be able to save, obtain insurance or transfer money. New technologies will strongly contribute to the development of products that provide this broader spectrum of services.
In addition to technological advances, sound regulation is a key enabler for the development of a strong and diverse financial sector. The example of India illustrates that a new and improved regulatory framework allows MFIs to become specialised banks, allowing them to expand the services they can offer. Yet there are also countries where regulation, often driven by populist or misguided motives, has the opposite effect, distorting incentives and damaging the business environment. Central Asia – and especially Azerbaijan – is a clear example of where regulatory interventions can go wrong.
Strategic focus on SME banks
A strong SME sector is essential for the economic development of countries where the average income per capita is low. At the beginning of 2015, Triodos Microfinance Fund implemented a pro-active strategy to fund banks that focus specifically on this important sector. During the year, the fund added five new SME banks to its portfolio. Some of these institutions, such as ACLEDA Bank in Cambodia, are ‘traditional’ MFIs that have made the transformation into a regulated bank and are gradually starting to count SMEs among their clients. Other institutions include local banks that have made SME funding one of their spearheads, such as Ipak Yuli Bank in Uzbekistan. In addition, Triodos Microfinance Fund will continue to focus on financial institutions that mainly target micro-entrepreneurs.