Improving access to finance and social cohesion in MENA

In a nutshell

Improving access to finance for unbanked people and businesses can be done through embracing digital technologies, which can provide the cost efficiency needed to increase financial inclusion.

There is room for government interventions to enhance access to finance and reduce the economic inefficiency of debt, by providing incentives for equity financing programmes.

Financing of cooperatives by microfinance institutions could be a component of a comprehensive government programme to tackle youth unemployment; ‘social impact bonds’ and public-private partnerships could also drive resources from donors and investors toward effective social programmes.

Even before the pandemic, the Middle East and North Africa (MENA) was one of the world’s most unequal regions. For example, the top 10% of the income distribution captures 56% of its average national income (Moshrif, 2020).

The Covid-19 crisis is widening income inequalities, pushing millions of vulnerable people below the poverty threshold, and causing the bankruptcy of thousands of micro-enterprises and small and medium-sized enterprises (MSMEs) worldwide. (See PNUD Tunisie (2020) for the impact of the pandemic on income inequality, poverty and micro-enterprises in Tunisia.)

Countries in the region are likely to suffer from the depletion of MSMEs’ potential to contribute to job creation and reduce unemployment, particularly among young people. MSMEs in the region have been suffering for a long time from limited access to finance. Indeed, MENA has the highest finance gap globally: 88% for formal SMEs, with about half of them not having access to formal credit.

Therefore, it is extremely important for many countries in the MENA region to reduce income inequality and improve access to finance. At the same time, they need to enlarge their fiscal spaces, in order to allocate the required financial resources for these objectives.

Reducing income inequality

Since the early 1990s, there has been much discussion of persistent inequality (for example, Banerjee and Newman, 1993; Piketty, 1997), seeking to explain it through the difficulties of accessing finance for poor people and MSMEs. In Capital in the Twenty-First Century, Thomas Piketty revived global debate on wealth and income inequality. In essence, he argued that with high returns on private wealth relative to economic growth, wealth inequality might reach or surpass 19th century levels.

In order to prevent this scenario, Piketty suggests the implementation of a progressive wealth tax at global scale. Economics Nobel laureate Joseph Stiglitz also stresses the importance of redistributive policies and addressing preferential treatment benefiting mainly rich people.

Recent experiences of Brazil and other Latin America countries in reducing income inequality and poverty, confirm the importance of such public redistributive policies. As noted by Neri (2017), reversing trends in income inequality and poverty was possible through specific public programmes based on conditional cash transfer programmes. In Brazil for example, government transfers to individuals and families play a central role in the social protection system, accounting for almost 14% of GDP in 2009.

Improving access to finance

Access to finance has been acknowledged by the World Economic Forum as one of the criteria for judging a country’s degree of financial system development. Hence, beyond redistributive policies, it is important to disrupt financial systems in MENA in order to improve the access to finance for unbanked people and businesses. This can be done through embracing digital technologies, which can provide the cost efficiency needed to increase financial inclusion (World Bank, 2014).

In Nabi (2018), I considered this perspective by discussing how digital financial services – through mobile payment, P2P platforms, crowdfunding (equity and donation-based), smart contracts and distributed ledger technology – can improve access to finance in MENA countries. Here, I summarise complementary perspectives in Nabi (2015, 2016, 2019).

Improve access to finance to SMEs by lowering the collateral constraints and favouring equity finance

In Nabi (2015) I propose an equity-financing banking whereby the financial contracting relationship between banks and agents (individuals or MSMEs) has two distinctive features:

It loosens the importance of collateral constraints.
It discourages excessive borrowing of wealthy agents beyond a particular threshold of wealth accumulation (thus reducing the concentration of wealth).

In particular, borrowing from financial intermediaries under the equity contract exposes wealthy agents to higher sharing ratios, which increases the cost of borrowing. Consequently, the incentive to borrow to expand their investment projects gradually vanishes and wealthy agents tend to self-finance their projects or become depositors. Consequently, the financial constraints on poor agents are relaxed and they are enabled to undertake their entrepreneurial activities.

In Nabi (2016), I also propose an original equity contract that embeds a dynamic incentive that links the entrepreneur’s share in the project’s payoff to his own invested funds. The results show that equity is more accessible than traditional debt financing for micro-enterprises.

In addition, I show that under two-periods financial contracting, the economic inefficiency inherent in debt financing (resulting from the termination threat in case of default) favours equity (from the micro- and macro-perspectives) in the common region of feasible access to finance. As consequence, there is room for government interventions to enhance access to finance and to reduce the economic inefficiency of debt, by providing incentives for equity financing programmes.

In Abdelkafi and Nabi (2017), we propose a financial mechanism tailored for cooperatives through providing incentives for equity financing. The financing is provided by microfinance institutions as a component of a comprehensive government programme to tackle youth unemployment.

Financing social programmes through philanthropy coupled with social impacts bonds

Philanthropy has huge potential for alleviating poverty in the MENA region. According to Mohieldin et al (2012), a proper Zakat collection and management can alleviate the poorest class living with an income under US$1.25 per day out of the poverty line in 20 out of 39 OIC countries.

Waqf constitutes another channel of philanthropy that has the potential to play an important role for the benefit of the unbanked poor. For example, Abdelhady (2013) proposes the establishment of a multilateral food security Waqf to improve food security in MENA. Among the suggested targeted objectives is facilitating access to finance for small farmers, MSMEs and other parties across the food supply chain.

In Nabi (2019), I suggest unlocking the potential of philanthropy by channelling its resources through ‘social impact bonds’ (SIBs) to serve the state’s social programmes. SIBs could be presented as a public-private partnership (PPP) that drives resources from donors and investors toward effective social programmes.

Through this PPP, the public authorities partner with service providers to develop, coordinate and expand the social programmes. The advantage for governments is the realisation of social programmes at lower costs since they only repay investors (and not the philanthropists) and only if the social programme achieves the expected results.

Reducing the burden of the external debt to increase fiscal space

The economic crisis caused by Covid-19 is obliging governments globally to raise financial resources to fight the pandemic, and to mitigate its negative socio-economic impacts on the most vulnerable people and micro-enterprises. This is not an easy task for many countries of the MENA region, which have limited fiscal space and limited domestic public resources due to the decline in tax and non-tax revenues.

In addition, the current levels of public debt are approaching the sustainability limit, and they are exposed to higher cost of capital on financial markets. Meanwhile, without adequate public interventions, many countries are exposed to huge increases in poverty, unemployment, inequality and social uprising, which would aggravate the economic downturn.

Among the financial instruments that could be activated by MENA region during the current period of high sovereign spreads are GDP-linked bonds. These have the advantage, if well conceived, to stabilise the debt-to-GDP ratio and limit the procyclicality of the external financial flows (and thus the sudden stops and flight to quality). They could lower interest payments during the crisis, and compensate the investors when economic performance improves.

In a recent open letter co-developed with Jayati Ghosh and signed by more than 130 economists, it was suggested to extend the Debt Service Suspension Initiative (DSSI) (of the Group of 20) to the middle-income countries in need, via a specific financial mechanism based on the GDP-linked bonds.