This Selected Economic Issues paper examines economic developments in South Africa during 1993–94. After a cumulative fall of 3.5 percent between 1989 and 1992, GDP at market prices grew by 1.1 percent in 1993. The major contribution to growth came from the turnaround in the inventory cycle, with positive investment in inventories recorded for the first time since 1989. Private consumption expenditure remained subdued in 1993, rising by only 0.5 percent; by contrast, public consumption grew by 1.8 percent in 1993.

Abstract

This Selected Economic Issues paper examines economic developments in South Africa during 1993–94. After a cumulative fall of 3.5 percent between 1989 and 1992, GDP at market prices grew by 1.1 percent in 1993. The major contribution to growth came from the turnaround in the inventory cycle, with positive investment in inventories recorded for the first time since 1989. Private consumption expenditure remained subdued in 1993, rising by only 0.5 percent; by contrast, public consumption grew by 1.8 percent in 1993.

VII. Financing Small Business in South Africa: Lessons from Other Countries

1. Introduction

The effects of the past exclusion of blacks from economic and education opportunities, exacerbated by the 1989-92 recession, have made black unemployment one of the major challenges the new Government has to face. About 45 percent of the labor force is estimated to be without formal sector employment; but for black South Africans the ratio is even higher. 1/ The promotion of small businesses, particularly those in which blacks have an equity holding, could play an important role in contributing to employment growth because these enterprises tend to be labor intensive. In addition, the growth of these enterprises could contribute to narrowing the current income and wealth differentials in the South African society. A major constraint faced by black small enterprises is lack of access to financing; this constraint is the focus of this chapter. It reviews experiences in other countries with credit programs intended to increase small enterprises’ access to financing, with the objective of deriving from them policies that might be relevant to the South African case.

The organization of the chapter is as follows. Section 2 discusses the current state of black small businesses in South Africa and the constraints they face. Section 3 contains a theoretical discussion of how information imperfections in credit markets affect credit allocation. Section 4 focuses specifically on how small enterprises fare in capital markets with imperfect information. Section 5 discusses the role of Government in the provision of credit to small enterprises and reviews the experiences of some developed and developing countries. Section 6 reviews experiences of some developing countries with group lending programs intended to increase financing available to small enterprises. Section 7 concludes with some policy options for South Africa in the promotion of small enterprises.

2. The state of black enterprises

a. Background

During, and even before, the apartheid era the participation of blacks in the formal economy was limited by regulations imposed on their movements, their places of residence, and the jobs open to them. Blacks were severely restricted in their involvement in formal businesses, particularly in urban areas. For example, the 1923 Native (Urban Areas) Act allowed blacks to participate only in businesses such as the sale of milk, bread, and vegetables (World Bank 1993). After 1948, more stringent regulations were imposed on the formation and expansion of black businesses. A rule introduced in 1963 prohibited black entrepreneurs from pooling their resources under a corporate structure. It also prohibited the formation of black financial institutions, and thereby limited the access of black businesses to capital markets.

In addition to direct prohibitions and limited access to financing, black business development was hindered by restrictions on the skills that blacks were allowed to acquire. For example, Bantu education and job reservation laws limited apprenticeships for blacks in skilled trades.

Laws that prohibited blacks from opening businesses in urban areas were repealed in the 1980s, and formal restrictions were relaxed. Clearly, however, it will take some time to overcome their historical effects.

b. Current state of black enterprises

As a result of the past restrictions imposed on black participation in business, black businesses are currently concentrated in the informal sector and are mainly micro- and small-scale enterprises. Surveys by the nongovernment organization Growth and Equity through Microenterprise Investments and Institutions (GEMINI) in 1990 and by the World Bank in 1992 identified two types of black enterprises: microenterprises and more established small enterprises. 1/

Black microenterprises, which account for the majority of black enterprises, have proliferated over the last few years because of the dearth of employment opportunities in the formal sectors of the economy (see Chapter I, Section 1) and the relaxation of government restrictions that had been imposed on them earlier. Half of the black microenterprises covered by the World Bank survey were less than three years old. The GEMINI survey found a high concentration of microenterprises in retail and wholesale trade: street vendors account for about 50 percent of the microenterprises surveyed, while light manufacturing--such as dressmaking, shoe repairing, and beer brewing--accounts for about 17 percent of the total.

The individuals in these businesses have a relatively low level of formal education: in the World Bank survey, about 90 of those surveyed had not finished high school. With increasing migration to urban centers in the 1980s and little if any employment growth in the formal sector, most of the individuals involved in microenterprise started their businesses as a means of survival. An average microenterprise employs about two workers in addition to the proprietor and perhaps other family members. Within subsectors, construction had the highest number of employees, followed by manufacturing. The highest employment growth was reported by those microenterprises that were most recently established (World Bank 1993).

Established small black enterprises distinguish themselves from the previous group in both their financial and their human resources. These enterprises tend to have more assets, and higher profitability and turnover than the average microenterprise. Furthermore, entrepreneurs in this group are likely to have better education and prior work experience that is relevant to their own business. In addition, this group’s entry into business was driven by entrepreneurial rather than by survival motives.

The sectors covered by the World Bank survey included retail trade, transportation (taxis), construction, and garment manufacturing. With the exception of transportation, all these sectors have a modest capital requirement.

In the retail subsector, high growth enterprises--i.e., those with higher profitability, turnover, and employment--are registered and thus are part of the formal sector. In addition, a large proportion of retail enterprises have received credit from formal financial institutions; in the World Bank survey, about 36 percent of retail enterprises had some history of credit from formal financial institutions. High growth enterprises in particular had more access to financing than any other subsector because they held assets that could be used as collateral. For the retail subsector as a whole, however, the large majority of owners financed the start-up of their enterprises by means of personal savings and family contributions. Retail enterprises employ on average about four workers.

The transportation (taxi) business is another subsector in which small black enterprises have expanded rapidly since the removal of legal restrictions on black taxi operations. 1/ As the number of taxis increased, the black taxi industry began to regulate itself. 2/ It currently has two organizations: the South African Black Taxi Organization (SABTA)--which serves the interests of providers of short-distance and peakhour commuter travel--and the South African Long Distance Transportation Association. SABTA negotiates lending arrangements from financial institutions by providing collateral for its members. The average employment of taxi enterprises is about two persons. However, including “pirate taxis,” it is estimated that this subsector employs about 300,000 workers.

In the construction sector, most black enterprises undertake contracts in the black townships and other informal settlements, which are unattractive to bigger construction firms. The average employment for the construction enterprises surveyed was about six workers. Black enterprise participation in the garment manufacturing subsector is limited. In the World Bank survey, which covered the geographical areas that account for about 70 percent of the country’s garment workers, there were no medium-sized, black-owned garment firms. The development of black garment firms had been stymied by Job Reservation Laws, which, until 1979, denied blacks the opportunity to obtain work in skilled job categories.

c. Constraints faced by black enterprises

Financing was one of the major constraints identified by both micro- and small-scale enterprises in the GEMINI and the World Bank surveys. In addition, as shown in Table 23, the distribution of bank credit extension by race provides a stark picture of the financing constraints faced by black enterprises. In 1990, the share of blacks in bank credit and hire purchase advances was only 5 percent, compared with black income and population shares of 36 percent and 70 percent, respectively. About 40 percent of the total credit advanced to blacks came from Stokvels, which are informal saving and lending organizations.

Table 23.

South Africa: Credit Extension to Individuals by Race Group, 1990

(In millions of rand; share in category in parentheses)

article image
Sources: Manning (1990); and Lachman and Bercuson (1992).

Stokvels are informal saving and lending groups.

However, as brought to light by the GEMINI and the World Bank surveys, there was a difference between micro- and small-scale enterprises in the extent of the financing constraint. For microenterprises, financing, especially that for fixed capital, was identified as a major constraint. For small enterprises, the entrepreneurs generally had higher savings at the startup of their businesses, and thus their credit situations were less difficult than those facing the microenterprises. Within the small enterprise subsectors, financing constraints were most severe for the construction subsector--this reflects a history of bond boycotts and difficulties faced by banks in foreclosing on black-owned properties in the townships in cases of default.

Stockvels were the major source of credit for microenterprises; they provided credit to about 20 percent of the microenterprises surveyed (World Bank 1993). 1/ A Stokvel is a voluntary saving/lending group, consisting on average of 27 persons who contribute to a fund from which members take turns to borrow; it is estimated that there are 24,000 Stokvels in South Africa’s major metropolitan areas, of which 41 percent are saving clubs and 29 percent are burial societies. 2/ However, credit from the Stokvels is short-term in nature and thus does not meet the medium- and long-term credit needs of the microenterprises. In contrast, a large proportion of small enterprises received credit from the formal private and public financial institutions (World Bank 1993).

In addition to financing constraints, micro- and small-scale enterprises face other hurdles, including government regulation, high input costs, and violence. Regulatory constraints are generally in the form of zoning laws--which prohibit street trading in certain areas--and health and safety regulations. Violence in the black townships has also been one of the major concerns of micro- and small-scale enterprises; for example, bond boycotts in the black townships reduce black entrepreneurs’ ability to access financing from the formal financial institutions. Furthermore, some high growth small enterprises face high labor costs because of the extension of industrial council wage setting to them (see Chapter III).

3. Theories of credit rationing

a. Capital market imperfections: Imperfect information

In competitive capital markets with no imperfections, all investments whose returns exceed the marginal cost of capital will be undertaken. However, with market imperfections such as information asymmetries between borrowers and lenders, an economy might be characterized by underinvestment as a result of credit rationing. Two problems that arise in the presence of imperfect information are adverse selection and moral hazard.

Adverse selection arises when lenders are unable to observe the individual risk characteristics of their borrowers’ projects (this could be due to the high cost required to unravel a borrower’s financial circumstances). In this situation, if a lender increases his lending rate above a certain level, his profit might decline as borrowers with less risky projects are crowded out from the market. To illustrate this point, assume that there is a continuum of entrepreneurs each of whom is endowed with a project and an initial capital W. 1/ Each entrepreneur’s project requires investment capital of K > W and he has to raise B = K - W in order to carry out his project. A project either succeeds, yielding a return of RSi, or fails, yielding Rfi = Rf for all i, where i is the index of the project. Assuming that all projects yield the same expected return, the expected return of a project is:

PiRsi + (1 − Pi)Rf = Cforalli,(1)

where C is a constant and piε[0,1] is the success probability of the ith project. Let f(pi) be the density function of pi. Given equation (1), project i is said to be riskier than project j, if pi < pj.

An entrepreneur borrows B through a debt contract, with (l+r)B repayment if the project succeeds and Rf if the project fails, where r is the interest rate on the loan. It is assumed that Rsi > (1+r)B > Rf for all i. Assuming that entrepreneurs are risk neutral, the expected profit of the entrepreneur with the ith project can be written as

Eπi = Pi(Rsi(1+r)B).(2)

Substituting equation (1) into equation (2), we get

Eπi = C − Rf − Pi[(1+r)B − Rf].(3)

From equation (3), the expected profit is declining in pi, implying that entrepreneurs with riskier projects are willing to pay higher interest for a loan compared with entrepreneurs with less risky projects.

An entrepreneur will invest in his project as long as:

Eπi = C − Rf − Pi[(1+r)B − Rf](1+γ)W,(4)

where γ is the safe rate of interest. Assuming that the right hand side of equation (4) holds with an equality and differentiating it, we get

dpdr =  − pB((1+r)B − Rf) < 0.(5)

Thus, the probability of success of the marginal project declines as the interest rate increases.

Lenders are assumed to be unable to observe the riskiness of each entrepreneur’s project but they know the distribution characteristics of the projects. Assuming that lenders are identical and risk neutral, the expected profit of a representative lender is:

EπB = (1+r)B0PPi(pi)dpi+Rf0P(1pi)f(pi)dp − (1+γ)B,f(6)

where p is the success probability of the marginal project. Differentiating equation (6) with respect to r, we get

dEπBdr = B0PPi(Pi)dPi + dpdrf[(1+r)Bpf(p) + Rf(1p)f(p)].(7)

The first term reflects the increased profits from the higher repayments from successful projects and the second term, which is negative (recall that dp/dr < 0), reflects the impact of the worsened risk mix of projects. Thus, an increase in the interest rate might lead to a reduction in the expected profit of the lender. If a higher interest rate leads to lower expected profit for the lender, then he will ration credit instead of increasing the interest rate.

The credit rationing equilibrium will result in underinvestment compared with the first-best equilibrium--that is, the solution that emerges when information is perfect--which requires all projects whose expected return exceeds or equals the cost of funds to be financed. This is the case because all projects have the same expected return, and thus those affected by the credit rationing would have been undertaken if information had been perfect.

Moral hazard, by contrast, occurs when, after loan dispersal, the borrower can take actions, not observable to the lender, that are detrimental to the lender’s payoff. For example, if borrowers can choose the riskiness of their projects after a loan contract, higher lending rates might induce them to choose more risky projects, given that in the case of a default, the lender assumes the cost of the loan. Thus, the adverse effect of high lending rates on borrowers’ incentives might induce lenders to ration credit instead of raising their interest rates.

To see that a credit rationing equilibrium can arise in a setting with moral hazard, assume that all borrowers are identical--instead of different borrowers, as was the case in the model discussed in the previous section--and that they can choose from a continuum of projects with the same expected return but with different probabilities of success. Then, assuming that equation (4) holds as an equality, an increase in the rate of interest will induce an entrepreneur to shift from a less to a more risky project. Furthermore, from equation (7), we know that the expected profit of the lender might decline as the risk mix of projects worsens, which could lead to a credit rationing equilibrium.

b. Market response to information imperfections in the capital markets

Over time institutions and mechanisms have emerged to mitigate information imperfections in the capital markets. For example, credit rating institutions (bond rating firms, credit bureaus) mitigate information asymmetries between borrowers and lenders by collecting information on firms’ past performance and providing it to current or potential creditors. Furthermore, lenders use indirect monitoring mechanisms such as collateral and covenants, which are intended to align the incentives of the borrower with those of the lender. Collateral, by increasing the stake of the borrower when his project fails, reduces the incentive for him to undertake riskier projects. Similarly, covenants that specify a certain observable and verifiable performance, which borrowers are expected to adhere to, provide lenders a mechanism for indirectly monitoring the behavior of their debtors. Observable and verifiable performance indicators might include, for example, a limit on debt-service ratios.

4. Information imperfections and small business financing

Information imperfections in the capital market and their consequences have a more severe effect on small enterprises than on large established enterprises. Most small enterprises have been in business for a short time period and are consequently unlikely to have developed a reputation (credit rating) in the capital market sufficient to mitigate information asymmetries between them and their potential lenders. Furthermore, loan processing costs for small enterprises--at least as a proportion of the loan--are much higher than those for large established firms, a fact that dissuades commercial banks from serving them. 1/ In addition, most small enterprises do not have enough marketable collateral to safeguard lenders’ positions by means of collateralized credits.

Credit constraints faced by small enterprises are particularly severe in developing countries: there are usually no credit rating institutions, the legal institutional framework is underdeveloped, and sometimes there are even problems with the establishment of property rights. However, even in developing countries some institutions have emerged to compensate for information and institutional imperfections. For example, lending and saving groups, such as Rotating Savings and Credit Associations (ROSCA)--which are informal lending and saving institutions formed by people who are well acquainted with each other and who overcome moral hazard through community and peer pressure--are common in many developing countries.

5. Role of government in the provision of small business finance

In the presence of adverse selection and moral hazard, the first-best outcome of an efficient market (Pareto Optimum) will not be achieved. The question that generally arises therefore is whether there is a role for government to improve the situation by offsetting information imperfections in capital markets. The presence of imperfect information, however, does not imply per se that there is a market failure. In the presence of adverse selection and moral hazard the market equilibrium that emerges will be constrained-efficient if there are no externalities. In this situation, unless Government is more efficient in the production of the information characteristics of borrowers--which is not generally thought to be the case-- government intervention will not lead to a Pareto improvement over the market equilibrium.

Rather than on the grounds of imperfect information, government interventions in credit markets are generally justified by market failure that is due to the presence of externalities in these markets. There are different forms of externalities that could arise in credit markets and would warrant government intervention. If information is a public good--this is the case when information generated by an individual lender about the risk characteristics of its borrowers is in the public domain--then lenders will produce less credit information output than is socially optimal. Furthermore, if provision of credit to the excluded segment of the population has economic benefits that private lenders do not take into account in their decision-making process, government intervention would be justified. This is the case, for example, if the provision of credit to small enterprises enhances technological innovations and economic growth. Another form of externality that might occur in capital markets is when the consumption or the use of certain inputs has an impact on the success of projects undertaken by borrowers. 1/ For example, if the use of more modern inputs by a class of borrowers reduces the susceptibility of their projects to adverse shocks, a subsidy for these inputs and a tax on outdated inputs might make these projects less risky.

Government intervention can also be defended if it could improve the lenders’ abilities to sort out the credit risk of the targeted population. For example, a temporary subsidy for loans to the targeted population might improve lenders’ capacity to assess their risk and thus their access to credit in the future. Government intervention may also be justified on distributional grounds. For example, a Government might deem it necessary to make credit available to certain segments of the society that are excluded or have limited access to credit markets. However, this is a political decision rather than an economic policy motivated by a market failure.

a. Forms of government intervention

Credit guarantee schemes involve a partial or full government guarantee of loans provided to targeted groups by banks. The guarantee by the government is intended to increase credit to small enterprises by reducing the default risk faced by banks. These schemes result in a moral hazard problem. Given that banks will be repaid whether a borrower defaults or repays his loan, they will have less incentive to carefully screen credit applications, thus leading to the undertaking of more risky projects; this will produce a higher default rate among loan guarantee recipients than among other borrowers.

Loan guarantee schemes also might result in a displacement effect: insofar as firms that would have qualified for commercial bank loans without guarantees are induced to shift to guaranteed loans, the guarantee scheme will not increase credit availability.

Direct government loan schemes are another means of increasing financing available to groups that are disadvantaged by credit constrains. These types of loans are generally provided at interest rates that are lower than market rates and are thus not self-financing. 2/ In addition, these programs distort investment decisions; for example, borrowers might undertake projects that have low returns because of the low lending rate that is available. Also, of course, to the extent that subsidized government loans displace commercial bank lending, there is no increase in credit availability.

b. Experiences with government intervention in credit to small enterprises.

Loan guarantee schemes have been used extensively in developed countries to encourage commercial bank lending to small- and medium-scale enterprises. Eligibility for guaranteed loans for most countries is based either on the number of employees or on total sales of the firm. Furthermore, all countries have ceilings on the amount of lending to any individual firm.

In these schemes, commercial banks are responsible for the disbursement of loans and the monitoring of their performance. Participating banks accept applications for loans from eligible businesses and if the project is thought to be viable, the bank applies for a loan guarantee from the government guarantee agency. If the guaranteeing agency approves, the loan is disbursed by the bank to the applicant. 1/ The guarantee comes into effect if a borrower is not able to service his loan after a certain period. In most countries, if a borrower defaults, the guarantee agency buys the loan and the interest payment arrears and it is responsible for the recovery of the loan from the borrower.

Government guarantees generally vary from 50 percent to 100 percent of each loan provided to qualified small- and medium-scale enterprises. 2/ In France, the Netherlands, and Japan, loan guarantees sometimes are as high as 100 percent. In the United States and Canada, the guarantee is up to 90 percent of individual loans, while in Germany and the United Kingdom, the guarantee is about 70 of each loan to qualified small- and medium-scale enterprises. Guarantee fees charged by guarantee agencies vary from country to country. In the United States, the guarantee fee is 1 percent of the guaranteed amount, while in Germany there is a 1 percent fee on the amount guaranteed and a fee of 0.5 percent a year on the outstanding guaranteed amount of the loan. Countries such as Canada and the Netherlands have no guarantee fees.

Despite fees and premium charges, all the credit guarantee schemes in the developed countries are heavily subsidized in order to cover the losses on loan guarantees. In the United States, losses on guaranteed loans in default are estimated to be about 25 percent of the total outstanding loans. 3/ In the United Kingdom, failure rate estimates varied from 5 percent to 20 percent. In New Zealand, from 1978 to 1985, 13 percent of the loan guarantees were invoked because of defaults. In Germany and in the Netherlands, losses on the guarantee schemes were estimated to be about 2 percent and 4 percent of the total outstanding guaranteed loans, respectively. 1/ In addition to loan defaults, administrative costs of loan guarantee schemes are very high particularly when guarantee agencies rigorously screen loan applications.

Some studies have shown that these programs have had relatively small impact on small- and medium-scale enterprises’ access to financing. In the United Kingdom, for example, a 1983 study found that without the loan guarantees, 40 percent of the loans extended under the scheme would have been made anyway. 2/ In the United States, some studies show that despite subsidies, credit guarantee schemes have not significantly increased the flow of credit to small enterprises. 3/

Developing countries’ guarantees schemes have been generally similar to those in the developed countries, except that the participation of banks in loan guarantee schemes has been limited. There is evidence--from Ghana, India, Liberia, Malaysia, Philippines, and Sri Lanka--to suggest that banks have been uncertain as to whether government credit guarantee institutions would honor their guarantees. This forced many banks, despite loan guarantees offered by the Government, to ask for collateral against small business loans, so that access to credit markets did not improve for collateral-constrained targeted groups.

The losses of these programs in developing countries were also much higher than those in developed countries. For example, in Nepal, the capital fund of the government guarantee agency in 1986 amounted to only 8.6 percent of its total guarantee obligations, while total overdue loans amounted to 52 percent of the outstanding guaranteed credit. Similarly, in the Philippines, banks participating in credit guarantee programs have experienced a ratio of overdue to total loans outstanding as high as 90 percent. In Ghana, banks withdrew from the government credit guarantee scheme after the Ghanian credit guarantee agency refused to honor losses on its guarantees. The large losses incurred by guarantee agencies in developing countries can be explained in part by the limited project appraisal skills of the staff of credit guarantee agencies.

Finally, direct credit programs are more common in developing countries than in developed countries. In developing countries, direct lending to small enterprises is generally funded by the government and it is channeled through government-owned development banks. Direct lending operations are also often partially financed by donors. Most direct government loans to small- and medium-scale enterprises in developing countries are heavily subsidized and in some countries the real interest rates on these loans are negative. This has reportedly led to investment in low return projects and the crowding out of commercial bank lending in many countries. 1/

6. Group lending programs

Group lending programs became popular in many developing countries in the wake of the failure of previous government programs intended to increase small enterprises’ access to credit markets. In these programs, financial institutions or nongovernmental organizations, which often receive donor grants, lend to a group as a whole or to individual members of a group. If a loan is provided to the group as a whole, the group is jointly liable for the loan received, and if a loan is provided to individual members of a group, the group jointly guarantees the loan received by each of its members. 2/ In most group lending programs, repayment of loans by all group members is a prerequisite for continued access to credit.

The presence of group joint liability or group guarantees induces self-selection and peer monitoring. Because the whole group’s access to credit will depend on the loan repayment performance of its members, individuals will form a group with others whom they know well and on whom they can exert social pressure to ensure loan repayment. 3/ This form of self-selection and peer monitoring mechanism lowers monitoring costs compared with those that would have been incurred by any outside financial institution. Furthermore, the group joint liability and group guarantees substitute for collateral and thus increase group members’ access to credit.

Most group lending schemes also reduce transaction costs by locating their operations near where their borrowers live and by using simplified loan application procedures. Lending operations are decentralized and individual branches make independent lending decisions, thereby speeding up loan approval procedures. In addition, the lack of collateral in loan contracts saves borrowers’ fees that would have been charged for collateral verification and registration.

One of the early successful group lending institutions is the Grameen Bank in Bangladesh, which was founded in 1976. The objective of this bank is to provide loans to peasants to finance a variety of microenterprises. The total amount of loans disbursed by the Grameen Bank has risen from less than US$26,000 in the early years of. its operations to about US$40 million in 1989. By 1989, Grameen Bank had 632 branches and 630,000 members. Similar lending groups have emerged and expanded in many developing countries. These include ACCION International in Latin America, Amanah Ikhtiar Malaysia (AIM) in Malaysia, the Badan Kredit Kecaman (BKK) in Indonesia, Caisses De Credit Agricole Mutuel du Benin, Credit Solidaire in Burkino Faso, the People’s Bank in Nigeria, and the Small Holder Agriculture Credit Administration and the Malawi Mudzi Fund in Malawi. Defaults experienced by these institutions are minimal: repayments were as high as 100 percent in Malaysia and Benin, 98.7 percent in Bangladesh and Malawi, and 98 percent in Nigeria.

In addition to lending programs, most of these institutions also provide financial services to their clients and operate as credit unions or cooperatives. This is an important aspect of these institutions because it emphasizes local savings mobilization to meet local investment demand instead of relying on funds from governments or international donors. 1/ However, Government and donors continue to play a major role in providing funds to these institutions to cover support services such as borrower training and group formation.

In most group lending programs, interest rates charged on loans are not subsidized and are comparable to those of commercial banks. This underscores the importance of having lending schemes that are at least self-financing, in contrast to the subsidy-dependence of most other government credit programs. Charging market interest rates also protects against resource misallocation and the crowding out of commercial bank lending. Furthermore, the scheme gives nascent entrepreneurs maximum freedom; there is no prescription that borrowers have to invest in any particular sector or area and they are free to put their funds to whatever use maximizes returns. Group lending programs seem generally to have succeeded in lifting living standards: a survey in 1988 showed that incomes of the Grameen Bank members were 43 percent higher than those of comparable nonGrameen Bank members and similar results have been reported for Indonesia, Benin, Burkino Faso, Malawi, and Malaysia. 2/

7. Lessons for South Africa

The lesson for South Africa from these experiences is that subsidized credit to small enterprises is not sustainable in the long run and, at the same time, might distort investment decisions. To increase the financing available to micro- and small-scale enterprises, nongovernmental agencies could build on and develop the current system of group lending and saving programs. 1/ In addition to providing credit, nongovernmental organizations could help in the provision of training and in the group formation process. It bears repeating that, in order for these programs to be effective and sustainable, interest rate subsidization must be avoided; access to credit rather than the cost of credit is generally the constraint faced by micro- and small-scale enterprises.

Group lending programs financed by nongovernmental organizations through donor or government funds will not be sustainable in the long run without domestic saving mobilization. This will require the transformation of lending and saving programs such as the Stokvels into banks. This is in line with the recent establishment of a community bank in South Africa that is intended to mobilize savings and serve the credit needs of the black community. The community bank will operate as a credit cooperative and will rely on share capital and members’ savings for loanable funds.

Furthermore, financing to small enterprises could be increased through the establishment of small enterprise associations or cooperations, which, on behalf of their members, can guarantee loans provided to their members by financial institutions. This would have three advantages. First, information costs will be reduced since such organizations would have better information than financial institutions about the characteristics of their members. Second, small enterprise associations can monitor their members’ performance better than commercial banks can. Third, small and medium-sized enterprises should be able to negotiate more favorable loan contracts as a group than as individual enterprises.

In the formation of small enterprise associations, government intervention should be kept to a minimum, to avoid the emergence of moral hazard. For example, if these organizations have expectations that the government will bail them out in times of financial crises, their incentive to carefully screen and monitor their members might be diluted. At most, government intervention should be limited to helping in the formation of these organizations by providing them with technical assistance.

Finally, success of the promotion of small enterprises will depend heavily on the macroeconomic stability of the economy. If the macroeconomic environment is not conducive to economic growth because of government controls, unsustainable government deficits, wage developments that squeeze profit margins, and high inflation, then any policy measures undertaken to promote small enterprises will not have the desired effects.

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ANNEX I South Africa: Tax Summary as of November 1, 1994

(All amounts in South African rand)

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South Africa - Exchange Arrangements

A full description of South Africa’s exchange arrangements as of December 31, 1993 is given in Exchange Arrangements and Exchange Restrictions, Annual Report 1994. At present, South Africa maintains one exchange restriction subject to approval under the Fund’s Article VIII, namely, the multiple exchange practice arising from the restriction that emigrants’ interest and dividend income above R 350,000 per annum can only be transferred abroad at the financial rand rate.

Other changes in the exchange system since end-1993 include:

Payments for Invisibles

August 29, 1994: The indicative annual limits on allowances that authorized dealers may provide for traveling to countries other than neighboring countries were raised as follows: (i) the basic tourist allowance, from R 20,000 to R 23,000 for an adult and from R 10,000 to R 11,500 for a child; (ii) the limit on additional allowances for business travel was raised from R 30,000 to R 34,000.

Table 1.

South Africa: Expenditure on GDP, 1989-94

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Source: South African Reserve Bank, Quarterly Bulletin.

Contribution to GDP growth.

Table 2.

South Africa: Gross Fixed Investment and Capital Stock, 1989-93

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Source: South African Reserve Bank, Quarterly Bulletin.

Including transfer costs.

Finance, insurance, real estate, and business services.

End of period.

General Government plus four departmental enterprises (Community Development Fund, Government Motor Transport Trading, Government Printing Works, National Housing Fund).

Table 3.

South Africa: Financing of Domestic Investment, 1988-93

(In percent of GDP at market prices)

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Source: South African Reserve Bank, Quarterly Bulletin.

Before inventory valuation adjustment.

Provision for depreciation at replacement value.

Table 4.

South Africa: Growth of Disposable Income of Households, 1989-93

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Source: South African Reserve Bank, Quarterly Bulletin.

After adjustment for net remuneration paid to the rest of the world.

After provision for depreciation and inventory valuation adjustment.

Table 5.

South Africa: Real Gross Domestic Product at Factor Cost, 1989-94

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Source: South African Reserve Bank, Quarterly Bulletin.
Table 6.

South Africa: Indicators of Mining and Quarrying Activity, 1986-93

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Sources: South African Reserve Bank, Quarterly Bulletin; Central Statistical Service, Bulletin of Statistics.

In 1985.

Through August.

Table 7.

South Africa: Manufacturing Volume of Production and Capacity Utilization, 1986-94

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Source: South African Reserve Bank, Quarterly Bulletin.
Table 8.

South Africa: Nonagricultural Employment, 1987-94

(1990 = 100)

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Source: South African Reserve Bank, Quarterly Bulletin.

Central Government, local authorities, provincial administrations, statutory bodies, and national and independent states (TVBC).

Transnet and the Department of Posts and Telecommunications.

Includes Electricity Supply Commission, Boards of Control, and universities.

Table 9.

South Africa: Remuneration, Labor Productivity, and Unit Labor Costs in the Nonagricultural Sector, 1987-94

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Source: South African Reserve Bank, Quarterly Bulletin.

Seasonally adjusted.

At 1990 prices; deflated by nonagricultural deflator.