In past budgets, microfinance has been overshadowed by heavyweight industries such as IT, autos, telecom, banking and infrastructure. But now microfinance is emerging as an influential and high-potential industry in its own right. C Rangarajan’s committee on financial inclusion this spring reported that microfinance institutions (MFIs) “could play a significant role in facilitating inclusion, as they are uniquely positioned in reaching out to the rural poor.” The government has underscored financial inclusion as one way to reduce poverty.
Microfinance clearly helps meet that goal by providing financial services — from small loans to insurance — to millions of unbanked households. However, several fiscal constraints keep the microfinance sector from reaching its full potential. Banks enjoy a host of beneficial tax reductions and exemptions but MFIs do not. MFIs also pay service taxes that our impoverished customers end up paying for even though they should be exempt.
If MFIs had a level playing field, they would be able to lower the interest rates, reach more customers and help millions more lift themselves out of poverty. MFIs are now well-regulated, supervised and follow the same kind of requirements as banks. Yet banks and their middle-class customers enjoy preferential fiscal policies that MFIs and their poor clients do not.
To address the issue, the ministry of finance should waive service tax on all micro-loans, which are defined as less than Rs 25,000, and on micro-insurance products that insure less than Rs 25,000. The middle and upper classes get tax breaks on insurance premiums and on interest on housing loans. MFI customers, most of whom are illiterate and live in remote villages, do not file tax returns and therefore can’t benefit from tax refunds. However, the poor still pay a 1% to 2% processing fee on their micro-loans as well as service taxes of 10.3% on their micro-insurance policies.They also end up paying a “poverty premium” since they can’t take advantage of tax breaks enjoyed by the middle and upper classes.
Secondly, MFIs should be allowed to enjoy tax concessions on 40% of profits, as enjoyed by housing finance and infrastructure companies. The government has rightly identified housing and infrastructure as priority sectors. But rural development and financial inclusion are also priorities in achieving inclusive growth.
Thirdly, banks and financial institutions get a tax deduction of 7.5% of gross total income for reserves kept against possible bad debts. Alternatively, banks can claim deductions of 10% on assets classified as doubtful or loss assets. If MFIs were given tax breaks already enjoyed by banks, they could lower their costs and pass those savings onto our borrowers by reducing interest rates. Microfinance would be more affordable for the poor and could flourish further across India.
The author is founder and chairperson of SKS Microfinance