Hydro Power in India

The conference had an interesting panel on energy, naturally a key segment of infrastructure. I found it interesting that India already has a fairly high focus on hydro power, a renewable resource. In fact, India's current power breakdown is 54% coal, 25% hydro, 10% natural gas, and 10% for others including solar, wind, and nuclear. To put it into perspective with other countries, the US only generates 8% of its energy from hydro, while China gets 23% and Paraguay gets 100%. While today's hydro power output is 36 GW (of a total power output of 143 GW), India has potential to generate 149 GW from hydro power, and the government has made it a priority on the eleventh and twelvth five-year plan to generate 40% of India's power output from hydro sources.

Also, while climate change is on the radar as the country thinks about renewable energies, the secretary of the Ministry of New and Renewable Energy clearly stated that their focus is on India's energy security with climate change being an incidental benefit. Very sensible to me, with the way oil economy and prices are going, but fortunately hydro power addresses both issues. I feel that one inherent risk with hydro though is seasonality particularly that during times of drought the power source could shut down; as with any country, it's prudent to invest in more than one renewable energy source to prevent power outages due to natural phenomena. To this, it was mentioned that other forms are being looked into, particularly biomass (where the focus is currently on funding small plants and entrepreneurs), wind turbines (where Suzlon is already a market leader), and solar.

Finally, the other major issue with hydro power that relies on dams is the land requirement and the effect of developing this land for infrastructure on its inhabitants. But I'll save my thoughts on that for another time, as the conference has a panel tomorrow on the very subject of land.

Interesting Take on the Indian Economy

The India Infrastructure Investors Forum started today. I did feel a bit out of place at first, the only consultant at an invitation-only conference for investors, hedge funds, and the like, but met quite a few interesting folks who, as one would expect, were very knowledgeable the Indian infrastructure sector. I'll only mention some of the parts of the conference I thought were most interesting, the first being an overview of some key trends in the Indian economy by Prof. Raghuram Rajan of University of Chicago GSB (and previously the IMF). The most interesting points I took away from his talk were around concerns and reforms India is facing:

1. Weak non-bank system. India is still primarily bank driven, resulting in a lack of investment opportunities and loan sources for corporations. The reform necessary is creation of a corporate bond market that would allow corporations to borrow from non-bank entities and lead to the creation of interest rate and exchange rate futures markets to allow risk hedging. India also needs to expand the range of asset classes to include private equity, pension funds, etc. to attract foreign investment. I found this very surprising, as I'd never imagined that an economy so large as India's would be lacking in something as fundamental as a corporate bond market.

2. Public sector banks not competitive. Regulators often assume management of state-run banks such as State Bank of India have financial knowledge and control. With the chiefs of SBI making less than $1000 per month and a lack of technology such as ATMs, etc. their advantage will erode compared to private sector banks. The reform necessary is to distance the public sector from the government and ease some constraints to allow these banks to open branches anywhere, etc.

3. Credit infrastructure needs to be strengthened, though there has been no momentum to do so. Since over 70% of the population is outside the formal financial sector, bank-based credit reporting is insufficient. India needs to create a national ID and credit history for individiauls, multiple bureaus to track credit, a collateral registry, and inclusion of non-bank credit items such as utility bills and land titles as part of a person's credit identity. Hmm... maybe IBM's new hub system could be helpful here.

4. Disaster recovery. Prompt corrective action and regulator coordination are needed. This includes recovery from disasters such as a credit crunch currently affecting the US. On a more micro-level, poor people tend to borrow for emergency needs and need money immediately, a task the formal banking system isn't currently flexible enough to handle.

5. Inclusion. Important to stability in all emerging markets is the need to include all people in the financial system and reduce disparity. India is currently not doing well in this regard. Over 75% of loans are less than $1000 and come from unofficial sources such as money lenders and family, implying that the formal system isn't reaching the poor. It was suggested that since the interest rate ceiling on loans doesn't apply to these unofficial sources anyway, it should be removed to motivate the formal system to lend to lower income people.

Seeing India through the eyes of a prominent economist was, well, eye-opening for me, particularly the first point about India's capital markets. I knew this conference was going to be very interesting.

A technology platform for MFIs

During my summer at the IFC I surveyed a few MIS (Management Information Systems) solutions for an MFI in Papua New Guinea. They realized that as they scaled, they would have to abandon their Excel spreadsheet in favor of more a more sophisticated and robust system. In my search I realized that the microfinance industry still lacks a standard for information management, tracking, and communication. Having a single standard and system would allow MFIs to not only organize their records better and reduce errors, but also allow potential investors to have more transparency into their accomplishments and connect them with other entities that would streamline other parts of their business.

Last week IBM presented just the solution I imagined: a platform that adds some much needed structure to MFI information management and provides communication between various constituents in the process. Today around 45% of MFIs are still using either a manual pen-and-paper or simple spreadsheet system; IBM has identified that gaining access to proper back-office technology was the single most important obstacle to growth of MFIs, and developed the "microfinance processing hub" which allows MFIs to connect to a central hub via client software (which they buy, making this a for-profit venture) and from there, to other entities in the microfinance process. While there is some resistance from MFIs due to their having to outsource information to an external vendor and relying on an Internet connection for their basic needs, the benefits are many, inlcuding (1) allowing MFIs to work in groups to negotiate standard prices from service providers, (2) branchless banking requiring only an Internet connection, which dramatically reduces fixed costs and increases reach, (3) portfolio and KPI information is readily available, making outside investors and banks more comfortable funding MFIs and increasing the overall transparency of the industry, and (4) decreasing client default risk (and hence, interest rates) once clients build credit reports which will be available.

In Africa, IBM has partnered with CARE to develop an African Financial Grid which will initially target 11 countries and over 400 million people. I do think adoption of this system will take time, since each country (or even region) will have a different set of banks, cellphone providers, credit bureaus, etc. that will need to "plug in". Still, the microfinance industry is long overdue for a technology standard; hopefully this will prove to be effective and gain more adoption.

Microfinance made simple

Last night I attended an event organized by JP Morgan and the Microfinance Club of New York (http://www.mfcny.org/) on successful microfinance strategies, featuring Mr. Shafiqual Haque Choudhury, founder of ASA Bangladesh (http://www.asabd.org/) which was recently ranked #1 on Forbes 50 top microfinance institutions list. He focused on strategies and innovations for achieving profits through operational efficiency and cost reduction rather than top-line growth (e.g. higher interest rates). Many may sound simple but, as he described, are often neglected by MFIs around the world:

1. Proximity to clients. Mr. Choudhury emphasized that MFI outlets "should be at the doorstep of people". This minimizes the travel cost for clients and makes funds more accessible. To have this ubiquitous presence also requires outlets to be as low cost as possible so they can be greater in number. I would add that developing infrastructure for micro-level funds transfer through mobile devices (as Globe Telecom has done in the Philippines) can further increase reach as well.

2. Observe after borrowing, as opposed to the more familiar methodology where the bank observes and evaluates the borrower before providing the loan. The benefit is reduced transaction cost and trust built up front by the MFI that motivates clients to repay the loan on schedule. I am slightly skeptical of this; while trust is important, I feel it doesn't address a borrower's ability to repay which can be partly assessed before transaction.

3. Minimize administration costs. While it seems obvious, the innovation is in how this can be done. ASA has done away with the complicated loan application form that requires multiple documents, pictures, etc. as well as long processing times and multiple visits by the client (thus decreasing access to funds). It also has no dedicated accountant or cashier. A branch may have just four loan officers who do everything from meeting clients to disbursing loans to managing the office (a loan officer at ASA handles an average of 412 loans).

4. Efficient branch design. Proximity to clients requires ubiquity of branches, making minimizing branch cost key. Contrary to many MFIs, which Mr. Choudhury described as having professional fronts, imported furniture, multiple rooms, and airconditioning, ASA branches are very minimal. The waiting area is in the same room as loan disbursement and a few ceiling fans substitute for airconditioning. Clients sit on a long bench as they await their turn.

5. No training. While training is a key component of the NGO model (Mr. Choudhury added that some MFIs spend up to 6 months on training officers), ASA follows a model of training through following a senior officer for six days, then learning on the job.

For all these innovations, ASA's cost for a $100 loan is $3 which is impressive. ASA is also able to maintain a 12.5% interest rate (though it should be noted that ASA follows a non-profit MFI model) and a NPL ratio of less than 1%. Comparing these ideas with my observations at Sahabat, the MFI I worked with in Indonesia, at first I was skeptical; from my experience there should be a balance between simplicity and excess. But then I realized how it works for ASA; with an average loan size of $130 and over 5.42 million borrowers (and 4.99 million savers) it is much more of a volume game, compared with the average loan size of Sahabat which was over $1000. The smaller loan size also implies a lower level of client sophistication which further reduces the need for sophisticated processes on the MFI's part. While I do feel these practices don't apply to every type of MFI, ASA stands as a testament to the value of operational simplicity.

Investing in Bangladesh

Two days ago I attended a conference on untapped investment opportunities in Bangladesh. It was structured as a panel discussion and less interactive than the PE round table due to the large audience size, but insightful nevertheless. The panel included the MD of a large Bangladeshi corporation, economists from leading investment and development banks, and private equity investors. With the recent growth in Bangladesh, I was curious about its drivers and needs. Here are some of my realizations from the conference.

Drivers and Opportunities
Road to political stability. The caretaker government that was put in place on Oct.29,2006 following a period of violence and volatility has since instituted several reforms, including reconstitution of the Elections Committee. The government also recently created the Better Business Forum to improve interaction between the business community and government and establish the need for public private partnerships (PPP) for infrastructure projects. The impending election and government emphasis on business should decrease risk and attract foreign investment.

Investment climate. Bangladesh has a favorable investment climate with the government allowing 100% FDI and joint ventures with the private and public sectors. The government has also instituted no ceiling on investment, tax holidays, duty-free imports of machinery, etc. for export-oriented industries, and multiple entry visas for foreign investors among other incentives.

Economic indicators. A 7% growth in GDP is further bolstered by a shift to new industries such as services, which now accounts for 50% of GDP, and an increased shift of the informal sector to the formal which results in value that was previously not being recognized now counting towards the national output. The Dhaka Stock Exchange is also up 66% this year, making it Asia’s top performer after China.

Isolation. With a foreign investment being 1% of GDP and only 20% of GDP being exported outside its borders, Bangladesh’s market is decoupled from the rest of the world and thus, relatively uncorrelated. The government is also promoting self-sufficiency by encouraging foreign investment in sectors that will help import substitution, such as high-tech. Foreign investors seeking to diversify their emerging markets footprint should find opportunity here, though the correlation will increase over time as Bangladesh continues to integrate with the rest of the world.

Favorable demographics. With a population median of 22.5 years in 2007 and 33% of Bangladeshis being under 15 years age, the next generation will dramatically increase the number of consumers and demand for consumer products. Arif Dowla, MD of ACI Ltd. (leading provider of pharmaceuticals, FMCG, and others) even commented that it could be difficult for businesses to keep up with the demand growth. Further, a growing cadre of tech savvy and entrepreneurial Bangladeshis, many educated abroad, are fueling new business growth and remittances from an increasing number of non-resident Bangladeshis are increasing stability.

Barriers and Needs
Lacking infrastructure. Repeatedly prioritized by several panelists as the leading area for reform, including electricity which is only available to 15% of villages (World Bank), roads, railroads, and telecommunications. The government also needs to go to market for investments in infrastructure through public private partnerships.

Marketing and branding. David Fernandez, head of emerging Asia economic and sovereign research at JP Morgan, made a point repeatedly that what Bangladesh needs (but is starting to build) is a credible story for investors. This includes developing a brand for the country and promoting opportunities to the global investment community. The country also lacks a credit rating as the government has yet to decide when the right time to establish that would be.

Fiscal reforms. Peter Berezin, senior global economist for Goldman Sachs, pointed out the need for greater fiscal reforms, underscoring the need for tax collection reforms. Unless the country is able to significantly increase its tax collection, through better tax administration or expanding the tax base, it will not be able to meet fast economic growth without increasing the fiscal deficit.