Research proposal sample
IMPACT OF INTEREST RATES ON ECONOMIC ACTIVITIES: A CASE STUDY OF SELECTED MFIS AND SMES IN SOROTI MUNICIPALITY
LIST OF ACRONYMS AND ABBREVIATIONS
AMFU Association of Microfinance Institutions of Uganda
BDS Business Development Services
DFCU Development Finance Company of Uganda
COMESA Common Market for East ans Southern African Countries
CRB Credit Reference Bureau
EADB East African Development Bank
EIB European Investment Bank
ILO International Labor Organization
LPM Linear Probability Model
MDGs Mellenium Development Goals
MFPED Ministry of Finance Planning and Economic Development
MFIs Microfinance Institutions
MSMEs Medium Small and Micro Enterprises
NAADS National Agriculture Advisory Services
OECD Organization for Economic Coperation and Development
OLS Ordinary Least Squares PPP- Public Private Partnership
SACCOs Savings and Credit Cooperative Organisations
SMEs Small and Medium Enterprises USSIA Uganda Small Scall Industrial Association
UBOS Uganda Bureau of Statistics
ABSTRACT
The major challenge that was faced by many developing countries, especially in Africa, was devising appropriate development strategies that would capture the financial services requirements of Small and Medium Enterprises (SMEs) which constitute about 70 percent of the business sector. Delivery of microcredit to operators of Medium Small and Micro Enterprises (MSMEs) in developing countries were increasingly being viewed as a strategic means of assisting the working poor. Over the past decades, a considerable amount of multi- and bilateral aid has been channeled into microfinance programs in Uganda with varying degrees of success. Like all development interventions evaluations and impact assessment studies to ascertain the achievements and failures of these programs would help a lot for future program design. In Uganda, the SMEs sub-sector has realized tremendous growth in terms of employment, income and business stock size. The sub-sector therefore attracted great attention of financial service providers to extend a range of financial offer to the poor. However, little was still known of the contribution of the microfinance industry to the growth of the SME sub-sector. The study sought to establish the impact of microfinance service delivery on the growth of SMEs in eastern Uganda. The study employed both quantitative and qualitative data analytical methods, and a multiple regression was run to estimate the effect of socioeconomic characteristics on the SMEs growth, while a logit model was used to assess the constraints to access to microfinance products in Uganda. The findings indicate that although the MFIs have performed below a set standard on average due to some industry wide challenges, they have had a significant impact in linking SMEs and the poor to sources of credit and contributed to their growth in terms of growth of business capital and stock accumulation. It was recommended that there was need for an institutionalized public-private partnership for creating favorable conditions for the operations of these enterprises. This reduced on the numerous constraints facing SMEs so as to make the nationals benefit from their overall contribution to poverty reduction. Designed tailored made products of SMEs are essential through investment in education, setting up an authority or coordination center for SMEs and promotion of prudential mechanisms by setting a regulatory and supervisory framework for all Microfinance Institutions. Key Words: SMES, Growth, Microfinance, Financial and Non-Financial Services
CHAPTER ONE
INTRODUCTION
1.0 Introduction
This study aimed at examining the effects of interest rates on economic activities mainly small medium enterprises in terms of growth and performance in Soroti Municipality. It was based on an economic assumption that access to credit by SMEs was important however, high interest rates charged by MFIs made loans too expensive hence affecting the growth and performance of SMEs. This chapter set the study. It provided the background information which highlighted the historical background of the problem. It then explained the statement of the problem, objectives of the study, research questions, scope of the study, significance of the study, definition of key concepts and conceptual framework.
1.1 Background to the Study
The importance of small medium enterprises (SMES) to national economy was well documented and that’s why its growth and performance was very critical. One area of interest to the growth and performance of SMES was access to finance. This explains why the introduction of microfinance institutions was considered central to the survival of many SMES simply because financial difficulties have been the number one constraint to their growth and performance. This made MFIs the main financiers of SMES, however, over the years, MFIs have shifted from their pro-poor credit terms to profit making in the bid to enhance their sustainability. How fair was such a shift, it was a debate for another study however, one particular aspect for this study was the ever increasing interest rates charged by several MFIs to SMEs had become a great concern since it implicated their performance and survival.
There was clear evidence that, interest rates charged by MFIs to borrowers more so, SMES have continued to rise compared to other traditional Commercial banks. The realization of the high rates prompted several obvious questions like, why were microfinance interest rates so high? What were the effects of both those high levels and of a more reduced level on demand for credit by SMES? These were a few of the questions that this study aimed at addressing.
According to Kimutai (2003), ‘‘interest rate is a price one pays for using borrowed money (loans). In monetary terms, money creates claims because it is an asset, store of value as well as a medium of exchange. It was in this respect that, lenders expected to be compensated for handing over their claims for the period of the loans to those who borrow money. Whereas, there was logic in this, it was also important to evaluate its effects on SMES. No matter the reason for, the itching issue among SMEs is that, there were increasing small business failures in Uganda; regardless of the sound logic behind the high rates, such burdens instead undermined the objectives of MFIs. Ingram (2011) stated that, interest rates were important because they controled the flow of money in the economy. Whereby, charging high interest rates curb inflation on the other hand, low interest rates stimulate the economy. The economic effects of interests on the general economy was known, however, the impact of interest rates on SMEs in rural areas such as Soroti District remained unknown due to little attention given to this subject.’’
In the past, it was widely believed that access to credit was much more important to borrowers than rates, because their micro businesses had a very high profitability provided they could get the working capital to start them (Aryeetey et al., 2004); however, over the years, studies found that borrowers were too sensitive to the level of interest rates at which they borrowed due to the high business failures in the recent years. Whereas, the role of credit was basically to bridge the gap between business owner’s financial assets and the required financial assets of the business/enterprise; however, the interest rate charges made borrowed credit more expensive and repayment more difficult due to uncertainties that befell their economic activities.
In Uganda, most MFIS charged interest rates that ranged from between 1.8 per cent to 2.5 per cent per month. Others, on the other hand, charge at least 0.5 per cent per week. This translated to between 21.6 per cent and 30 per cent per year. The institutions had repayment periods of weekly and monthly depending on the size of the loan, lending rules and how one agreed with other members of the group ran by the MFI, who jointly acted as guarantors of the loan. It should also be noted that, since most of the loans offered by MFIs did not have grace period, borrowers started servicing the loans as soon as they received them. What all this implied is that, interest rates from MFIs were higher than that of most commercial banks, whose lending rates were between 21 per cent and 24 per cent. If the performance and growth of SMEs was important to the general economy of Uganda; diagnosing interest rate problems was paramount. This study was an effort to investigate the effect of interest rates on economic activities of rural Entrepreneurs in Soroti Municipality.
1.2 Statement of the Problem
The continued high interest rates charged by MFIs made access to credit yet a challenge to promising entrepreneurs. It was argued that such interest rates erode surpluses generated by borrowers, leaving them with little net gain. As if that was not enough, there was also concern that high rates reduce the demand for and uptake of financial services hence crippling potential businesses due to fear for high burdens that come by borrowing. As Dehejia, Montgomery and Morduch (2012) pointed out, whereas these effects were seen; high interest rates undermined the original intention of rural entrepreneurial development. Although several studies eluded the negative impacts of high interest rates charged by MFIs in name of meeting administrations costs among others, however; there was a general paucity of rigorous impact. It was upon this background that the researcher was prompted to assess the nature of impact of interest rates on economic activities from SMEs’ perspective.
1.3 Objective of the Study
1.3.1 General Objective
The study was aimed at investigating the impact of interest rates on economic activities in Soroti Municipality, Uganda.
1.3.2 Specific Objectives
The study was to be guided by the following specific objectives:
- To find out views on nature of interest rates charged by MFIs to small scale business operators in Soroti Municipality
- To examine the significance of finances towards performance and growth of small scale business operators in Soroti Municipality
- To determine the performance and growth of small medium enterprises in Soroti Municipality.
- To determine the relationship between interest rates and performance of small medium enterprises
1.4 Research Questions
- What was the nature of interest rates charged by MFIs to small scale business operators in Soroti Municipality?
- Of what significance was finance towards performance and growth of small scale business operators in Soroti Municipality?
- What were performance and growth indicators of small medium enterprises in Soroti Municipality?
- What was the relationship between interest rates and performance of small medium enterprises?
1.5 Scope of the Study
1.5.1 Content Scope
The study was focusing on examining the effects of interest rates on economic activities of small scale and medium enterprises in terms of performance and growth.
1.5.2 Geographical Scope
The study was conducted in Soroti Municipality in the Eastern region of Uganda among small scale and medium enterprises simply because it holds both informal and formal business enterprises.
1.5.3 Time Scope
The study was carried for period of five months namely May – September 2016 to fit within the University academic calendar.
1.6 Significance of the Study
The results of this study were expected to play an important role by providing the information necessary in the relevant areas to relevant stakeholders.
First of all, this study was of great benefit to policy makers, more so, Ministry of Finance, Central Bank and Microfinance Institutions in Uganda (AMFIU) by providing agents with updated information about the effect of interest rates on economic activities of rural entrepreneurs. They might use this data to formulate successful credit policies with regard to interest rates and programmes that enable them to allocate scarce financial resources to the development of basic sectors of the economy. It also pinpointed that the government through the Central bank of Uganda could use this data to effectively regulate the microfinance sector to improve/promote the development of SMEs in Uganda.
The study was also useful to the Management practice in the microfinance sector. This study was intended to generate information from selected MFIS which helped the MFIs to identify the possible ways of determining competitive interest rates that reduced the high default rate due to high repayment interest rates.
The findings of this study enabled credit consumers to make informed decisions on the interest rates charged by MFIs and the appropriate loan sizes to apply for.
Further still, the study provided important information to scholars and academicians especially those in the field of finance and banking who could have wish to conduct further study on this subject area and other related aspects of that study. Thus, that study served as point of reference by scholars and students.
The study also contributed to the body of knowledge in regard to interest rates, its effected and measures to address implications.
1.7 Definition of Key Concepts
Growth (of SMEs): is defined as an increase in size or other objects that can be quantified or a process of changes or improvements (Penrose, 1995).
Interest Rate: is defined as a fee charged by a lender to a borrower for the use of borrowed money, usually expressed as an annual percentage of the principal; the rate is dependent upon the time value of money, the credit risk of the borrower, and the inflation rate (Yasir Hayat and Abu Hassan,2014).
Small and medium-sized enterprises: are non-subsidiary, independent firms which employ fewer than a given number of employees; most frequent upper limit designating an SME is 250 employees.
Performance: defined as the process of how an organization translates plans into results. Thus business performance is related to success and the construct of ‘excellence’ (Cokins, 2006:2).
1.8 Conceptual Framework
Figure 1: shows conceptual framework
Source: Derived from research topic by the researcher
The figure above indicate the relationship between the study variables that is, interest rates as the independent and economic activities of SMEs. It is argued that, when interest rates increase it will negative affect smes burdened due to expensive loans thus, affecting their profit margin but when they decrease it creates breathing space for investment and growth.
