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Bad economics, poor decisions

March 25, 2004

Let's say you are an auto-rickshaw driver. Typically, you would not own the vehicle you drive, but instead rent it from its owner for a flat daily fee, which will range between Rs 100 and Rs 170 depending on the condition of the vehicle and the type of fuel it uses.

Gas-powered vehicles offer a better return to renters than the petrol-based ones; since the owners know this quite well they charge a higher rate to rent out the former variety. You can expect to earn Rs 8,000 to Rs 12,000 each month, and after paying the rent and the costs of running the vehicle, you will probably take home somewhere between Rs 3,500 and Rs 5,500.
That, as we saw earlier, would add up to a
middle-class income for your family. Keep that thought handy as you read along, for inadequate access to credit shackles not only the extreme poor, but also the everyday person, the guy whose income is squarely in the middle.
Even before you start driving, you can do the math well enough to see that the big dent in your potential earnings is the rent.
Anywhere between 35% and 50% of the money your customers give you is simply handed over to the investor whose capital keeps you in business. An auto-rickshaw can run six years on average, and over that period, you'll pay roughly two-and-a- half times its value in rent alone. That's 25% a year of the principal value for a product you don't own any part of at the end of the six years. If your car dealer or real estate agent offered you those terms, you would laugh away the proposition, but the middle class and the poor don't have that choice. The seth who lends money at 2% a week is often the closest thing to a personal banker they've met.
There is a word to describe such finances: usury -- an unconscionable and exorbitant rate of interest charged to a borrower for the use of money. Throughout India today, excessive rates of interest inhibit the efforts of families to raise themselves up
economically. In the majority of cases, the families earn enough that they would make small savings and climb the economic ladder, if their debts could be repaid at interest rates that you and I avail of. The loan terms to buy our Santros and finance our homes are infinitely better than the ones used to buy cycle rickshaws or goats.
There's another word to describe this same state of affairs: illegal -- not sanctioned by law. It has long been understood that
not all sorts of trades can claim to be legitimate ones protected by the Constitution. Trafficking in slaves, for example, isn't the sort of profit-seeking enterprise that can turn to the courts for protection of business. Sure, money-lending doesn't appear as insidious or sinister, but the consequences can be just as devastating, leaving families in bondage to usurious creditors for several generations.
In the 1970s, Maharashtra decided that money-lending as a business is simply too distasteful to permit. This view did not include money-lending for business, the kind of borrowing that all firms undertake to engage in their trade, but focused on lending to landless laborers in rural areas, and to urban workers. The state ordered that countless old debts be cancelled, and that any collateral provided by the debtors be returned to them. The Maharashtra Debt Relief Act was immediately challenged in the courts, and found the attention of the Supreme Court in Fatehchand v. Maharashtra (1977). The court, by the pen of Justice V R Krishna Iyer, concluded that it was debatable whether money-lending is really a business or trade, but if it was, then the restrictions on it imposed by the Act were reasonable.
This nebulous view must be understood along with a reality that the court itself noted. The bottom line, then as now, is that formal lending institutions (banks, mostly) do not meet the credit needs of the rural poor and the urban working class. To hold that the only form of credit available to such people is illegal would amount to driving them even further into the arms of pernicious lenders. The court's opinion reflected a hope that some solution would be found, and appeared to merely observe that states are empowered to tackle the problem through legislation if they chose to.
Almost predictably, the court's hopes were dashed; alternate (and regulated) systems of credit did not take root as the court hoped they would. Indeed, in recent years, with nationalised banks under increasing pressure to match the profitability of private banks, regulated credit is even less accessible to the lower income groups. But states continue to try legislative approaches that lead nowhere; as recently as last year, Tamil Nadu passed the Prohibition of Exorbitant Interest (Ordinance) Act, thus far to no avail. It is not uncommon -- not will it be, for many years, unless there is a dramatic revision in our approach to usury -- to find families whose debts are many times the total of their annual earnings, and just as often many times the principal amounts actually borrowed.
This is ironic, given the government's obsession with keeping interest rates low enough to drive economic growth to even greater heights. An administration that is truly interested in driving consumption and growth would focus deeply on reducing interest rates for the poor, thereby releasing enormous volumes of money that would most likely be instantly spent on needs that are now not met at all. The poor are far more likely to spend additional income than the wealthy are; the latter can afford to simply bank their additional inflows. Focusing on freeing up more money for the latter is contrary not just to justice, but to all economic sense. The sooner we rid ourselves of theories of trickle-down growth (where the rich are first enriched even further, and their gains flow down to the poor) and focus instead on directly improving the financial freedoms of the poor, the more robust our economy will be.
That we do not attempt to provide increased access to credit for the working class and the poor, is a sign of shame but also of intellectual failure. Bankers have long viewed the poor as unworthy of credit; their lending practices assume that their money would be unsafe if loaned to lower income groups. Until very recently, if you wished to buy an auto-rickshaw using a bank loan, you would first need to find a government employee who would act as guarantor of your loan with the bank.
This fear of making loans to the working poor is laughable, because the wealthier classes are way more likely to default on their loans than their less fortunate brethren. Throughout the country, banks find themselves holding bad debts not because thousands of their small borrowers have become unable to repay, but instead because their large borrowers have no intention to repay loans made for politically expedient purposes.

On the other hand, as micro-credit institutions have shown repeatedly, the poor have an enormous stake in repayment -- it is their only ticket out of their misery -- and are far more reliable as borrowers. Grameen Bank's repayment rates have remained above 95% throughout its history -- beginning from the time Mohammed Younus made private loans to a few villagers, and continuing to this day, when the institution serves thousands of villagers and is expanding into new economic arenas.
The banking structures for lending to the poor, however, can be unfamiliar to bankers more used to the comforts of city living and interacting with clients over company-account dinners. Their successes are measured by the magnitude of the loans they make, and not by the value they bring to their clients' lives, or even their success in ensuring repayment of those loans! The vast majority of decision-makers in banks would not be seen dead with a truly needy person. This cultural bias, founded on bad economics and outright ignorance of the evidence, is the single most important reason for continuing poverty throughout India. People's lack of access to financial capital is directly linked to the bankers' and economists' lack of intellectual capital.


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Ashwin Mahesh

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