Monday, March 17, 2008

Farm Waivers

Two interesting events the past week in the Indian microfinance space. First off, in what can only be described as a clear vote buying maneuver (a general election is likely later this year) the finance minister, Palaniappan Chidambaram, announced that all loans to farmers with Rs. 50,000 (US$1,250) or more outstanding would be forgiven. The plan, which allocates 60,000 crore (US$15bn) is equivalent to 15% of the entire national budget.

Many of India’s farmers are clearly in trouble. Due to a combination of price volatility and over-indebtedness (more on the cause of this below) 150,000 farmers have committed suicide since 1997. While this recent proposal does address the latter, as the waiving of loans is universal- loans that are performing well (the vast majority) will also be forgiven.

This is all somewhat ironic given other government policy. The Indian government promotes increases in agricultural productivity by requiring 13.5% of commercial banks net credit activity to be in the form of “direct agricultural loans"; as this increases supply to the segment, farmers are able to access loans at below market rates. The thinking goes that increased access to credit will allow them to make capital purchases and thus increase their productivity. So after years of shoveling credit onto farmers the government now seems is now using loan forgiveness is the correct , what will be the next weeks policy?

The good news is that there is no direct impact on microfinance- the scheme only provides for waiving of bank loans (MFI’s aren’t banks.) Also, only loans above Rs. 50,000 will be forgiven, much larger then the average Rs.8000 of microfinance loans. The greater worry comes when microfinance clients look at their wealthier neighbors who are having much larger loans forgiven- what about me?

The foundation of micro lending has always been to educate the borrower on basic financial principals and instill strict credit discipline. With these twin pillars in place MFI’s have been able to offer unsecured loans that achieve phenomenal rates of repayment. If the culture of credit discipline is undermined by the hope of loans being forgiven- the entire basis of the industry is at risk.

The other interesting event was the introduction by Reliance group of a dedicated microfinance fund. Initially it will be a debt only fund- which is great, MFI’s can always use more access to debt finance. Reliance generally moves very aggressively into new markets and everyone is a bit tense to see if this initial foray is the start of something bigger- offering microcredit directly to consumers?

Obviously this is a great thing- the more competition the merrier- and better for our ultimate goals; it is hard however, after pouring yourself into an organization- to welcome a very robust competitor into the space. We'll just have to work that much harder.

Admittedly, they do make great commercials….

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