November 01, 2010
What’s happening in Andhra Pradesh?On October 15, the government of Andhra Pradesh, India’s fifth-most-populous state, issued an ordinance aimed at protecting women who “are being exploited by private microfinance institutions through usurious interest rates and coercive means resulting in their impoverishment and in some cases leading to suicides.” The ordinance seems designed to quash microcredit in the state, where it has grown explosively in the last five years through a process of commercialization that has brought ample capital and made millions for some investors and founders.Unfortunately, the ground truth remains murky for those removed from the situation. On the one hand, the harm of microcredit appear exaggerated in much of the current rhetoric: the inflammatory suicide charges may have been ginned up by the papers and political players with vested interests in other forms of microfinance. Still, there is good reason to worry that the fast expansion has gotten many poor people into debt trouble---into situations in which repayment is coerced, verbally or even physically, by peers and loan officers. What is beyond doubt is that the Indian microcredit industry, the largest in the world, is in serious peril; and that this crisis is sure to seed discussion worldwide about whether and how microfinance institutions (MFIs) can commercialize responsibly.What does the ordinance do exactly?The ordinance requires, among other things, that all microcreditors cease disbursing and collecting loans immediately, pending registration with local officials—a registration process whose tempo would lie entirely in the hands of these officials. The ordinance also gives such officials the power to revoke registrations at any time for any reason. And it limits interest rates to 100%/year, which is odd since most MFIs there charge in the 20’s. More subtly, the ordinance has fostered an hostility toward microcredit throughout the state. On October 22, police arrested loan officers working for SKS and Spandana, two big lenders, for harassing a borrower named Ammulu. They indicated their interest in arresting the chiefs of the two organizations, Vikram Akula and Padmaja Reddy.The Microfinance Industry Network (MFIN), formed earlier this year, quickly sued, and won a temporary stay on October 22. However, as I have blogged, microcredit loans are like sand castles: without constant maintenance, they quickly fall apart. Why? In the absence of collateral, three main factors coax steady repayment out of microcredit borrowers: the habit and discipline of weekly payments, peer pressure from jointly liable borrowers, and access to new loans if old ones are repaid on time. By creating uncertainty and cuing local officials to obstruct microcredit, this ordinance is undermining all three factors. If people doubt that MFIs will be around tomorrow, they will think twice before repaying today. And if their neighbors stop paying, they’ll think thrice, for fear of being fools. Default can spread like a contagion.The uncertainty is biting. One Indian microcredit executive quoted in the Financial Times sounded as if he was dying of thirst: “Cash flows are getting worse day by day . . . We cannot sustain this for long. We will be dead very soon.”Whence the backlash?Andhra Pradesh is the hotbed of microcredit within India, which in turn just surpassed Bangladesh as the country with the most microloans. The growth rates have been unprecedented and stupendous. SKS Microfinance, the leader, exploded from 11,000 borrowers in 2003 to 5.8 million earlier this year. SHARE, Spandana, and BASIX, also based in Andhra Pradesh, have grown comparably, reaching more than a million clients each.The expansion has been based on the importation of the group microcredit model, famously refined by the Grameen Bank in Bangladesh, into the similar context of southern India. But in contrast with Bangladesh, where the microcredit industry grew more gradually and is largely non-profit or cooperatively owned, another basis of the Indian expansion has been commercialization. The big Indian MFIs are for-profit. This has allowed them to raise funds from venture capitalists such as Sun Microsystems founder Vinod Khosla. And it allowed SKS to go public this summer, a deal that earned Khosla $117 million.With the equity in hand as a shock absorber for losses from defaults, the Indian MFIs have then gone to banks to leverage each dollar of equity into a typical $3–9 in loans, which they then pour into new microloans. In fact, India’s priority sector lending rules, somewhat like the U.S. Community Reinvestment Act, require that domestic banks channel 40% of their credit to certain activities or groups of people deemed particularly deserving. Currently, MFIs qualify to drink from this torrent of capital. In a sense, then, the multimillion-dollar profits of Khosla, SKS founder Akula, and others accrue from the subsidy embedded in this social policy.Just as in 2007, when Mexico’s Compartamos went public, the sight of investors making millions off loans to the poor has aroused intense controversy. Among the charges:
- It is immoral to get rich off the poor.
- When microcreditors cede ownership to outside investors, they can no longer be trusted to put the poor ahead of profits. Indeed, argued Nobel laureate Muhammad Yunus in a debate with Akula, “microcredit” becomes “moneylending.”
- The interest rates are usurious…even though they are not much higher than those charged on U.S. credit cards.
- There have been harsh collection practices, perhaps particularly among dubious fly-by-night operations appropriating the mantle of microcredit. There are stories of goons hired to threaten defaulters with violence. And now microcredit-induced suicides are being reported in the papers and government documents.
- Just as in the subprime crisis in the U.S, which was also partly propelled by social policy [but see comments below], the fast growth has caused careless lending. While it is hard to judge this issue precisely, there seems little doubt that many people are borrowing from several MFIs at once, that micro-debt levels have risen fast, and that all of this is cause for serious concern. On the one hand credit can be a life saver (if it finances medicine); on the other, when credit is easy, people are often poor judges of how much they can handle.
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CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.