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Easy loans are a burden on poor

By Seema Mustafa
BY BHARAT JHUNJHUNWALA A five star microfinance company SKS Microfinance has
successfully issued share at a good premium. This company provides small loans to the
poor. Borrowers can buy buffaloes or do other businesses with this capital or they can
meet their immediate needs such as that of daughter's wedding without having to take loan
from the moneylender at a hefty rate of interest. Such loans are considered helpful for
poverty alleviation. These are preferred instruments of inclusive growth. But improvement
in incomes of the poor is not necessary. Instead these loans can lead to even more
exploitation and poverty.

Simple logic tells us that lower interest rates will lower the cost of production of the poor
households and be beneficial for them.

However, this assumes that the price of their produce will remain unchanged. This may not
be true. Say there were 10 buffaloes in a village, which produced total 100 liters of milk a
day. MFIs lent money at low rates of interest to some households and they purchase five
more buffaloes. The total number of buffaloes in the village went up to 15 and the total milk
produced increased to 15 liters. Now the village will have to find a market for this larger
quantity of production. The supply of milk in the nearby town will increase which will lead to
lower prices. A new equilibrium between supply and demand will be established at lower
price. This will be clearly beneficial to the urban consumers. On the other hand, the impact
of the loans on the poor households is not certain.

It is possible that the loss due to decline in prices may be more than the gain from lower
interest rates. Further, the loss due to decline in price occurs to all farmers of the village,
including those who have made no borrowing.

Thus, the total loss to the producing community is more.

Now consider a different process of development.

Say the price of milk sold in packets was Rs 20 per litre. Of this, the dairy companies
were paying Rs 15 to the producing households.

They were also importing some powdered milk because the quantity of milk available in the
domestic market at Rs 15 was not sufficient to meet their needs. Now if the government
increased the import duty on imported milk powder by Rs 2 per kg. That would force the
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dairy companies to increase the domestic price of milk by Rs 2 per litre. As a result the
purchase price would also increase and the farmers will now get Rs 17 per kg. A new
equilibrium will be established at higher price and lower quantity. The policyalt146s impact
on the producer households is clearly positive.

They will get higher price for their produce.

On the other hand, the impact on the consumer households is negative since they have to
pay higher price for milk.

The impact of the loan- led development process is surely positive for the urban consumer
and uncertain for the rural producer household. And in demand- led development process
the impact is clearly positive for the rural producer household and negative for the urban
consumer. Therefore, we should follow the latter policy insofar as the objective is removal
of poverty of the rural households. The government should identify commodities being
produced by the poor households and raise taxes on imports and big companies that are
producing competing goods. It makes no difference if the loans are provided to the poor
producer households at lower interest rates of 12 per cent as against 24- 30 per cent
being provided presently. The cost of production of the poor household will be reduced but
this may yet not lead to higher income because the fall in price of the produce may be
equally steep.

This aspect of loan- led development process is almost never recognized in the literature.
At a workshop on rural finance held at IIM Ahmedabad in Sept 2004, Mr. V Leeladhar,
CMD, Union Bank of India said, " There is an urgent need for shifting from a minimalist
approach of offering only financial intermediation to an integrated approach of providing
enterprise development services like marketing support with direct linkage between
borrowers and buyers." Mr. Rama Reddy, President, Cooperative Development
Foundation, Hyderabad said, " Unless microfinance is tuned with livelihoods in production,
manufacturing, and service sectors, it would not be able to deliver anything. It will make
more and more people indebted because of an easy access to credit." Samar Datta,
Professor at IIM Ahmedabad said, " Even if we increase credit by 15 times, the borrower
can possibly absorb provided we empower him to sell his product and services. Therefore,
we need to have the system of linkages in place before we venture into more directions
from the state." These specialists emphasize the linkage between loans and productive
activities, which is well justified. At the same time it is also necessary that policies be put in
place to ensure that the prices do not fall due to competition from cheap machine- made
production- domestic or imported.

The first requirement is to put in place policies for hiking the prices of goods produced by
poor households. If prices are right, many poor households will find means to buy the
necessary productive assets. This should be the mainstay of the development process.
This can be complemented with cheap loans, marketing linkages etc. To give cheap loans
etc. in absence of price support policies is like putting oil in fire. The poor households are
already suffering from low prices. They get additionally burdened with debt- lured by low
rates of interest.

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Unfortunately, the government- both central and states- are putting more emphasis on
provision of cheap loans. This can only be explained by their desire to provide relief to the
urban consumer at the cost of the poor producer household.

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