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.
In my view, the primary issues are the last two, perhaps especially the last: has rapid growth caused microcredit to hurt more than it helps? I take the suicide reports with a lot of salt. Last year, rigorous studies found little impact of microcredit on poverty—and demonstrated the danger of drawing conclusions based on heartwarming stories. We should interpret heartrending stories cautiously too. Stories can cut both ways: a Wall Street Journal reporter just visited the mother of man whose suicide police were investigating for a microcredit link. The mother blamed his death on debts to moneylenders, not microcreditors.
So is the backlash is all about the harm to poor people?
No. The truth appears be more sultry. Before the non-governmental, Bangladeshi-style MFIs stampeded onto the scene, a more distinctively Indian, more government-driven method for delivering financial services had grown large: the Self-Help Group. In this system, some 15 women join together, open a joint bank account (which most have never had individually), and begin to save regularly. Once their savings reach a certain level, they can borrow even more than they have saved. The National Bank for Agricultural and Rural Development, a government agency, backstops and drives the system with wholesale loans to the banks.
But SHGs do not generally arise spontaneously. Groups called “promoters” organize them, and get paid for the service. Thus the interests and the ideology of these promoters, which have formed 4.5 million groups so far, are directly threatened by the rapid advance of the MFIs. A new report from Intellecap, a consultancy based in the Andhra Pradesh capital of Hyderabad, compares the drama to a Bollywood plot. The propriety the upstanding, establishment-minded first-born brother clashes with the brash, somewhat overzealous younger one. More specifically, the report argues that SHG promoters and their allies, in addition to resenting the competition, may be mystified by the how the MFIs achieve nearly perfect repayment rates (unlike SHGs), and infer physical coercion.
The role of SHGs as an interest group is not conjecture: The recent ordinance casts itself as defending SHGs. The women it seeks to protect, referred to in the quote at the top of this backgrounder, are stated to be the women of SHGs. The provision allowing local officials to revoke registrations singles out SHGs as complainants who could prompt such action.
So is the attack on microcredit warranted?
While the moves in the grand game are easily described, what is going on in the villages is hard to discern. Sensationalist stories about suicide do not suffice to inform us.
Though the largest backlash against microcredit in India, it is not the first. Investigations of past incidents have concluded that while local religious and political leaders, and certain vested interests, instigated the challenges, the microcreditors had much to answer for, in pushing credit and collecting payments so aggressively. Some, for example, forced women to sit in the weekly group meetings for hours until everyone made payments. This time around, the situation is similar, according to one industry insider. SKS founder Akula once told me that he took inspiration from Coca Cola, a company that came into India and quickly scaled up with a standardized product. But if a soft drink industry’s growth outstrips demand, this becomes immediately obvious through depressed prices or overfull warehouses. When a credit industry grows to fast, the very growth can mask the problem. The fundamental source of the instability is that credit is like an addictive drug: people who buy too much often respond by buying more.
That said, as the Financial Times has argued, this precipitous, politically driven, and vaguely worded ordinance is unnecessarily destructive of the microfinance industry specifically and the Indian business environment generally. It is far from the ideal as an approach to wrestling with the complex challenge of reining in microfinance so that it optimally serves the poor. Most worrisome is the appearance that interests and ideology of the SHG camp are overriding an open-minded, empirical analysis of whether a sudden shutdown in access to credit serves the poor.
In connection to the question at the heart of my forthcoming book (draft chapters listed at right)—does microfinance work?—the Andhra Pradesh debacle drives home a key point. To evaluate microfinance, you cannot just look at randomized trials in isolated locations, important as those are. You must also come to grips with the dynamics of the industry. Imagine if rigorous studies of subprime mortgages in the U.S. in 2003–04 had concluded that they were working great---borrowing households earned more, spent more, etc. That would not have been the whole story. A tough, core question for me is: when is growth development…and when is it the opposite?
What will happen next?
Knowing little about the Indian political scene and legal system, it is hard for me to speculate. And I suspect those closest to events are unsure. Investors have knocked down SKS’s share price, one indicator of future prospects, by 40%—but that only brings it back to the IPO price, which is still arguably quite rich. In fact, SKS is better positioned to weather the crisis than most of its competitors. It alone got to market in time to raise more capital (while the others will have to put their IPO plans on hold), and has a low debt-equity ratio (“leverage”) of around 3. That means that it could sustain losses of one-third of its loan portfolio without defaulting on any of the loans it owes to banks. (Shareholders would be wiped out though.)
A best-case scenario is that the Indian industry survives, wounded, wiser, and more responsible. In that case, this episode will be seen as a brutal but perhaps healthy check on the excesses of an industry. But because the main assets of the industry—its outstanding loans—are so delicate, this outcome is by no means assured.
And while the circumstance of the crisis are unique to India, it seems likely to spawn discussion worldwide about whether and how commercialization of microfinance can be done responsibly. What can socially motivated investors, who still provide the lion’s share of capital to microfinance, do to assure responsible conduct? When is their own eagerness to pour in money part of the problem?