Is India in Financial Trouble? When Dreams turn into Nightmares...

SKS Microfinance ClientImage by kalyan3 via FlickrSKS Microfinance client

Sorry, this post is late: I'm just back from Vienna (what a wonderful town and the Viennese are sooo hospitable! Do make sure you put Vienna on the map on your next tour of Europe!)

Watching the Irish debacle this week and the threat to the Euro, which in turn could jeaopardize recovery in Europe, and perhaps in the rest of the developed world, I was reminded once again how much we depend on the emerging markets.

Now that their GDPs have grown to about half of world GDP, trade with them has become the key to recovery. China and India have become preferred trade partners.

But how solid are they? 

We all know that China suffers from debilitating social tensions that could potentially become devastating. What about India? It  has been one of the great success stories of the Great Recession. It has grown at a fast pace and produced hordes of millionaires while the Western World was teetering on the brink of disaster. But there is a chink in the armour, a small one that could grow into a big chasm...This week, when Andimuthu Raja, the Indian government minister for telecommunications had to step down in the midts of a corruption scandal, possibly the biggest in India's history, we were all reminded how corruption in India's governing elite is a constant threat to the country's stability. As reported by the New York Times (see article below), "he is accused of using his post to sell off valuable mobile telephone spectrum licenses in 2008 at rock-bottom prices. His decisions may have cost the Indian treasury as much as $40 billion, according to a government investigative report released last week."  Yip, $40 billion!

But is corruption limited to the political classes? Hardly. Lending to the poor - otherwise known as microfinance - is another area where serious problems have recently surfaced. Here, it's not exactly corruption, but a determined pursuit of one's own personal profit and a general disregard for the common good. The problem came to the attention of the media  when the poor began to default en masse, particularly in the State of Andhra Pradesh. Suicides, especially among  poor indebted women, suddenly rose. So State authorities have moved in, capping interest rates and clamping down on lending practices. This has had the immediate effect of slashing revenues of SKS Microfinance, the largest microlender in India, backed by big investors like George Soros and Vinod Khosla, and the first to be quoted on the Mumbai market. Its shares have fallen and will probably keep falling as long as people worry about knock-on effects on other borrowers.

Why would that be important in India's financial world, famously known for the stability and conservatism of its banking system?   Because microfinance  which started small some twenty years ago in Bangladesh has turned into a tsunami in India over the last five years. The trouble is that this vertiginous growth has much in common with  the sub-prime mortgage phenomenon in the US. The pattern is strikingly the same: loans are showered on small borrowers without any checks on whether they can pay back their debt. Multiple loans are allowed, and a borrower starting with 8 or 9,000 rupees soon finds herself (because it's usually a woman) owing multiples of that sum, simply because she has borrowed to pay off the first loan and then borrowed and borrowed again.

In short, microlenders are out to build their own institution - they would all like to end on the stock market like SKS and be able to rake in lots of additional funds - and so they just  pile up loans and couldn't care less whether borrowers have any sort of viable business plan.

Business plan? Not quite the right word. Here is how it all started. Microlending was the brain child of Mohammad Yunus who worked with rural women's groups back in the 1990s. He worked with poor women who needed seed money to get started in small, artisanal enterprises, and while they had no collateral to put up, they had formed groups that could back them up and pay in case of default. Group pressure was exercised, which ensured that microlending was extraordinarily successful in keeping defaut down and allowing small businesses to be born in the poorest sections of the rural world - in this case, Bangladesh. Yunus earned a Nobel Prize for this. It was a beautiful dream and for a while it really seemed to work. And it was eagerly copied around the developing world, not only in Asia but elsewhere. I saw it in Nicaragua. It really was a great idea, it stimulated women to work, it opened doors on a bright new world.

But the idea was founded on the group. Without a solid group of women backing it - women who know each other and trust each other - and with a clear, realistic development plan, it has no chance of working. Ever. Indeed, in India, microlending has fast turned into a sophisticated form of shark lending. In other words, good old-fashioned usury. Except the ones doing it are urban-based savvy, modern companies that drop in on the villages once a week to collect money.

One may assume that the Indian financial community will know how to defend itself: there is talk of setting up an emergency fund. But microfinance will never be the same again: it had started as such a beautiful dream and has ended a nightmare - like so many human endeavours.

I worry that this seemingly small financial hiccup is taking place in a political environment threatened by corruption. India is obviously going through growing pains and I can only hope that she will come out of them, stronger and a healthier trading partner for all of us...

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