05 December, 2008
Government Debt Forgiveness Programs
By Tamsin Harriman
Earlier this year, the Thai government forgave four billion Baht in overdue loans to 340,000 poor farmers. This may help those farmers now, but may not be the best policy in the long run. Ironically it could end up hurting farmers in the future by creating an environment in which banks and MFIs are even less willing to lend to farmers than they already are.
The Indian government has implemented several loan waivers for farmers in the past, the most recent being in April this year. According to Vijay Mahajan, Chairman and Managing Director of BASIX in India, "As a result of [the Indian government's loan waiver] policy, any lender, whether they are in the public or private sector, will factor in the possibility of a future loan waiver, and therefore would like to keep their exposure to farmers limited. So in a sense, the loan waiver will quite perversely lead to a shortage of formal credit rather than solve the problem of farmer indebtedness" (qtd in IFMR Center for Microfinance's "Eye On Microfinance", June 2008).
The Economic & Political Weekly editorial board, quoted in the India Development blog also foresee this problem: "A socio-political environment that nurtures expectations of a loan waiver is not conducive for building a healthy financial system, particularly in rural areas where borrowers have weak bargaining power and bank officials are known to be reluctant to lend at the smallest sign of a poor recovery."
If governments forgive microloans, they set a bad precedent. Such policies exacerbate borrowers' beliefs that the money is a gift or a grant, rather than a loan. This means that people may not use their loans for productive purposes (so that they can make money and repay the loan, as well as improving their lives), and are far less likely to repay those loans. In her book Access for All, Bridget Helms of CGAP says, "Borrowers view soft government money as grants or gifts and are less likely to repay loans from subsidized programs. This is especially true in countries with a history of forgiveness programs for agricultural or other lending. Default rates of 50 percent and higher in subsidized rural credit programs are typical worldwide" (page 77). This is a bad situation for the government, which loses money, and for the borrowers, who may be refused further loans if they don't repay.
Government loan waivers can have bad results for MFIs as well. MFIs could face a potentially large decrease in their clients' willingness to pay back their loans. When people hear that their friends' loan debts have been forgiven, they may expect that their loans should be forgiven as well. "[A]s far as people’s willingness to repay loans from any source, even though it’s not been a loan waiver for MFI loans, I will be most surprised if the [Indian government's] waiver doesn’t have some negative effects on people’s willingness to repay loans from other sources. I know that the 1989 loan waiver by the BP Singh government [...] had a very negative impact on the credit culture", said Malcolm Harper in IFMR Center for Microfinance's "Eye On Microfinance", June 2008.
Perhaps a better policy for the government to adopt would be including some form of microinsurance with their loans. For a small fee, they could provide access to a pool of emergency money (created by pooling each borrower's insurance fee) that farmers could tap into when their crops failed, their yield was low, or other circumstances prevented them from repaying their loans. Once the borrower was able to repay, he could pay back the loan from the insurance fund and begin repaying his loan again. In this way, the above problems for farmers, MFIs, and the government could be avoided by avoiding the necessity for a debt forgiveness program. There are surely other ways for governments to solve repayment issues as well. Debt forgiveness may be the most obvious and straightforward way, but can have unintended bad consequences. Governments would do well to implement more creative solutions - and consider their long term effects on everyone involved - in the future.
Earlier this year, the Thai government forgave four billion Baht in overdue loans to 340,000 poor farmers. This may help those farmers now, but may not be the best policy in the long run. Ironically it could end up hurting farmers in the future by creating an environment in which banks and MFIs are even less willing to lend to farmers than they already are.
The Indian government has implemented several loan waivers for farmers in the past, the most recent being in April this year. According to Vijay Mahajan, Chairman and Managing Director of BASIX in India, "As a result of [the Indian government's loan waiver] policy, any lender, whether they are in the public or private sector, will factor in the possibility of a future loan waiver, and therefore would like to keep their exposure to farmers limited. So in a sense, the loan waiver will quite perversely lead to a shortage of formal credit rather than solve the problem of farmer indebtedness" (qtd in IFMR Center for Microfinance's "Eye On Microfinance", June 2008).
The Economic & Political Weekly editorial board, quoted in the India Development blog also foresee this problem: "A socio-political environment that nurtures expectations of a loan waiver is not conducive for building a healthy financial system, particularly in rural areas where borrowers have weak bargaining power and bank officials are known to be reluctant to lend at the smallest sign of a poor recovery."
If governments forgive microloans, they set a bad precedent. Such policies exacerbate borrowers' beliefs that the money is a gift or a grant, rather than a loan. This means that people may not use their loans for productive purposes (so that they can make money and repay the loan, as well as improving their lives), and are far less likely to repay those loans. In her book Access for All, Bridget Helms of CGAP says, "Borrowers view soft government money as grants or gifts and are less likely to repay loans from subsidized programs. This is especially true in countries with a history of forgiveness programs for agricultural or other lending. Default rates of 50 percent and higher in subsidized rural credit programs are typical worldwide" (page 77). This is a bad situation for the government, which loses money, and for the borrowers, who may be refused further loans if they don't repay.
Government loan waivers can have bad results for MFIs as well. MFIs could face a potentially large decrease in their clients' willingness to pay back their loans. When people hear that their friends' loan debts have been forgiven, they may expect that their loans should be forgiven as well. "[A]s far as people’s willingness to repay loans from any source, even though it’s not been a loan waiver for MFI loans, I will be most surprised if the [Indian government's] waiver doesn’t have some negative effects on people’s willingness to repay loans from other sources. I know that the 1989 loan waiver by the BP Singh government [...] had a very negative impact on the credit culture", said Malcolm Harper in IFMR Center for Microfinance's "Eye On Microfinance", June 2008.
Perhaps a better policy for the government to adopt would be including some form of microinsurance with their loans. For a small fee, they could provide access to a pool of emergency money (created by pooling each borrower's insurance fee) that farmers could tap into when their crops failed, their yield was low, or other circumstances prevented them from repaying their loans. Once the borrower was able to repay, he could pay back the loan from the insurance fund and begin repaying his loan again. In this way, the above problems for farmers, MFIs, and the government could be avoided by avoiding the necessity for a debt forgiveness program. There are surely other ways for governments to solve repayment issues as well. Debt forgiveness may be the most obvious and straightforward way, but can have unintended bad consequences. Governments would do well to implement more creative solutions - and consider their long term effects on everyone involved - in the future.
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