Should Govt. bail-out borrowers?

Does it make sense for the Government to bear the interest costs?

Oct 10, 2020

Hey guys :)

This is the 2nd part of the Moratorium issue series. If you haven’t already, I would highly recommend you to first read our Part 1 to connect the dots better. (Click here to read the 1st part of the series.) Btw, don’t forget to come back and join me here, just a gentle reminder ;-)

Anyway, a short recap… moratorium ends on 31st August and borrowers demand waiver of interest and ‘interest-on-interest’ (compound interest due to unpaid EMIs). While Supreme Court rejects waiver of interest part, for the ‘interest-on-interest’ waiver, neither the Government nor the banks were willing to bear the loss, for all good reasons though (details in Part 1).

Nonetheless, it seems now the Government has a change of heart. The Central Government filed an affidavit with the Supreme Court on Oct. 2, where it has supported the waiver of ‘interest-on-interest’ on small business loans and some personal debts up to Rs. 2 Crore for “vulnerable” borrowers. What’s more, the Government shall bear these interest cost, which according to analysts shan’t exceed Rs. 5,000 - 7,000 Crores. Not to forget, this benefit shall be for “all borrowers irrespective of whether they availed of the moratorium or not”! Hurray!!

While borrowers heartily welcome this proposal, it has to be taken with a pinch of salt! As Bloomberg Quint’s Ira Dugal calls it — “a palliative of sorts” (something intended to improve the situation but may not actually do so!) Why, you ask? Well, let me explain.

At the outset, there’s a technical flaw in the arrangement. Look at the the interest waiver cap limit — Rs. 2 Crore for all eligible loans, whether loans of MSMEs (Micro, Small and medium Enterprises) or personal debts like Home loans, Education loans, Credit card loans, etc. While small business loans of Rs. 2 Crore could be justified, a person who has the ability to take a loan that huge can’t be described as “vulnerable”. As CNBC’s Latha Venkatesh puts it succinctly… if someone takes a Rs. 2 Crores loan to build a house of Rs. 2.7 Crores, how can you classify him as “vulnerable” (financially distressed)!? Out of 1.46 crores Indian taxpayers, 1 crore people have an income under Rs. 10 Lakhs. And “most of these persons, may not in their lifetime be able to afford a house costing Rs 2.7 crore. Then why should their taxes be used to subsidise people far richer than themselves?”

You get that? Likewise, a person who can afford an education or credit card loan that big must be filthy rich. See.. each depositor, each loan has its unique attributes. Based on law, a ceil limit of up to 30 Lakhs for home loan is affordable. Consider the likes of IIMs & IITs, an education loan of up to 30 Lakhs is reasonable, affordable car loans of less than 10 Lakhs, and this way they should first figure out and set different ceil limits for each category. “No point in equating the unequal.”

Remember.. no free lunches! Cause look at the gravity of the financial situation. Within the first five months, India’s fiscal deficit (excess of government expenditures over tax collected) had already reached 109% of the entire year’s target! With the tax collection being low, the Government should be very careful with the taxpayers’ hard-earned money that could better be utilized to procure vaccines and manage the pandemic.

See, every eligible borrower didn’t opt for the same moratorium period, some went for 6-months, some took 3-months and some didn’t. Calculation of waiver for all of them is a cumbersome task. Now think of lenders (banks). Asking banks to rearrange prepared models and recalculate stuff will only over-burden them! And what’s more, banks align specific IT systems to cater their needs. A little tweak might require outright replacement and building of new software and applications. And new tech solutions imply further expenditures.

Btw, you can hardly expect (private) banks and the Government to align in terms of calculations. This would mean legal costs for banks to fight the Government. And even if it’s sorted, there is a requirement of more clarity on the reimbursement period. History tells that the Government takes 9 to 24 months to reimburse the agreed amount to the banks. Blockage of money for so long would only add to the financial stress of banks, exacerbated by $120 Bn of bad loans and a slow credit growth. Ouch!

You know what, we need to address the elephant in the room. A moral hazard. Aware of the fact that the Government is there to rescue, people might make risky bets in upcoming times of crisis. They might borrow money to purchase unnecessary stuff, or to pay off other loans with the anticipation that even if they default, the Government has got their back. This sort of irresponsible behavior will hurt the credit culture in the economy! Borrowers who stressed their household expenses this time just to pay their EMIs on time and not opt for the moratorium will feel cheated and the next time, even if they have the ability to pay, they won’t. And this will impair the credit discipline!

Past is a great teacher, they say. Well then, dive back. India has witnessed a number of farm (agriculture) loan waivers. Time and again, these’ve proved to be detrimental to the economy! Although farm loans are of a different nature, one thing that essentially comes is moral hazard. One notable farm loan waiver was that of 2008 which involved a huge outgo of Rs. 71,680 Crores! On that, a World Bank economist Martin Kanz writes —

While bailout programs may work in other contexts, our results underscore the difficulty of designing debt relief programs in a way that they reach their intended goals. The impact of such programs on future bank and borrower behavior and the moral hazard implications should all be taken into account. In particular, our results suggest that the moral hazard costs of debt relief are fueled by the expectation of future government interference in the credit market, and are therefore likely to be especially severe in environments with weak legal institutions and a history of politically motivated credit market interventions.

And the last line you read, yup, that’s India.

You know, it’s sometimes hard to digest how you let Supreme Court decide financial matters. If at all anything was to be done (beyond the loan restructuring), it should have been entirely the RBI’s call. Moreover, the committee based on which the Government reached at a conclusion had no representatives from the RBI, neither is their report public! Anyway, let’s look forward to the next hearing (Oct.13).

So, hey guys, hope you found this article thought-provoking. Btw, I leave it to you, to read and infer. If you loved the article or you know someone who bets the Government is doing real generous stuff, you should absolutely share this piece with them.

I’d also like to know your thoughts on this arrangement.

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