Debt trap leads to despair for rural poor

With only a tenth of a hectare of dry land to farm, Kanakam Ramesh, 28, and his wife Rajiti, 24, were struggling to care for two young sons and Ramesh’s ageing father, when an agent of a microfinance company based in Hyderabad, Andhra Pradesh, arrived in their village offering small loans to groups of women.

Despite existing debts of Rs10,000 ($225) to a government credit scheme, and Rs10,000 to a local brickmaker, Rajiti borrowed another Rs10,000.

Typical of India’s fast-expanding private microfinanciers – mostly styled on Bangladesh’s Grameen Bank – the loan required Rajiti to repay Rs275 a week for a year, while four other village women, who were also borrowers, were obligated to cover if she could not meet it.

After 15 weeks, she ran out of money. Twice, Rajiti’s four guarantors unhappily coughed up; the third week, she pawned the family’s brass water vessels. That night, she argued bitterly with her husband about their plight, and threatened to immolate herself. Neighbours intervened. The next morning, on October 15, Ramesh went to the field and hanged himself.

“We were leading such stressful lives,” says the young widow. “It was difficult to face the humiliation.” Suicides by debt-burdened farmers are not new in India’s southern state of Andhra Pradesh, where crop failure and aggressive tactics by money-lenders have long been a deadly combination.

Indian microfinance schemes – mostly started as donor-funded charities – were conceived precisely to rescue the poor from such loan sharks.

Network creates a code of conduct

Even before Andhra Pradesh's move to rein in microfinance companies, the industry was aware of the need to clean up its act, writes Amy Kazmin in New Delhi.

Leading players recently formed the Micro-Finance Institutions Network, with 44 for-profit members. Its code of conduct requires transparent interest rates, a limit of three companies lending to a client and the prohibition of “abusive, violent or unethical” collection methods. The network is also pooling members’ client records to better assess borrowers.

Yet Alok Prasad, the network’s chief executive, admits that feverish growth means that lending and collection practices were sometimes at odds with the sector’s professed values.

“There has been a disconnect between what top management is saying and may really want to do, and what is happening on the ground,” he said. Local moneylenders have also rebranded themselves as microfinance institutions, further tarnishing the industry’s image.

K. Rosiah, the state’s chief minister, wrote to the central bank in May, complaining the industry had “amassed huge profits at the cost of the rural poor”, and appealing for help to curb “cruel coercive” collection tactics.

The bank governor expressed sympathy but offered no quick fixes. Now, authorities and industry executives are in talks on addressing mutual concerns without putting microfinance companies out of business.

“Let’s beat them up for their flaws, but you can’t kill them,” says Vijay Mahajan, network president,

But a recent wave of suicides by borrowers of what has evolved into a huge, for-profit microfinance industry – charging interest rates between 26 to 30 per cent – has raised serious questions about whether the pursuit of profits has corrupted Indian microfinanciers’ original social mission.

Over the past 15 years, Andhra Pradesh, which is home to 6 per cent of India’s population but accounts for 35 per cent of the money lent through microfinance, has developed its own successful scheme to provide credit to women’s self-help groups.

But authorities have concluded that the private microfinance sector had gone too far. Two weeks ago, the state passed an emergency ordinance abruptly halting debt repayments, sending microfinanciers into a tailspin.

“The government is not against the industry,” insists Reddy Subramanayam, the state’s principal secretary for rural development. “What the government has objected to is the way microfinance is being practised to achieve hyper-profits.”

Even in its early days, microfinance was not cheap, but its practitioners were careful. Programmes run as non-profit activities also charged interest of 30 per cent or more to cover capital and outreach to poor women across dispersed areas. But they took a gradual approach to extending credit.

That has changed in recent years, after Indian microfinance programmes turned into for-profit companies and raised more than $500m in private equity from foreign venture capital players, specialised microfinance funds and high net-worth individuals.

As companies, led by SKS Microfinance, looked towards initial public offerings, growth was the name of the game. India’s banks, including ICICI and HDFC, were required to meet annual “priority sector lending” targets and so facilitated that rapid growth by flooding microfinance institutions with around $6bn in credit.

The result was intense competition to lend, often to borrowers already struggling to manage multiple debts and unable to grasp the financial logic pushing them into deeper debt traps.

“MFIs are just dumping their loans,” said Professor Kurapati Venkatanarayana, a Kakatiya University economist. “They did not verify the capacity to repay, source of income or expenditure of the borrower.”

As the sector expanded at a blistering pace, their high interest rates came under ever-intensifying scrutiny, especially as founders of the largest players – SKS, Share and Spandana – were seen to be amassing fortunes. Ahead of his company’s $350m IPO, Vikram Akula, founder of SKS, sold shares worth nearly $13m, and holds options worth tens of millions more.

“Costs did fall, but several of us that achieved economies of scale did not pass on the benefits,” said Vijay Mahajan, founder and chairman of Basix, India’s first microfinance company, which combines credit with intensive livelihood counselling. “We were seen as just concerned with growth and profit, rather than the social mission.”

“Basically,” added Mr Mahajan, now president of the Micro-Finance Institutions Network, which represents 44 for-profit companies, “the sector rendered itself indefensible”.

Microfinanciers are now struggling to get back on their feet. A court has permitted them to resume collections in Andhra Pradesh, but once-enviable repayment rates of 98 per cent have plunged. Companies are also holding crisis talks with their bankers.

In slums and villages, over-indebted borrowers also fear the relentless pressure to pay up will resume. Among them is Fatima Bi, 50, who attempted suicide to escape debts of Rs150,000 to at least five companies, but was stopped by neighbours. “I want a way out,” she said. “I cannot pay this in my entire life.”