Let's move beyond the goon model

By 2015, the number of Indians who will borrow will cross 500 million, so we need a more efficient recovery mechanism.

Economist Print Edition: December 14, 2006

Chindia has now become an accepted word, implying not only China and India together, but also increased economic clout of these two countries. And since respective reforms, it is argued China and India have followed divergent paths to development. With an investmentrate of 43% and savings rate of 45%, China followed the investment route. With an investment rate of 30% (it used to be lower) and savings rate of 29% (it used to be lower), India has followed consumption route. This dichotomy shouldn’t be driven too hard, since the two countries are converging. Besides, the household savings rate in India is higher than in China, the difference is due to corporate savings, including the public sector. But what is remarkable is that consumer debt/GDP rates are low in both nations. The Indian figure is 11%, the Chinese 12%. Across South-east and Far East Asia, the figure crosses 40% and even 60% in South Korea. Thailand, at 15%, is the only other outlier. Are we to then assume that Indians (and Chinese and Thais) are socially and culturally reluctant to borrow? One hears such arguments within India too. That people in the North are more eager to borrow than people in the South.

Culture isn’t everything. Nor is it constant. First, there is the prosperity element. Several years ago, we talked about a 300 million middle class. That figure disappeared into thin air, but we are getting there now. Second, there is the related rural/urban issue, with badly developed land markets constraining land use as collateral. Third, issues like recourse to privatised supply of education and health, insurance, breakdown of joint families and community-based social safety nets, support for aged parents and multiple income-earners in the same household affect attitudes towards savings and consumption. However, if one extrapolates present trends, by 2015, the number of Indians who can and will borrow will cross 500 million, perhaps 600 million. Fourth, there is the matter of what the debt is for—housing, consumer durables, consumption smoothening et al. The 11% (of GDP) Indian figure is now divided equally, 6% for housing and 5% for the rest. Fifth, most importantly, there is the cost of consumption credit. This has declined since 2001, but it’s still high because of lack of dis-intermediation, large administrative costs of delivery, risk premiums because of high default rates and inefficiency in the banking system. However, because of the decline, EMI now drives decisions.

Banks make mistakes and lend to people they should not, squeezing out those they should lend to. This is called adverse selection and jacks up rates for everyone. However, default rates aren’t high only because banks lack expertise. This leads to the sixth problem, one insufficiently appreciated. It concerns a lender’s ability to recover the asset in case of default. Recovery through court intervention is possible but it takes years. The Transfer of Property Act of 1869 still prevents foreclosure of mortgages without court intervention. A law on hire, purchase and leasing was passed in 1972 but never notified. Hence most recovery is only possible through goon squads. Look at it this way. Other than being avoidable, who pays for these goons?

Every borrower does. A modern economy should move beyond this Mumbai underworld or 1920s’ Chicago kind of model. Income will grow. Consumption will explode. Consumer credit will grow. Let us have laws in place that facilitate these. Otherwise, Polonius (“neither a borrower nor a lender be”) will be proved right.

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