SynopsisA key decision variable when you decide whether or not to accept the EMI plan is the effective interest rate charged. Car loans at 10-15% annual interest rates are not uncommon.
When you need to buy an expensive item and you don’t have enough cash to pay for it, you may buy it on credit. Banks, and retailers themselves, are eager to offer you credit with a plan to repay the principal and the interest using a convenient repayment plan that may involve equal periodic instalments (EPI) over a long, but fixed, period. People buy cars and white goods with equal monthly instalment (EMI) plans over, say, five years.
A key decision variable when you decide whether or not to accept the EMI plan is the effective interest rate charged. Car loans at 10-15% annual interest rates are not uncommon. Sometimes retailers offer you much lower interest rates — even no interest — to induce you to buy a product sooner than you would if you were to save its entire cost and choose to buy it.
What if you were offered an EPI plan with an effective annual interest of over 100%? Preposterous? You’re likely to reject such an ‘usurious’ offer. The poor, however, regularly, routinely accept these ‘preposterous’ rates. You may think that these are rates offered by nefarious ‘moneylenders’, while pointing out that such lending is not so prevalent, particularly with attractive financing increasingly available from microfinance institutions and self-help groups.
But one is not talking about moneylenders. The problem is much deeper, more pernicious. The poor regularly buy items of basic necessities such as flour, rice, oil, daal in smaller quantities at a time but with a higher frequency. So, for example, a middle-class family may buy a package of 5 kg daal for ₹590 that would last it for five weeks. But a poor family would buy 0.5 kg daal for ₹65 twice a week 10 times. This is equivalent to offering you a loan of ₹590 upfront and with an instalment plan in which you make 10 equal payments of ₹65. That amounts to a loan at an annual effective rate of over 200%!
There are no greedy moneylenders here, and this picture occurs repeatedly, all over the country for millions of India’s poor. If you find the presence of moneylenders charging 40-50% annual rate disturbing, you should be up in arms about the incredibly expensive buying habits the poor are forced into because of having no access to simple and inexpensive financial credit products available easily to others. This is where financial exclusion hurts the poor the most.
Fortunately, there is a simple fix for this giant problem. It does not require any regulatory intervention, or policy reform. It only requires that the poor feel secure about digital transactions allowing easy and low-cost access to digital financial services for everyone. A retailer could offer a package of 5 kg daal at a low-cost weekly instalment plan if the weekly repayments were simple, with near-zero transaction cost, and tied to a credible customer identity that made default by the customer a highly unattractive option.
This can be accomplished by offering automatic credit for those with Jan Dhan bank accounts, with automatic authorised deductions each week. The chances that people will default and jeopardise their future access to these, and many other benefits, for a one-time gain of a few hundred rupees default will be negligible, and can be easily priced into the product cost.
According to a World Bank report, the poor spend about 56% of their income on food and basic necessities. A back-of-the-envelope calculation shows that by buying small quantities, the poor end up paying effectively an 8% tax on their income (or 16% tax on food expenditure). Accordingly, the poor in India are estimated to lose about ₹88,000 crore each year from their income on EPI interest payments — which probably exceeds what the poor pay in exorbitant interest charges to moneylenders.
All the pieces required to make it happen are already here. We just need to put them together with some ingenuity and creativity.