Central Bank to help war-affected families tackle mounting household debt

The Hindu: Sri Lanka’s external debt burden is well known. The country, which came out of a long civil war in 2009, is currently struggling to service an outstanding debt of about $46.6 billion. But more recently, the Central Bank has found a very high level of household debt in the war-affected communities of the north and east where post-war, microfinance companies targeted families with high-interest loans for self-employment. Following a recent visit to the north to further study the problem, Central Bank Governor Indrajit Coomaraswamy spoke to The Hindu on how the apex bank plans to address it.

By Meera Srinivasan

Q: Recently, you led a high-level team from the Central Bank to the north to study household indebtedness in the war-affected areas. What led to this problem in the first place?

A: The Government’s strategy after the war ended [in May 2009] was infrastructure development on the one hand, and credit to individuals for self-employment on the other. It was very well-meaning and well-intended, in my view. But if you give people credit, and don’t create the enabling environment for them to service that credit through flows of income, clearly you end up in the situation we have today. That was the problem.

Q: What is the enabling environment that should have been created?

A: I think you need to tie up the credit with viable projects, programs and livelihoods. Here, I think they just gave people money and hoped they would create some livelihoods for themselves. But what happened is after 30 years of war, people were desperate for consumption and they just used it all up in consumption. And now they are severely indebted.

A lack of financial literacy, plus this pent-up demand for consumption which was there took over and banks were also very aggressive. Financial institutions thought this was a new market to take advantage of and gave their workers and employees in those areas very ambitious targets. That meant money was pushed out. The income generation side was not adequately addressed.

And then, very aggressive debt collection became the inevitable consequence of this set of circumstances. That is what is causing all this animosity among the population, because the debt collection practices have become unacceptable and in instances, abusive. The constant refrain we heard from civil society, in particular, is “please do something to stop these people from coming to our homes, our villages. Let them do their business in their offices,” because they often come in the evening. Women are especially vulnerable and exposed in terms of how they operate. There have been many clear cases of abuse.

Q: How does the Central Bank propose to address this problem?

A: One of the things we have told the people is that where there is clear abuse or violation of the law, they should go to the police. We have offered the services of our regional office where we are going to set up a help desk. That is for the extreme cases.

But you need a more structured approach. We are trying to formulate a response based on three aspects. One is to do with the overhang of unsustainable debt that currently exists. For that, we are considering a moratorium on debt servicing, we have to decide for how long and for whom.

The Central Bank cannot solve the whole development challenge in the north, so we must have a very focussed, targeted response to alleviate the condition of the most debt-distressed part of the population. That is where we are trying to focus, we don’t want to get distracted because we can end up not being able to do anything. We need to identify those very debt-distressed people and try to alleviate their current debt burden through a mixture of responses – a moratorium, increasing the maturity of the loans, and exploring how interest rates can be reduced. There are different options, it could be an interest rate cap, it could be something else, we have to look at all the options.

So, we buy time with a moratorium, then stretch out the payments, and try and reduce the interests so that the burden is reduced. Those are our three interventions as far as the existing debt is concerned.

Q: You talk about reducing interest rates, how high is it at the moment?

A: Well, as high as 70%, the effective rate. That’s the other thing we were told, that there is a lack of transparency about the effective interest rate. Often, borrowers are not given copies of the documentation of the terms, interest rates. And some people take multiple loans, including weekly loans, going from one lender to another. The situation is untenable, and there is a lot of anger and frustration in the community.

Also, a large segment of the population does not have the financial literacy and capacity to manage their personal affairs in a way where they can use credit effectively. To raise awareness, we are drafting a customers’ charter which will lay out both, the rights of the customers and the obligations of the financial institutions. We are going to disseminate that widely.

Clearly, credit is essential because there are not enough resources to develop the region without it, but we have to make sure the next time around it will be used effectively.

Lending directly to individuals does not seem to be the right option now, so we are trying to look at intermediary institutions such as banks, rural cooperative societies, thrift societies and women’s associations to customise these credit programs to local requirements.

We need new programs which will structure the intervention in such a way that it is linked to income generation. Otherwise there is no point in stretching out the debt and reducing the interest rate, because they still need to have the wherewithal to repay the debt.

Q: You emphasise the need to link this new credit prograe with income generation and livelihood. That is not within the ambit of the Central Bank, so how do you propose to take that recommendation forward?

A: We have to rely on the people whom we have just met to create a structure, an architecture for a credit program. It goes through the banks and then the intermediary entities that I talked about. We are counting on those people to be able to ensure that the activities funded by this credit are viable.

Q: But don’t you think there is a need for a broader job creation program in the post-war areas?

A: Sure, in the end you have got to get investment in. I hope that the diaspora will also help. We need foreign investments, but getting that remains a challenge for the whole country. The Government is giving a 200% allowance for investing in conflict-affected areas, so hopefully that will help in getting some investment. The ease of doing business must improve.

What we can do is to tackle this indebtedness and then create credit schemes, and choose entities that can play a role in intermediating effectively. The overall enabling environment, for instance the marketing aspect and creation of supply chains, has to be sorted out. We can do this to a point, but efforts from other agencies such as the Industrial Development Board, the Exports Development Board have to kick in.

The tendency is for people to expect the Central Bank to address the whole development challenge in the north, which we can’t. We have a fairly narrow remit in terms of economic and financial stability. There is a limit to what the Central Bank can do. Our mandate is relatively narrow, but there is scope for us to make a contribution.

We are also concerned about rising household debt in the North Central Province, the hill country and areas in the south. Our idea is to use this effort to come up with an intervention to alleviate the problem in the north, and then use that as a pilot and see if we can replicate it in other parts of the country facing a similar problem.

Q: In the north, household debt has the peculiar dimension of the post-war reconstruction policy but what about other parts of the country? Why are people there facing a similar predicament?

A:  We have to look at what is happening on the demand side, in terms of consumption. While learning outcomes in STEM subjects and English may not be good, there is a very high enrolment ratio in primary and secondary education. People have an understanding of what is going on around them – satellite television, advertising and modern branding makes them aware of the material worth one can have. Naturally, we have become a very aspirational society.

At the same time, development has not accelerated sufficiently to generate an income base which will support such an aspirational society. There is this gap between income and expenditure, which is being filled with credit. What we have to essentially do is get more productive and a higher value [for production], so that incomes are higher and people can meet their aspirations without borrowing.

Q: Finally, a broader question on the country’s economy. In May this year, you said the extreme weather, the drought in particular, had made the country heavily reliant on imports, and that it could go up to $800 million if the drought persists. How is the situation now? You have indicated that the growth rate could go up to 4.5%.

A: Yes, between 4 and 4.5%. I think we will do well to get 4.5%. We have made some progress and hopefully will make more in stabilising the economy.

Of course, if you look at the numbers things are not as good as what we had expected in the beginning of the year. Headline inflation is 7.1% at the moment, while we want it to be between 4 and 6. We have the instruments to deal with demand-pull inflation.

The VAT was introduced last November – so from this November onwards the base effects will come down, positively impacting headline inflation. At the moment, it is higher because of factors beyond our control – international prices, the base effects of tax and drought and flood, supply disruption.

The currency has depreciated by about 2%, we are being very vigilant.

On the Balance of Payments, what is encouraging is that in the last four months exports have increased after a prolonged spell of decline. However, imports have gone up faster, largely because of the effects of the drought and floods. Three consecutive cultivation seasons were affected, but hopefully the next season will be better. Also, while exports continue their increasing trend one hopes that the effects of GSP plus will begin to kick in to a greater extent.

The two indicators of stability of the economy –inflation and current account deficit -- have been affected by the weather, but we feel the policy stance we have is broadly right. We are watching the data very carefully to see whether we need to move, but so far the policy stance seems to be effective and particularly if there is some improvement in the weather, it should get us where we want to get.

We want the growth rate to be close to 6%, if possible. This year it is between 4 and 4.5. There is a temptation for people to try to accelerate the growth rate through unsustainable macro-economic policy. They say why doesn’t the Central Bank reduce interest rates, that has happened in India as well, and if the exchange rate is strong we can import and sell and so on.

But one lesson we need to learn from our past is that we cannot create these sugar highs in growth rate by unsustainable macroeconomic policies because, the only way to increase growth rate is through reforms. We have to improve investment climate, do effective investment promotion, trade facilitation, trade policy reforms and ensure ease of business.

Essentially, we have to strengthen the growth framework, that is how you get on the high growth rate trajectory, not with these artificial boosts by creating excess demand, which will eventually lead to unsustainable outcomes.