Raghuram Rajan's warning about Mudra loans last year may be coming true— and now a Citi report confirms it

  • Many of the working capital loans made to India's small entrepreneurs may be turning bad.
  • RBI Deputy Governor MK Jain raised an alarm in a speech yesterday but former governor Raghuram Rajan had already warned of 'credit risk' in September 2018.
  • Indian banks have given over ₹7 lakh crore worth loans under the Pradhan Mantri Mudra Yojana.
  • This will be added burden for Indian banks that are already saddled with bad loans worth over ₹9 lakh crore.
Many of the working capital loans made to India's small entrepreneurs may be turning bad. MK Jain, the deputy governor of the Reserve Bank of India (RBI) raised an alarm in a speech yesterday but former governor Raghuram Rajan had already warned of the potential 'credit risk' in September 2018.

In his report to the Lok Sabha (the lower house of Indian Parliament) Committee on Estimates in September 2018, Rajan highlighted that the "government should focus on sources of the next crisis, not just the last one. In particular, government should refrain from setting ambitious credit targets or waiving loans." At the end of March 2019, the total defaults since inception of the scheme was ₹17,650 crore (over $2.5 billion), roughly 2% of all the money lent under the programme.

Rajan told you so...

Rajan, who famously predicted the global financial crisis of 2008, specifically highlighted the rising quantum of contingent liability on account of Pradhan Mantri Mudra Yojana, which gives collateral-free loans to small entrepreneurs to meet their day-to-day business needs. A contingent liability is a possible future burden that cannot be quantified right now. In this case, banks giving these easy loans should have kept aside some money in case the borrowers become unable to repay the money.

As it seems, the chickens have come home to roost. “The Mudra is a case in point-…while such a massive push would have lifted many beneficiaries out of poverty, there has been some concern at the growing level of non-performing assets among these borrowers,” the current RBI deputy governor Jain said on Tuesday (November 26).

Over ₹7 lakh crore worth loans have been given under the Mudra scheme since its inception in 2015. Just as Rajan had warned, the amount of loans defaulted more than doubled in just one year, according to a report earlier this year. What's worse, another report showed that only 20% of the money borrowed went into starting a new business.

Earlier this year, RBI had announced one-time restructuring of loan for small business owners who have borrowed less than ₹25 crore or if the loan default happened after January 1 of 2019. This has helped the MSMEs whose cash flows were adversely impacted due to transition under Goods and Services Tax (GST) and demonetisation. "Inefficiencies in lending practices, poor credit appraisal, willful default by borrowers and impaired cash flows due to slowdown also contribute to higher default rate," a Citi report this week said.

Though the number of defaulters, and the amount of unpaid loans, is significantly lesser among smaller borrowers, this is an added burden for Indian banks, particularly the state-owned ones, who are already saddled with unpaid loans to the tune of over ₹9 lakh crore at the end of March 2019.

SEE ALSO:
Raghuram Rajan’s recipe to revive India's economic growth

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