Consumption expenditure of the borrower is important in determining the regularity or irregularity of loan repayment in priority sector (PS) credit by banks.

If one looks at the share of PS credit non-performing assets in total NPAs of banks over the period end-March 2001 to end-March 2011 ( see chart ), it is evident that it was increasing in all the three categories of banks; in 2009, the figures dipped owing to the Agriculture Debt Waiver and Debt Relief Scheme, 2008; and the rise in 2011 was high in the case of public sector banks and foreign banks.

Viability of repayment

Project appraisal is vital for any loan given by a financial institution. The aim of the appraiser should be to estimate as realistically as possible the factors that go into determination of viability of the activity financed.

However, it is a common observation that the borrower’s consumption expenditure is taken hypothetically without taking into account ground realities. Many a time, the calculation will be only a decade old, without taking into account the increases in consumption expenditure due to inflation and/or change in consumption pattern of the borrower.

All the focus is on whether the borrower can repay the loan instalment from the income generated. It would be quite wrong to presume that since small borrowers are those from the “bottom of the pyramid”, their consumption expenditure would be small and hence one can be casual while appraising the finance for those activities.

One should not forget that the family size of the small borrowers which, more often than not, is large.

According to the 59th Round of national sample survey on household consumption expenditure (NSSO) conducted in January – December 2003, whose results are available now, average household size in rural India was 5.0, including 1.8 children per household. Not all of them would be fully and/or gainfully employed. There would be no subsidiary occupation to supplement the earnings from main occupation which is either farming at a marginal/small scale or agricultural labour.

Consumption for survival

Before availing of the bank loan, ‘financial exclusion’ is often the norm for this section of the population. In addition, marginal propensity to consume is higher in the case of PS borrowers than other borrowers.

Consumption for survival, rather than for saving, is the main motive behind earning any income. According to the same NSSO survey, the average rural monthly per capita consumer expenditure was Rs 554in 2003 (Range: Rs 398981).

Therefore, in the post-loan period, when some incremental income is generated the consumption expenditure of the borrower-household immediately increases. Moreover, is it not the universally accepted objective of PS loan programme that the borrower’s standard of living should increase after the loan fructifies?

The above situation can be likened to the “protein inflation” — a manifestation of the National Rural Employment Guarantee Acts scheme which gave additional purchasing power in the hands of beneficiaries who spent it on protein-rich food items such as dal , eggs, fish and chicken. A sudden increase in demand or such commodities led to a rise in their prices which came to be known as “protein inflation”.

Even in the case of not-so-poor small borrowers, whose basic consumption needs have already been met, the proportion of incremental income going towards consumption would decline but that for consumer durables would increase conforming by and large to what in Economics is popularly known as the Engel’s Law. [Engel’s law is an observation in Economics stating that as income rises, the proportion of income spent on food falls, even if actual expenditure on food rises.]

This is apart from their high disposition to indulge in expenses on social extravaganzas such as marriages or similar other social functions.

The consumption expenditure of small borrowers is of “daily” nature, whereas the repayment of bank loan is generally of “monthly” nature. Therefore, there is always an inherent tendency among such borrowers to postpone the latter in favour of the former.

In the case of small borrowers, if the asset financed is impaired (e.g., breakdown of tractor, death of cows/buffaloes/bullocks, etc.) they have to divert resources from the activity for making good the losses. This also comes on the way of repayment of loan.

The best way to overcome the difficulties posed by higher consumption expenditure by PS borrowers in the post-loan period is to widen and deepen financial inclusion programme and financial literacy and credit counselling campaigns being passionately implemented by the Government, RBI and banks.

Regular saving, as a habit, has to be inculcated among these people.

However, the ultimate remedy should be found in programmes like NREGA or any such ‘hunger’ alleviation programmes, coupled with bank assistance in the form of consumption loans.

(The author is a former commercial bank economist)

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