Human misery cannot be quantified by an inanimate number, such as, “Gross domestic product (GDP) is expected to contract by x% over the next one year.” Human misery is real – it affects every aspect of human existence; social, emotional, economic and mental.
The ramifications of the COVID pandemic and the all-round deep misery it has caused, and is causing, is being felt by one and all. But is the way relief provided by the government of India by waiving part of the interest payable on loans to a section of borrowers, in any way justifiable – both in terms of what has been done and the way it has been done?
A rupee today is more valuable than a rupee say one year from now, or for that matter a rupee tomorrow – this is what is known as the time value of money.
A rupee in hand today may either be used for consumption or be saved. If used for consumption, it would yield one rupee of satisfaction. If it is saved and invested in an earning asset, the rupee, after one year, would be more valuable than its value today.
Moreover, the future is always uncertain. If the rupee is not consumed immediately, there is the risk that it might be stolen, borrowed and not returned, lost, or simply lose value due to inflation. Therefore, there are multiple logical reasons why a rupee today is more valuable than the same rupee after the passage of any period of time.
The mechanism used to keep track of the time value of money is by way of interest and discount rates. A practical matter, which has to be kept in mind while calculating interest, is the period for which the interest is to be calculated. Once interest is applied, it becomes part of the dues of the borrower and indistinguishable from the principal dues.
By convention and tradition, interest calculated at yearly intervals is known as simple interest but when it is calculated at shorter intervals, say monthly or quarterly, it is known as compound interest. It is interesting and pertinent to observe that even simple interest gets compounded at yearly intervals.
Periodic calculation and payment of interest by borrowers reassures banks and gives an objective basis for evaluating the quality of the loan as well as the quality of the bank’s health. If interest is not being serviced in a timely manner, it is a clear indication that the borrower is either into financial troubles or his inclination to repay his dues has reduced.
Loan contracts are commercial agreements between the borrower and the lender and it is assumed that both are not only competent to enter into the contract but are also doing it without any kind of extraneous pressures. Legal recourse in interpretation or enforcement of commercial agreements is taken only if there is disagreement between the borrower and the lender on the terms of the contract or some of the clauses are considered legally untenable.
Either party to an agreement may take recourse to legal measures for getting an impartial appraisal and decision on the terms of the agreement or the legality of the contract. Other than that, courts, as a policy, should not, and do not, interfere in the working of legally binding valid agreements.
For giving relief to a class of people having difficulty in servicing their borrowings, it is understandable, but not necessarily justified, for the government to step in as a result of political pressures. No one would disagree that the cohort availing loans are not only economically and politically powerful but also very vocal.
However, for the honourable courts to push for waiver leaves one with a sense of disquiet. First, there seems to be no conflict between the borrowers and lenders. If borrowers have difficulty in repayment, they need to approach the lenders for relief who, in turn, have to evaluate the validity of such demands on merits.
Second, the small sub-set of people, who are able to avail loans in the first place, are in general better placed in life than the rest of the population. They become even better off by having larger capital at their disposal through the borrowing arrangement. If part of the legitimate dues are then waived off, they become still better off. The bigger the loan, the bigger the waiver which, in turn, leads to higher increase in income and wealth inequalities in society – at the cost of all those who have not availed borrowed capital!
Third, it sets a (very dangerous) legal precedent of seeking legal recourse to avoid paying legitimate dues.
Fourth, the benefit to individual borrowers from waiver of the quarterly compounding effect over two quarters would be marginal compared to the size of the borrowing, but its effect in derailing the maintenance of discipline for efficient and effective operation of financial markets is massive and, ultimately, adversely affects each and every aspect of the real economy.
The time value of money is one of the fundamental truths of life and keeping this in mind is essential for the smooth functioning of our economy and society. It is as fundamental as, say, the law of gravity. Without gravity, none of the planets would be able to maintain their orbits, there would be no regular seasons, evolution as we know it, would not happen. Life without gravity is inconceivable. Similarly, not accounting for the time value of money can lead the entire social and economic superstructure to collapse.
The decision of waiving compounding of interest was something that our esteemed democratically elected government and honourable courts should have given more thought to, before pushing the banks to implement it.
(The author worked with various banks - public, private, and foreign both in India and abroad - for nearly 30 years and is currently on a self-imposed sabbatical to try and understand as to what ails Indian banking and what, if anything, can be done to improve its functioning.)