Squeezed between loans engendered by the lofty dreams of the boom years and the prospects of layoffs in a slowing economy, urban India will have to make a few hard choices ? financial and lifestyle-related ? to survive this downturn
Tanvi, my teenage daughter, was completely awe-struck when she visited an ATM for the first time as a three-year-old kid. She enquired whether the machine would give us money whenever we needed it. I had to do a deposit transaction to show her that one needed to put the money in first. But that part had less of an impact on her little mind. The lasting impression she took away was that money was easy to get. In the boom years many of us have been like little Tanvi. It all seemed so easy. The harsh reality that money is but a limited resource, and has to be earned before it can be spent, is dawning on many of us only now.
First crisis
The current crisis is likely to snowball into an unprecedented period of indebtedness, job losses, and uncertainty for a large number of people. Perhaps many will experience these risks for the first time. The causes and effects are mostly sociological, and partly financial. So the solutions will also remain mostly outside the boundaries of pure financial decision making. There is no denying that spending beyond one?s means is not a trait to be encouraged. But the reasons why people end up in a debt trap are a combination of easily available loans at low rates and the starry-eyed enchantment with easy money. The socio-economic adjustments can vary widely, not just based on a rough classification I intend providing, but based on personal trade-offs one is willing to make.
At the bottom of the pyramid
Consider the situation of the urban poor, many of whom work as drivers and housemaids for us. Their incomes are limited. And given their basic skills, they are unable to seek alternate employment or skill upgradation. Their financial problems can be broadly classified under three situations. First is their inability to provide for unexpected large expenses. Many of them fall into debt due to marriages and other social obligations, or due to unexpected health problems. The latter is an insurable risk, but insurance is inaccessible to many of them. Second, most are well aware of the limits to their earning capability. So they are easy prey to ?grow-rich? schemes, lotteries and such, seeking shortcuts to fortune. Third, they are unable to save and invest, as they generate very little regular surplus. The solution to many of their problems lies in providing them access to credit, insurance, saving and investment products. Since these have eluded them for very long, they do not expect external support or aid to get out of their financial problems. They learn to live with it and make adjustments to their lifestyles. They don?t seek bailouts.
At the top
The situation of the wealthy is the polar opposite. They exhibit the highest tactical response to an opportunity. They have the comfort of regular surplus, the cushion of larger wealth, and therefore are willing to take higher risks. A prolonged period of easy money (low interest rates) can, however, lure several of them to stretch their borrowings beyond their ability to service. They can then find themselves on the verge of bankruptcy when the situation turns worse. But the wealthy have access to the most sophisticated services in accounting, taxation, and law. So they tend to create structures that ensure that failure of one or even a few of their tactical bets does not lead to their own bankruptcy. One of my friends in a development financial institution used to tell me that his clients came in a Fiat car to seek a loan, but turned up in a Mercedes to seek a referral to BIFR (Board for Institutional and Financial Reconstruction, the erstwhile bankruptcy mechanism for small companies). In today?s scenario, they are lobbying for bailouts and protection.
Trapped in the middle
The salaried middle class, as always, is caught in the middle. A combination of factors leads to a debt trap among the middle class. First, the middle class aspires, based on confidence in itself, that its income will move up. So plans for better living are always on the drawing board. A bigger house, a better car, a grander holiday ? the list is fairly long. Sociologists do not classify this as greed, but as high-aspiration quotient. Second, they are easily lured into spending, and they love discounts, low interest rates, loans, and installments. Psychologists who study over-spending point out that shopping provides tremendous emotional gratification. The approval of the salesman, the jealousy of co-shoppers, the joy of ownership and the power of decision-making all make shopaholics out of all but those with the strongest will-power. Third, assessing risk is something that does not come naturally to someone earning a regular monthly income. They tend to overrate their probability of earning a steady income in their plans to spend, save and invest. Therefore, adjustment in a downturn is tough for this group, caught between their aspirations and addictions on the one end, and the risk to their income on the other.
Coping with the downturn
The debt trap in which many find themselves, therefore, requires financial, social and behavioural responses. All borrowing is about spending tomorrow?s money today. If tomorrow?s income is at risk, yesterday?s expenditures need to be funded by something else. So the usual remedies of selling off assets, buying a smaller home, selling off the car, and reducing credit card spend will all be needed. Ruthless decisions to downsize the EMI that will cut into the now shrinking monthly income will be needed. Bringing back austerity may be tough. But frugality and saving will be back in vogue, reducing the social pressure on the thrifty.
Many people tend to keep bank deposits at 10 per cent while servicing an unaffordable personal loan at 16 per cent. It is important to take a holistic view of your finances, and pay off what is tough to service. Counselling centres run by banks will help in restructuring debt and working out a payment plan. Debt restructuring is the first step to take, however tough it is.
Augmenting income. If you have understood that your income could be at risk, it is time to secure that income. Augmenting it by doing odd jobs and moonlighting projects is one option. In a downturn, businesses are trying their best to bring costs down. There are still several jobs to be done, and at lower fees they are attractive to businesses. If economic booms created the opportunity for the expensive and the lavish, the downturn will create a market for the low-priced and the reasonable. That throws open new employment and entrepreneurship opportunities to do something at a lower cost and still earn an income. If scale was the mantra during the upturn, scaling up gradually will work in the downturn. Starting small and keeping costs under control can prepare new businesses to be ready when the next opportunity presents itself. The sociological adjustment needed is to associate a price with every job, and not be picky.
Every downturn overstates the pessimism, and thrives on fear of the unknown. Those that survive will be the ones who take charge of their own situation, without waiting for something dramatic to happen that will alter their fortunes overnight. It is return-to-reality time.
The writer is managing director,Centre for Investment Education and Learning
