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Posts Tagged Loan Defaults

No free lunch for Pakistan’s youth


No free lunch for Pakistan’s youth

Published: December 24, 2013

The writer works at Orr, Dignam & Co and teaches undergraduate law students pursuing their LLB from the University of London (External Programme)

The Prime Minister’s Youth Loan Scheme has been launched with the hope of revitalising the economy by facilitating the growth of small businesses. If you are aged between 21 and 45 and hold a CNIC, you could be one of the lucky (or well connected) 100,000 Pakistanis to get a loan of up to two million rupees at a subsidised rate, provided you have a guarantor, who is either a government employee in BPS-15 or above, or a person with a net worth of 150 per cent of the amount being borrowed. Borrowers will also have to make an equity contribution equivalent to 10 per cent of the loan.

While the scheme appears to be well intentioned, it is difficult not to be sceptical about its execution. The government’s failure to lay out a transparent mechanism by which successful applicants will be chosen has done little to quell the scepticism. This is compounded by the fact that these loans are only secured by personal guarantees, leading to several issues with regard to enforceability. There has been no indication of what measures will be taken to ensure that guarantors do not leave the country or dispose of their assets. Interestingly enough, since the loans are to be repaid in eight years’ time, the present PML-N government might not even be in power to face the brunt of it all in the wake of potential defaults.

Though much has been said about the lack of a plausible security being a cause for concern for taxpayers, the process of obtaining a personal guarantee is also likely to be an impediment for many candidates. Despite all the criticism of the scheme and a general acknowledgement that if implemented properly, it would benefit the economy, hardly any alternatives have been suggested. While it is true that most government-sponsored lending schemes have not done well in the past, it is important to learn from these failures and model the scheme on a success story, such as the one in the US.

The US Small Business Administration (SBA), in a programme similar to a government-sponsored venture capital, has licensed and regulated a network of private small business investment companies (SBICs) that supply equity capital, long-term loans and management assistance to small businesses. The SBA does not directly provide cash to the SBICs. Instead, the SBA guarantees loans that the SBICs take out in order to inject capital into the small businesses. In order to obtain a licence, the SBICs need to prove their management has the requisite expertise to invest in, manage and guide such businesses.

The noteworthy upside of a similar programme would be the government’s role as an equity owner in the business as opposed to a lender. In the event the business does not do well, in most cases, the investment could be recovered by disposing of the business’s assets, which is significantly easier for the owner compared with a creditor doing the same. Having equity ownership would also make it easier to supervise the affairs of the business and ensure regulatory compliances, particularly the payment of taxes. It would also make it possible for the government to steer investment in specific social businesses. This investment can be made on terms whereby upon achieving predetermined objectives, the original owner can buy back the equity from the government. Whilst the effective implementation of this alternative would be a challenge, it is certainly not impracticable.

Published in The Express Tribune, December 24th, 2013.

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