In Debt & Broke in Georgia

The ISET Economist, a blog about economics in Georgia and the South Caucasus by the International School of Economics at TSU (ISET)

By Davit Keshelava

An individual living in Kutaisi took a $1500 real estate secured loan from a microfinance institution in 2011 and had to pay a $75 interest rate for the following six months. The purpose of taking this loan was to finance the treatment of her child. She was unable to cover monthly payments and prolonged the term to 10 months, but failed to cover these payments again and was fined several times. In the end, the loan was restructured and monthly interest raised to $83, while the amount of total loan nearly doubled to $2700. As a result, she was unable to pay that much money and got an enforcement decision regarding the auction sale of her property.

Excess Borrowing in Georgia

This is just one sad story of an individual entering the over-indebtedness trap, while we hear thousands of such stories nowadays in Georgia. It is widely recognized that the majority of the Georgian population has debt with financial institutions, including commercial banks, microfinances and various private lenders. According to the recent Financial Access Survey (FAS) proposed by the International Monetary Fund (IMF), Georgia is among countries that has an excessively high number of borrowers from commercial banks. It turned out that the number of borrowers per 1000 adults has already reached 680 people which is the second highest rate in the world (FAS 2015). It is notable that the number of borrowers was increasing steadily until 2015, when the recent economic slowdown forced commercial banks to be a little more careful while giving out loans to individuals.

In addition, according to the CEO of ‘Credit Info Georgia’, Aleksandre Gomiashvili, there has been a rapid expansion of registered loan contracts in recent three years. On December 31, 2014, the number of loan contracts registered (containing individuals and legal entities) in the system was 8.5 million. This number first increased to 12.5 million by the end of 2015 and then soared to the record high of 18.2 million by the end of 2016. Furthermore, the number of individuals that borrowed money based on these loan contracts amounted to an alarmingly high 2.4 million people by the end of 2016.

Based on these statistics, one can easily estimate that nearly 64% of the total population, including juveniles and pensioners, have some kind of loan contract, or several contracts, with financial institutions, and if we exclude teenagers and pensioners from the reference population, this number will increase even more. The average number of loan contracts per person in commercial banks also seems to be quite high.

Indebtedness on a macroeconomic level

Improved access to finance and the rapidly increasing number of adults with debt in different financial institutions are reflected in various macroeconomic indicators commonly employed to measure the indebtedness of the population. For instance, the highest household debt to GDP ratio before the global financial crisis of 2008 was below 15%, while this indicator reached a historic high of 35% at the end of 2016. From this, we can conclude that debt accumulation in the economy is increasing much faster than Gross Domestic Product.

Even more alarmingly, household debt to households’ disposable income ratio skyrocketed to 200%. Such a high ratio is rare in the world. For example, there were only 5 countries among OECD nations in 2015 that had a ratio higher than Georgia – Switzerland (211%), Australia (212%), Norway (222%), Netherland (277%) and Denmark (292%). The same measure was relatively low (commonly less than 100%) for less developed countries.

No doubt, debt to disposable income is a very simple measure, and policy makers should be cautious when interpreting it. For example, this ratio compares the stock of debt to the flow of disposable income and a person – it doesn’t mean that a person is required to pay off their loan in a single year. Moreover, debt to disposable income ratio measures the debt of people who borrowed money relative to the income streams of people who may or may not have borrowed.  

To better see the dynamics of debt burden, one could look at  the ratio of household debt service and principal payments to income. It is not surprising that the average debt burden of Georgia was relatively low in 2012 and its growth accelerated only from the beginning of 2015, reaching the peak value of  24.6% in the third quarter of 2016.

This recent worthening of the debt burden is directly related to the sharp depreciation of the Lari against the US Dollar and slowdown in economic growth.

And yet, despite the increasing burden of debt, households seem to be repaying their loans: both by IMF and NBG measures, the non-performing loans of deposit-taking institutions remain at a reasonably low level (it is widely recognized that non-performing loans are much higher in the case of microfinance institutions, but it creates less problems in terms of financial stability). Thus, the stability of deposit-taking financial institutions is not yet under threat. 

What is the risk of over-indebtedness?

Just because the non-performing loans ratio is low and stable, it doesn’t mean that we have nothing to worry about. Elevated debt levels create the risk of lower consumption and sluggish GDP growth that further increase the risk of over-indebtedness in the future.

In economic literature, over-indebtedness is defined as inability to meet a recurring expense associated with a contracted financial commitment (this inability must be persistent to exclude one-off occurrences like forgetfulness). Society with excess borrowing is prone to over-indebtedness when 'risky life events' take place. For example, a sudden job loss (quite relevant when economic growth has slowed down), a business failure, illness and emergency surgery treatment (despite a universal insurance system, patients still need to share expenses) and sharp currency depreciation (especially for countries with a huge currency mismatch).

Furthermore, over-indebtedness might be caused by irrational borrowing by individuals which come from poor financial management skills of the population and aggressive marketing by lenders, which endangers the least educated and the least well-off groups of the population.

Microfinance institutions and lost property

Going back to the story at the beginning, over-indebtedness is especially painful when people lose their property. In this respect, the lending practices of microfinance institutions (MFIs) call for further scrutiny.

It is widely accepted that most MFIs get their high profit from charging high interest rates and from repossession and sale of the pledged real estate in case of a default. Since the collateral requirements are very high relative to the value of the loan, even if the MFI sells an expropriated property at half price, they can still profit from a loan project.

Therefore, there is a strong issue of moral hazard – MFIs are mainly ignoring the financial health of borrowers (they even give loans to people without a permanent income) and rely on the real estate provided as a collateral. Bearing in mind the much stricter loan standards in commercial banks, the MFI type of credit is mainly taken by poor and unemployed people. They are the ones most vulnerable to over-indebtedness trap (Economic Policy Research Center (EPAC) – Management of nonperforming loans in Georgia, 2014). 

These findings perfectly agree with the empirical data. First, the number of loan contracts with microfinance institutions has been increasing dramatically in the past several years. For example, in the first quarter of 2013, there were 400,000 loan contracts with microfinance institutions, while this measure increased to 700,000 by the first quarter of 2016 and then reached a historical high of 1.1 million in the last quarter of the same year.

Second, according to the Financial Access Survey (FAS) of the International Monetary Fund, Georgia was the third country by the number of borrowers from microfinance institutions per 1000 adults in 2015, behind Bangladesh and Peru.

Third, the amount of real estate and movable property taken into ownership by microfinance institutions has been increasing rapidly in recent years. For instance, the value of repossessed real estate was 1.6 million GEL in the first quarter of 2012, then it increased to 6 million GEL in the first quarter of 2015 and skyrocketed to a historically high 14 million GEL in the first quarter of 2017. Therefore, despite the fact that MFIs are, for the most part, not deposit-taking institutions, we should remember that behind these “impressive” numbers, there are stories of poor and vulnerable people whose finances collapsed under burden of expensive loans and who lost the only property they owned.