Just as a new round of existential self-flagellation seemed primed to capture the time and attention of the foreign aid Twitterverse, news broke that reoriented the discussion from retrospective hand-wringing to forward looking action. Margaret Wente’s weekend essay—”Is Humanitarian Aid Bad for Africa?”—provoked a flurry of debate (though none of it so far as I could tell took issue with the Palin-esque categorization of “Africa”as a homogenous giganta-country) and attracted the attention of aid luminaries Dambisa Moyo and William Easterly. Then everything changed.

On Tuesday, the Bill and Melinda Gates Foundation announced a major strategic sea-change in its approach to combating poverty around the world. Melinda Gates, speaking at a media roundtable event in Seattle, made known her foundation’s commitment to

spend $500 million over the next five years to spur savings among the world’s poorest workers who live on less than $2 a day. As part of the pledge…Gates announced $40 million in new grants to six recipients that will start or expand savings programs, test new approaches such as mobile banking and research how such programs improve the lives of the poor.

The move marks an important move away from support for microcredit ventures. The Puget Sound Business Journal inquired whether

microlenders—which have an established network of locations to serve borrowers, unlike microsavings institutions—would play an important role in the foundation’s new strategy. The answer is no.

And good thing, too! The New York Times reports that microcredit is in huge trouble in the very place where it has been hailed the greatest success: India. The Times notes also that:

The crisis has been building for weeks, but has now reached a critical stage. Indian banks, which put up about 80 percent of the money that the companies lent to poor consumers, are increasingly worried that after surviving the global financial crisis mostly unscathed, they could now face serious losses. Indian banks have about $4 billion tied up in the industry, banking officials say.

Why the sudden problems? The roots may be found in some of the early criticisms of leveled against the microfinance industry. Chief among them, skeptics of microlending argue that the exorbitant interest rates that often attend loans reduce the practice to little more than formalized loan sharking. As the Times itself reported this past spring,

the phenomenon has grown so popular that some of its biggest proponents are now wringing their hands over the direction it has taken. Drawn by the prospect of hefty profits from even the smallest of loans, a raft of banks and financial institutions now dominate the field, with some charging interest rates of 100 percent or more.

The phenomenon is especially acute in countries like India, Mexico, and Nigeria, where the demand for small-market loans has completely outstripped local supply, opening the door for institutions to begin charging usurious interest rates to vulnerable borrowers.

In the case of India, officials

fear that microfinance could become India’s version of the United States’ subprime mortgage debacle, in which the seemingly noble idea of extending home ownership to low-income households threatened to collapse the global banking system because of a reckless, grow-at-any-cost strategy.

Responding to public anger over abuses in the microcredit industry — and growing reports of suicides among people unable to pay mounting debts — legislators in the state of Andhra Pradesh last month passed a stringent new law restricting how the companies can lend and collect money.

Even as the new legislation was being passed, local leaders urged people to renege on their loans, and repayments on nearly $2 billion in loans in the state have virtually ceased. Lenders say that less than 10 percent of borrowers have made payments in the past couple of weeks.

The lion’s share of public resentment surrounding microcredit institutions in India seems directed at the country’s largest provider of microloans to the poor, SKS Microfinance. The firm recently took its venture public, with its CEO Vikram Akula personally pocketing a crisp $13 million from the sale of his shares.

For his part, Akula defended his group, pinning blame on “rogue”actors who undermined the integrity of the microcredit structure though “errant practices.” The Wall Street Journal notes that

Mr. Akula said SKS’s lending rates had dropped consistently, to 24 percent, from 31 percent as the lender was able to take advantage of economies of scale. Within that, the company’s cost of funds was 9 percent and the cost of delivering a loan was 9 percent, he said. In addition, there was a 3 percent corporate tax, and another 1.5 percent was set aside for loan-loss provisions. “From a microfinance perspective, we have some of the lowest cost structures in the world,”he said.

This may be, but Alula’s suggested remedy for the crisis—”enlightened regulation”by the Indian state—would do nothing for micro borrowers such as K. Shivamma, a 38-year-old farmer profiled by the Times, who

took her first loan hoping to reverse several years of crop failure brought on by drought. “When you take the loan they say, ‘Don’t worry, it is easy to pay back,’ “Ms. Shivamma said. The man from Share, the company that made her first loan, did not ask about her income, Ms. Shivamma said. She soon ran into trouble paying back the $400 loan, and took out another loan, and then another. Now she owes nearly $2,000 and has no idea how she will repay it. The television, the mobile phone and the two buffaloes she bought with one loan were sold long ago. “I know it is a vicious circle,” she said. “But there is no choice but to go on.”

All of which seems to suggest that the microcredit crisis threatening the Indian economy offers initial support to William Easterly’s quick takeaway from Wente’s article, namely that “the viable arguments are that (1) aid’s record is sufficiently disappointing that it is unlikely to ever be the main driver of successful development, [and] (2) if aid were more accountable it would do less ill and more good.”But if the fears of some observers are realized in this particular case, “more good”will be completely off the table moving forward, and “ill”a mild understatement of the consequences.

Michael Busch, a Foreign Policy In Focus contributor, teaches international relations at the City College of New York and serves as research associate at the Ralph Bunche Institute for International Studies. He is currently working on a doctorate in political science at the Graduate Center, City University of New York.

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