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The Chit Fund Fiasco in West Bengal
|by Dipankar Dasgupta|
The chit funds that have given rise to much indignation recently were once upon a time apparently innocent games housewives played with the savings from their monthly budgets. These games, and they may not have turned extinct yet, were played under the banner of kitty clubs. A kitty club was an informal society requiring each member to contribute a specified sum every month. If a group of twelve such persons were to subscribe Rs. 100 each, then the size of the monthly fund would be Rs. 1200. A lottery decided who amongst the members had the right to spend the entire sum for the month. The facility of spending in excess of one’s saving of course brought along with it a liability. The lucky first, second, third and successive winners, were required to keep on contributing their promised monthly sums till each member of the “association” had been offered an opportunity to lay her hands on the regenerated dough.
The arrangement may be described in the language of formal economics too. Consider the first time lottery winner. She receives Rs. 1200 as a return on her payment of Rs. 100. This implies a monthly rate of interest of 1100 per cent, a return that is entirely guaranteed by capital contributions made by others, instead of the fund being invested in productive activities. Following the first month, the person’s return falls to zero per month, the prize having been already won. This involves a marginal loss, since her pledged contribution of Rs. 100 per month could have been invested in a recurring deposit account in a bank for a small interest earning. However, the 1100 per cent gain in the first month would far more than offset the interest loss in future and the first winner would clearly perceive herself to be a substantial gainer.
And then what will be the state of affairs for the third winner? Once again a slightly complicated calculation is called for and the answer to the question turns out to be a monthly return of 88 per cent for three months and a yearly return of (88/12 + 88/12 + 88/12) = 22 per cent.
Real life for sure is more complicated than the simple examples. Chit funds in the country do not offer monetary flows alone. They are known to promise land or residential flats in lieu of money as well. Besides, many of them engage in productive investment activity too, as evidenced by the growth of media, entertainment business, hotels and real estate enterprises. However, the returns from these ventures are never as high as the promised chit fund returns. Government of India data shows that during the period 1951-52 through 2011-12, the “trade, hotels, transportation and communication” sector had a highest annual growth rate of 13.5 per cent in 1995-96 and “financing, insurance, real estate and business services” had a highest growth rate of 12.6 in 2005-06. It follows that the excessive returns offered by chit funds could not have arisen from the productive activities they carried out in these sectors. Thus, to remain in business, the funds invariably resort to Ponzi schemes, viz. new borrowing to pay off old creditors. Even governments are often caught in debt traps such as these, but the problem turns far more serious when private organizations are involved.
Originally published by The Telegraph, Calcutta, April 25, 2013 under the title Something Cannot Be Produced Out of Nothing.
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