Massive crisis in the microfinance sector

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Today on The Daily Brief:

• How bad is the crisis in microfinance?
• Why Is Burger King India Struggling?
• Why Are Tata Technologies' Profits Declining?

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How bad is the crisis in microfinance?

Microfinance in India started with a simple goal: to get loans to people who really needed them but couldn't access traditional banking. Now, however, it's in a tricky spot, facing serious challenges like rapid growth, changing regulations, and high interest rates. The Reserve Bank of India (RBI) is taking a close look at how the sector is run, especially with more loans turning bad and the overall quality of loans dropping.

In 2022, the RBI made a decision that changed things significantly—they removed the cap on how much interest microfinance institutions (MFIs) could charge. The old system was pretty straightforward: MFIs could take their cost of borrowing money and add up to 12%. So, if it costs them 10% to get funds, they could charge borrowers up to 22%. This system worked well, allowing MFIs to cover their costs and make a fair profit without overwhelming borrowers with high rates.

However, when the RBI removed the cap, hoping that competition would keep interest rates reasonable, things didn’t go as planned. Instead of rates going down due to competition, many MFIs raised their rates—some reaching as high as 45%. RBI Governor Dr. Shaktikanta Das openly acknowledged in a CNBC TV18 interview that they had misjudged the situation. The market forces they expected just didn’t show up, so now they’re working on new ways to protect borrowers.

On top of this, there's an issue with how borrowers are identified. Around 2017, the sector shifted from using Aadhaar cards to voter IDs for borrower identification. This might seem like a small change, but it’s created major issues. Voter IDs aren't as secure as Aadhaar, and some borrowers have figured out ways to use different IDs to take out multiple loans from various lenders, leading to what’s known as "overleveraging." This is a big reason why we’re now seeing more loans go bad.

CreditAccess Grameen (CA Grameen) is a prime example of what's both working and struggling in microfinance today. Their numbers tell an interesting story: their loan portfolio has grown to ?25,133 crore (an 11.8% increase from last year in Q2 FY25), which sounds promising. But look a little deeper, and there are some concerning signs.

Source: CA Grameen Investor Presentation

Source: CA Grameen Investor Presentation

Their Portfolio at Risk (PAR) - loans overdue by more than 15 days - is 1.5% nationally, which doesn’t seem too bad until you focus on specific areas. In Bihar, for instance, it’s a staggering 8.9%. To protect themselves, CA Grameen is keeping provisions 1.79% above what regulators require, giving them an extra buffer of ?431.1 crore. Even with these safeguards, their Profit After Tax (PAT) still dropped 46.4% year-on-year to ?186 crore, highlighting just how much these challenges are impacting their profits.

Source: CA Grameen

Different banks are handling these challenges in their own ways:

• IndusInd Bank has 9% of its total portfolio in microfinance, and they’re seeing more loans go bad, especially from newer, higher-risk borrowers. Their approach? Set aside more money for potential losses while staying committed to microfinance.

• Kotak Mahindra Bank is taking a more cautious path. CFO Dipak Gupta said, “We restricted growth because we were seeing some strain... We expect this trend to continue for the next quarter or two before stabilizing. While some states are showing improvement, others continue to face challenges.” They’re focusing on areas where borrowers have a strong history of paying back loans.

The RBI isn’t reimposing rate caps (at least not yet), but it’s definitely tightening its oversight:

• They’re conducting more in-depth inspections to monitor how MFIs set rates and treat borrowers.
• They’re requiring MFIs to be completely transparent about all rates, fees, and penalties.
• They’re considering setting different rate caps for different regions, especially where borrowers are more vulnerable.

The sector itself is working on solutions to stay sustainable:

• Revenue Diversification: Major players like CreditAccess are expanding beyond loans into micro-insurance and other financial services to reduce reliance on high-interest lending.
• Digital Transformation: The industry is investing heavily in digital platforms to cut operating costs, which could eventually lead to lower interest rates.
• Credit Infrastructure: Plans are underway for a centralized credit bureau to track all of a borrower’s loans, which could help prevent overleveraging.

The microfinance industry is at a crossroads, trying to balance profit with real support for people in need—all while facing stricter oversight and working to keep borrowers from taking on too much debt.

Why Is Burger King India Struggling?

Burger King India is hitting a rough patch, and it’s not just them; the whole Indian fast-food industry is facing some challenges. Restaurant Brands Asia (RBA), the company that runs Burger King in India, recently released its financial report for the quarter ending September 30, 2024. The big picture? Losses are mounting, thanks to shifting consumer habits, rising costs, and tough competition.

So, what does this mean for Burger King, the fast-food industry in India, and even for us as consumers? Let’s break it down.

Starting with the numbers, Restaurant Brands Asia reported a net loss of around ?60 crores this quarter, a noticeable increase from the ?46 crore loss in the same period last year. But that’s not the only concern. The company’s revenue—or simply, the money they make from sales—only grew by 1%. This small growth rate is the slowest Burger King India has seen in about three years!

This slow growth hints that fewer people are spending at Burger King and similar fast-food places. People might be eating out less or are being more cautious with their spending.

During a recent earnings call, RBA’s management noted that foot traffic—the number of people visiting Burger King locations—has also declined. This has particularly affected existing stores, where growth has actually turned negative.

There’s another important industry metric called Same-Store Sales Growth (SSSG), which shows how well stores that have been open for a year or more are performing compared to previous periods. Unfortunately for Burger King, this metric was down by about 3% this quarter—a sharp shift from the 3.5% growth seen in the same quarter last year.

All of this adds up to a challenging time for Burger King India and the wider fast-food sector, as they try to keep up with changing consumer habits and an increasingly competitive market.

So, why is Burger King India facing these challenges? Several factors have come together to create this tough situation. Let’s dive into a couple of the main reasons:

1. Decline in Same-Store Sales: A major factor has been a drop in sales at older stores, where fewer people are visiting or spending money. This decline in foot traffic reflects that people are becoming more careful with their spending, especially on fast food and dining out. This reduced demand in India’s fast-food market has weighed down Burger King’s overall performance.
2. Rising Operational Costs:?Running fast-food restaurants is expensive. According to RBA’s management, the costs to run stores have increased by about 3% this quarter, bringing total expenses close to ?700 crores. This increase is mainly due to higher prices for materials and rent, which is squeezing the company’s finances and making it harder to keep profits steady.

Together, these issues have put Burger King India in a challenging spot.

While much of what we've discussed so far focuses specifically on Burger King, this trend actually reflects a larger pattern in India's fast-food sector. Many major fast-food chains across the country are facing similar challenges. Companies like Sapphire Foods, which operates Pizza Hut and KFC, Westlife Foodworld, which runs McDonald's, and Devyani International, which manages Yum! Brands, have also recently experienced slower sales in the same way.

Overall, the entire fast-food industry in India is currently facing a tough time, and there seem to be two main reasons for this.

1. Consumer Spending Caution:

Many people in India are becoming more careful about their spending. The retail inflation rate for September rose to 5.49% year-on-year, up from 3.65% in August. This means the overall cost of living has noticeably increased.

As a result, people have less money to spend on non-essentials like dining out. Fast-food spots like Burger King, which are generally seen as occasional treats rather than everyday necessities, are feeling the pinch as consumers try to save more.

2. Competitive Pricing Pressures

In a bid to attract more budget-conscious customers, Burger King and other fast-food chains introduced lower-priced items, with some options as low as ?50. While these deals draw interest, many people are still hesitant to spend even on discounted menu items.

So, while price cuts may help a bit, they aren’t a complete fix for the current slowdown in spending.

Despite these challenges, RBA remains optimistic about Burger King India’s future. They’ve set several long-term goals, including expanding their digital presence, improving profit margins by adjusting delivery pricing and supply chain operations, and opening more locations to reach a broader audience.

Overall, RBA’s management is focused on steady, planned growth rather than making quick, reactive changes. For now, however, the company faces a careful balancing act between attracting customers and managing costs. When the economy stabilizes and consumer spending picks up, Burger King India could be in a strong position to capture more of the market. But until then, they—and other fast-food chains—will be working to weather the storm.

Why Are Tata Technologies' Profits Declining?

If you’re someone curious about the future of cars, planes, and even industrial machines, Tata Technologies is a company you shouldn’t overlook.

This isn’t your typical tech or IT company. Tata Technologies is deeply involved in engineering, design, and manufacturing—the actual building of machines and factories. So, when it comes to what vehicles and factories will look like in the future, Tata Technologies plays a key role.

To understand how Tata Technologies fits in, think of it as a company helping industries like automotive and industrial machinery build the “brain” of their products. They handle everything from design to how it will be manufactured, partnering with companies to make products that work efficiently, safely, and with advanced technology.

It also helps to know the difference between Tata Technologies and Tata Elxsi, another company in the larger Tata Group.

• Tata Technologies: Think of them as the engineers focused on how a car is built. They work on the car’s core—its structure, safety features, and the technology that makes it run smoothly. They’re focused on how the car operates and how it’s manufactured.
• Tata Elxsi: They focus more on the experience inside the car. Tata Elxsi is about digital interfaces, infotainment systems, and features that enhance the user experience. So, Tata Technologies builds the “brain,” while Tata Elxsi makes the experience enjoyable and user-friendly.

Tata Technologies isn’t just based in India; it’s a global player, operating in multiple countries and bringing in revenue from different markets:

• 36% of their revenue comes from India.
• 24.2% of revenue comes from the UK, where they are heavily involved in automotive research and development.
• 20.4% come from North America, where they work on manufacturing projects.

Source: Tijori Finance

This spread positions Tata Technologies well in markets with unique needs—from automotive innovation in the UK to large-scale manufacturing in North America.

Their products and services fall into two main areas:

1. Automotive Services account for 77.7% of their revenue and include engineering for carmakers, product lifecycle management, and digital solutions for vehicle design.
2. The remaining 22.3% comes from Technology Solutions, which offers software reselling and workforce training to help industries adopt modern engineering tools and improve skills.

Source: Tijori Finance

For the latest quarterly update, Tata Technologies reported a 2% drop in profits, bringing it to ?157 crore. This marks the third consecutive quarter of profit declines, even though revenue grew slightly by 2.2%. With clients remaining cautious, Tata Technologies' profit margins are shrinking, meaning they’re earning less profit for every rupee.

So, why is this happening?

In recent quarters, their major clients in the automotive and industrial sectors have been hesitant to launch large, game-changing projects. Instead of committing to big deals, clients are making smaller investments, which has directly impacted Tata Technologies’ earnings.

The slowdown in Tata Technologies' core markets has a few key underlying causes. Let’s break them down in more detail:

1. Economic and Regulatory Uncertainty: In the U.S. and Europe, economic uncertainty is making clients hesitant to commit to large projects. The upcoming U.S. elections add to this "wait-and-see" mindset, while European clients face pressure from Chinese EV manufacturers and are awaiting possible government support. Tata Technologies' CEO, Warren Harris, noted that recent deals have been smaller, as clients take a cautious approach until conditions improve.
2. Shift from Full EVs to Hybrid Vehicles: Many carmakers, especially in North America and Europe, are shifting their focus from fully electric vehicles (EVs) to hybrids. Hybrid vehicles meet environmental standards without needing as much expensive infrastructure as EVs. Tata Technologies, which has invested heavily in EV projects, now sees slower growth in this area as clients lean toward hybrids instead. This shift affects Tata Technologies' EV-related projects, like battery integration and electric powertrain design.
3. EV Market Hesitation: The EV market has been a major focus for Tata Technologies, particularly in designing battery systems and electric powertrains. However, high costs and regulatory delays are making clients cautious about large-scale EV investments. Tata Technologies’ CEO pointed out that clients are rethinking their EV investments due to the high expenses and a lack of clear regulatory support.

While EV projects have slowed, Tata Technologies still has other revenue areas that are performing well:

• Digital Manufacturing: Tata Technologies helps boost production efficiency through automation and AI. While clients are interested, they prefer smaller, gradual improvements over large-scale investments.
• Education and Training: Tata Technologies partners with states like Maharashtra to offer engineering upskilling, providing steady, though limited, revenue amid the EV and manufacturing slowdown.

Despite a challenging quarter, Tata Technologies remains optimistic about the future. The company expects that as economic and regulatory uncertainties ease, clients will regain confidence and start investing in larger projects again. As Warren Harris put it, they’re facing short-term challenges, but the fundamentals of their business—like the shift toward EVs and digital manufacturing—are strong for the long term.

Tidbits:

1. India’s long-postponed census is set to begin in early 2025, with results expected by 2026. This census will guide the redrawing of Lok Sabha constituencies, a critical step in reflecting demographic changes.
2. Bharti Airtel's profit jumped 168% to ?3,593 crore in Q2, driven by tariff hikes and premium customer acquisition. The telecom giant also announced a structural reorganization of its DTH and broadband businesses for future growth.
3. The RBI is rolling out an AI-based system for real-time cyber fraud detection, boosting digital transaction security through centralized monitoring and tools like MuleHunter AI.
4. Apple’s iPhone exports from India surged to nearly $6 billion, showcasing the tech giant's commitment to diversify its supply chain and increase production outside of China.

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This post was first published on Substack.