Soft Loan Meaning
A soft loan means a loan with generally no interest rate or an interest rate lower than the market interest rates and is offered majorly by the government organizations to the developing countries to fund their needs. Soft loans which are also called soft financing or concessional funding has very lenient terms and also a lot of grace period to pay back the loans. Though they are generally offered for the development of the developing countries, sometimes it is also granted to have political and economic ties with a country.
Examples of Soft Loan
Some of the examples of soft loan are as below:
- World Bank is one of the biggest financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. which offers soft loans to various developing countries. The International Development Association is an international financial institution in the process of offering concessional financing and grants to the poorer countries of the world. It is a part of the World Bank and is headquartered in Washington D.C, USA. It was established in 1960 to complement the already existing International Bank for Reconstruction and Development to lend to countries with poor creditworthiness and lower per capita incomeCapita IncomeThe per capita income formula depicts the average income of a region computed by dividing the total income of that area by the total population of the region. It is used to figure out the average income of a city, provision, state, country, etc.. These two bodies International Development and Association (IDA) and International Bank for Reconstruction and Development (IBRD) are collectively known as the World Bank.
- They are even offered by a country’s government to promote the growth of the nation. For example in India, Small Industries Development Bank of India (SIDBI) offers loans and grants to promote the Make In India campaigns. It helps the MSMEs to get money to fund their expansion which in a way helps the country to grow leaps and bounds.
- Similarly, countries are offering soft loans to other countries to establish strong relations between them. One example of a country lending to the other is Japan lending money to India to its bullet train project. But here though the interest charged was minimal, Japan had an agreement that India will purchase a certain percentage of machinery required for its bullet trains from Japan. So in this way, Japan helped India to get money at a cheaper rate, allowed its industries to grow by exporting the machinery to India, and also established good business relationships with India.
Advantages of Soft Loan
Some of the advantages are as follows:
- The poorer countries get easy funding to fund their expansion and also the time frame offered can be extended.
- It helps businesses to grow which may not get money from other sources.
- It helps the countries to establish relationships with each other. For example, China helping the African countries to grow through their soft loans.
- Generally allows economic collaboration wherein all the countries involved in the soft loan financing benefits in some or the other.
- The government of the country can promote the businesses and their local players to use this money to expand themselves and help the country to grow economically. For example, the Federal Ministry of Finance (FMF) helps businesses in Austria to get loans and expand themselves for the overall development of Austria.
Disadvantages of Soft Loan
Some of the disadvantages are as follows:
- Sometimes the country getting soft loans may not afford it and can get into a debt trap. An example of such a case is a country named Ethiopia. Ethiopia had got a soft loan from China to funds its expansion. But due to these, the debt to GDP ratioDebt To GDP RatioThe debt to GDP ratio is a metric to compare a country's debt to its GDP and measures its capability to repay its debt. A country with a high ratio would not have difficulty repaying its debt but will not seek debt due to higher chances of defaulting. of Ethiopia had risen to 88% which caused a lot of trouble. So sometimes the country may not need that much money and may get into trouble if things don’t work out well.
- The terms of the loan are lenient and this causes a negative view for the development. The businesses may not take it seriously and if the business fails, the loan is converted into a grant by the government.
Soft Loan should be taken whenever there is poor creditworthiness and a serious need for a country to grow. The terms of the soft loans are lenient and ability based. Meaning the borrower is expected to pay back the loan when it can.
The World Bank with its arms of IDA and IBRD should try its best to offer soft loans for the poorer nations with very low per capita income and in a dire state where it needs money to grow. They can also help a nation to grow on the economic front by granting a soft loan to another country with guidelines to get business in return and promoting exports. It also helps to establish political and economic relationships with other nations.
The businesses in a country that are in the nascent stage should make the maximum use of soft loans by governments to grow themselves and also help in the development of the nation. There are proper guidelines established by the government agencies as to who is eligible to get the soft loans and the granting process involves a lot of parameters.
This has been a guide to what is soft loan and its meaning. Here we discuss examples of soft financing along with advantages and disadvantages. You can learn more about investment from the following articles –