Note4Students

From UPSC perspective, the following things are important :

Prelims level: Soft Loans

Mains level: India's soft loan diplomacy as against China's debt trap diplomacy

The volume of India’s soft loans to neighboring countries has increased from about $3 billion to almost $15 billion in the last eight years.

What are Soft Loans?

A soft loan is a loan with no interest or a below-market rate of interest.
Also known as “soft financing” or “concessional funding,” soft loans have lenient terms such as-

Soft loans are often made by multinational development banks such as the Asian Development Fund affiliates of the World Bank etc.

Why are soft loans popular?

Diplomatic tool: Soft loans are often offered not only as a way to support developing nations but also to form economic and political ties with them.
Economic benefit: Nations exchange credit in return of some important resources.
Geopolitics: Soft loans have been an important diplomatic tool to sustain political influence in the neighborhood and beyond as well as counter the growing Chinese presence, especially in Africa.

Pro: Breaks for Business– Soft loans offer favorable business opportunities.
Con: Shaky Returns– The length of time it may take to repay a soft loan could mean the lender is tied to the borrower for an extended number of years.

For instance, in 2015, Japan offered a soft loan to India to cover 80% of the cost for a $15 billion fund a bullet train project at a less than 1% interest rate.
This was done with the caveat that India would purchase 30% of the equipment for the project from Japanese companies.
By the time the countries signed a formal agreement, Japan’s commitment increased to 85% of the cost, in the form of soft loans, for a then-estimated $19 billion project cost.

The amount of development assistance India has offered to other nations in 2019-20 was more than twice what it had extended in 2011-12.
However, such loans have usually gone to countries in Asia, Africa and Latin America that are lower down the economic strength ladder.
India has extended a total of $27.8 billion in lines of credit since 2002-03.

Extending development assistance is nothing new for India and about half of the foreign ministry’s budget is made up of grants and loans to foreign governments, especially India’s neighbours.
For a country that for long had to rely on international loans to meet key development goals, India understands the diplomatic value of providing a helping hand.