The Indian Left, whether in the Congress or outside it, has fostered many myths that have eventually left the poor worse off because of the policies these myths generated. One of these myths was about the village moneylender. He was generally portrayed as an unscrupulous shark who gouged poor farmers with extortionate rates of interest and dodgy methods of calculating it.

While some of this was no doubt true, the other side of the picture, namely, that the village moneylender performed a useful economic (if not social) function, was never kept in view. This economic function of course was the provision of homoeopathic loans -- immediately when needed, and with minimum fuss. It was, if you will, financial inclusion in the real sense of the word.

Everyone's credit needs were met, albeit at a price, though the All-India Debt and Investment Survey has now shown that while the interest rates range from 12 per cent to 150 per cent, the average rate is 18 per cent to 36 per cent, which is in the same ball-park range as what the micro-finance girls and boys charge.

Financial inclusion has become fashionable once again, and the formal sector -- banks and micro-finance institutions -- is straining every nerve to dole out these microscopic loans, and mostly failing because that is not their institutional design.

In fact, the Survey shows that the share of moneylenders in loans to rural households has been increasing. In 1991 it was 7.5 per cent; by 2002 this had gone up to almost 30 per cent. This was accompanied by a decline in the share of formal institutions, from 64 per cent to 57.1 per cent.

The Reserve Bank of India [Get Quote] has come up with what appears to be a workable idea. It is based on the old ju-jitsu principle: use your opponents' strength to achieve your objectives.

A technical group set up by the RBI and comprising not just RBI officials but also other experts and state government officials, has suggested ways of harnessing village moneylenders. Pointing out that the subject -- money-lending by village moneylenders -- is a state subject, the group has put forth a draft of the legislation for the states to consider.

The core of the recommendations consists of four elements.

First, recognise that the village moneylender plays a useful economic role; second, therefore, co-opt him; third, control him by licensing him and putting caps on the interest he can charge; and finally, capitalise him via a bank which will monitor his activities. In short, if you can't beat them, get them to join you by creating a new class of lenders at the grassroots level called accredited loan providers who are to be kept at arm's length, but used.

As constructive ideas go, this is not a bad one. But it suffers from a fatal flaw as it fails to reckon on the unmatched ingenuity of the Indian politician.

It will only be a matter of time before the whole scheme is captured by the relatives of the local politician, who will use the licensing bank to acquire more and more 'loanable' funds while violating the interest caps. Indeed, a large number of village-level moneylenders are already small-time cogs in the political machine.