What Is a Soft Loan?
A soft loan is a non-interest loan or a reduced interest rate. Soft loans have lenient conditions, such as lengthy grace periods in which only debt, service costs, and interest are unpaid. They are often called “soft financing” or “concessional funding,” They typically have longer amortization schedules than traditional banking loans (in some cases up to 50 years).
Soft loans are mostly offered to developed nations by international development banks (e.g. Asian Development Fund), World Bank affiliates, or government institutions who are unable to borrow at market rate.
How a Soft Loan Works
Soft loans are offered as a means of promoting and helping in the overall shaping of the economic and political relations with the developed nations. This also helps in the event that the borrowing nation has a lender-interesting property or content that does not only want redemption of the debt, but also preferential access to the resource.
A “soft financing” or “soft loan” is a loan that promises more leniency than any conventional loan, with negligible or no-interest at all and a longer grace periods.
Most developed countries need financing but are unable to afford the interest of the market rates.
In the case of government lenders, soft loans may be used to forge relations between countries that lend and borrow.
In the last decade, China, in particular, has been instrumental in spreading support to African nations. For instance, according to the China-Africa Study Initiative at the Johns Hopkins University School of Advanced International Studies, Ethiopia received $10.7 billion in loans from the Chinese government from 2010 to 2015. This involves a complete $23 million grant and soft loan package to finance the growth and infrastructure of Ethiopia, such as power lines, wireless networks, industrial parks, highways and a railroad connecting the cities of Djibouti and Addis Ababa, the capital of Ethiopia. The soft loan became a part of the China’s plan to stay in support of Ethiopia and to help them promote the development of trade that takes place between the African country and the Asian giant.
Soft loan provides attractive trading prospects, as an addition to acting as a forum for the lender to develop wider diplomacy and policies with the borrower. The aforementioned example of development in Ethiopia, the development is handled by the Chinese firms, not just with Chinese funds. Many businesses coming into the complexes are also Chinese, and the Ethiopian government enjoys significant tax cuts on sales and imports.
The debt-to-GDP ratio rose to 88 percent as a result of those Chinese loans, and it was in danger of defaulting on them. China had to agree to restructure some of the loans, thereby reducing repayments and expanding the loan maturity periods by 20 years. Soft loan is the loan that deals with financing on generous terms, that are below the market interest rate and often offered to the developing countries.