Let’s get a couple of things straight right at the outset. Indian farmers remain vulnerable to a host of adversities that include both crop failure and overproduction. There are chronic problems of low farm-gate prices, with farmers at times getting less than a third of the final retail price. These often result in a crippling debt burden. The question is: Is the waiver of bank loans to farmers (I estimate it at a potential 2.6 per cent of gross domestic product or GDP, adding up the states that have declared and those that are planning a waiver) the answer?
To begin with it is important to recognise that there is still a large percentage of farmers who depend on alternative sources of credit. According to the 2011 Agricultural census, no more than 10.6 million of 32.8 million small and marginal farmers in the eight states demanding loan waivers depend on bank loans. The other 22.1 million farmers depend on moneylenders and relatives for borrowings. It is possible that this number has declined substantially but is still likely to remain large in absolute terms.
The government’s effort at expanding the reach of crop insurance (through the Pradhan Mantri Fasal Bima Yojana, PFMBY) is indeed commendable. However, these insure essentially against natural calamities that result in crop damage. The current problem in our farm sector stems partly from overproduction of crops (particularly pulses) that has sent prices crashing. Crop insurance will not work in this case.
Some experts writing on this issue have claimed that crop loans are insured through agencies like the Agricultural Insurance Corporation of India and so banks need not worry if farmers default. This, just to set the record straight, is misleading. Crop insurance is not loan insurance. Typically crop insurance payments are much smaller than a crop loan. Besides ask any agricultural loan officer and he is likely to tell you that in the middle of the kind of distress that a farmer actually receives an insurance payout, repaying a loan to banks is the last thing on his mind.
I think there should be no difference in opinion on the fact that farm loan waivers do serious damage to the “credit culture”. There is sufficient anecdotal evidence now that perfectly solvent farmers across states are holding back on repayments and this could lead to a rise in non-performing loans for a number of banks. The difference in loan waiver models is also abetting this behaviour. Punjab and Maharashtra have announced waivers for all farmers but Uttar Pradesh (UP) has offered it to only small and marginal farmers. There is enormous pressure building up from the far lobby to extend the scheme to all farmers in UP and in other states that are contemplating a waiver like Madhya Pradesh and Gujarat.
Illustration by Binay Sinha
The 2008-09 farm loan relief offered by the Centre could be a useful benchmark to gauge the behavioural impact of a debt waiver. A World Bank paper (“The Economic Effects of a Borrower Bailout: Evidence from an Emerging Market”, Working Paper No. 7,109, April 2016) makes two interesting points. First, after a waiver, defaults rise in a classic play of moral hazard. Second, banks anticipate this default and channel less credit to the areas where the impact of the waiver is felt the most. The study finds that one standard deviation increase in the share of credit covered under the program lead to a 3.6 per cent decrease in new loans made after the bailout and 2.4 per cent increase in the share of non-performing credit.
What about the impact of the waiver on the business cycle? Could loan relief lead to a rise in consumer spending that could offset an adverse impact on investments that the loan waiver is invariably going to entail. Here again the 2008-09 example is useful. The World Bank study cited earlier found that the bailout had no measurable positive effect on household consumption, maybe as households did not view the loan waivers as a permanent change in their access to credit and more productive inputs.
The impact on investment spending of the loan waivers has to be analysed against the backdrop of how these waivers will be funded. While farmers get a reprieve, banks need to be compensated by the state governments for this. This, prima facie, would mean that states will have to borrow from the markets and as state bonds hit the market, bond yields (and interest rates) are likely to rise. The rise in borrowing cost could hurt investment. However some states, notably Punjab and UP, do not have the leeway to (state borrowing limits are set through some conditions of fiscal prudence) to borrow more.
There seem be two things that these strapped states are trying. First, a little bit of financial engineering to kick the can the down the road. UP, for instance, has floated the idea of Kisan Rahat bonds, an avatar of the UDAY bonds used to relieve the financial stress of state power distribution companies. This involves conversion of bank loans into state-backed bonds that banks hold. The state pays the interest on the loan. This requires Reserve Bank of India approval and it remains to be seen if the central bank would buy into this idea. Punjab on the other hand has sought a conversion of the short-term farm loans into longer-term loans so that the pressure to repay the principal is delayed. This would upset the cash-flow projections of banks and make them reluctant to lend. This could lead to a funding constraint for investment projects.
That’s, however, not the end of it. The UP Budget released recently produced a fiscal deficit estimate of the mandated limit of 3 per cent. Slipped into this is a massive jump in grants-in-aid from the Centre as well as cut back in expenditure. This rise in central assistance in the UP (other states could follow) suggests that it expects the Centre to fund the waiver. If the Centre plays ball it might compromise the central deficit forcing it to reduce critical expenditure and capital spending, as we have seen in the past is the softest target. If it refuses, states will have to wield the axe. The victim in either case will be investment spending.
The writer is chief economist, HFDC Bank
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Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper