PSU banks may resist FM plan of farm credit at 7%

Finance Minister P Chidambaram is likely to face stiff opposition from the public sector banking community on the government's proposal to provide short-term credit to farmers at 7%.

The other issue on which bankers are agitated is on the budget proposal to summarily remove tax exemptions on interest and capital gains on infrastructure investments.

Bankers fear that farm lending at 7% will only worsen the credit risk profile of banks as it is much lower than the banking industry's average yield on advances of about 8.5%.

The government plans to implement the 7% farm credit scheme through a special refinance package via National Bank for Agricultural and Rural Development (Nabard). Banks normally do not avail of refinance from Nabard or even the National Housing Bank for finance provided. They tap the refinance window only in times of liquidity crunch.

Farm credit is expected to increase to Rs 1,41,500 crore by the end of March 2006 from Rs 1,25,309 crore in March 2005. The finance ministry has proposed to ask banks to increase the level of farm credit to Rs 1,75,000 crore in 2006-07 - an increase of about Rs 33,500 crore. In addition, banks are being asked to bring into the banking fold 50 lakh more farmers.

IDBI Capital Market Services, in its comment on Budget 2006, said the move to channelise farm credit at 7% may prove "painful" for banks since the spread deficit on agricultural lending will have to be set-off by increasing lending rates to other segments.

Bankers said the government should go in for direct subsidy on interest rates to farmers as it has done in the case of crop loans for the 2005-06 Kharif and Rabi seasons. The 2006-07 budget has provided Rs 1,700 crore for crediting directly to the farmers' account an amount equal to two percentage points of the borrowers' interest liability on the principal amount up to Rs 1,00,000.

The decision by the finance ministry to omit Section 10(23G) has also come in for sharp criticism as it comes amidst government's plans to substantially increase investments in the infrastructure sector. With the removal of the section, interest earned on advances and capital gains from equity support to infrastructure projects have now become taxable.

Bankers said the removal of the tax exemptions for exposure to the infrastructure sector will compel banks to charge about 50-100 basis points higher on loans to infrastructure projects.