Are farm loan waivers really so bad?

In recent months, the pink press has gone to town against a series of announcements by various state governments declaring their intent to waive farm loans to varying extents. It all began with the new chief minister of Uttar Pradesh (UP), Yogi Adityanath, making this his first substantive economic announcement, in keeping with his party’s manifesto, although there was no overt demand from UP farmers then. Ever since, farmer agitations and suicides have snowballed across the country, compelling other state governments to consider this as a serious option for relieving farmers’ distress.

While the media and other commentators recognize the reality of farmers’ distress, they take serious exception to farm loan waivers as a means of addressing the problem. The position taken by India’s elite is best summed up in the words of the Reserve Bank of India (RBI) governor Urjit Patel: “I think it (farm loan waiver) undermines an honest credit culture, it impacts credit discipline, it blunts incentives for future borrowers to repay, in other words, waivers engender moral hazard. It also entails at the end of the day, transfer from taxpayers to borrowers. If on account of this, overall government borrowing goes up, yields on government bonds also are impacted. Thereafter it can also lead to the crowding out of private borrowers as higher government borrowing can lead to an increase in cost of borrowing for others.”

Different aspects of this ominous view have been picked up by different interlocutors to create a new, frightening urban legend. It is important to critically examine the validity of these claims in the specific context in which waivers are being considered.

The first point that needs to be made is that this isn’t the first time farm loan waivers are being given. Therefore, it is possible to subject its effects to empirical validation. Second, even if such effects are valid, they need to be evaluated against the counterfactual: what is the likely outcome if waivers are not granted? Third, are these repeated instances of waivers just political populism or do they point to a more fundamental problem in the design of farm loans in India?

Credit culture and moral hazard

The last incident of waivers was in 2009-10, when the country was hit by the worst drought in 35 years. Following that, there has been no evidence whatsoever of farm loan repayments slackening in any sense or of repeated demands being made for waivers, not even during the two-year drought period of 2014-16. This has in fact been true post every farm loan waiver in the past.

Credit culture and moral hazard are attributes of individual behaviour, which are more relevant to the “regulatory forbearance” which RBI has routinely been extending to corporate loans than to this form of waivers that are granted to farmers as a class by a third party, namely the government. If any individual farmer doesn’t repay a loan on the expectation that it will be waived, he is exposing himself to the normal consequences of default if the government doesn’t oblige. The theory does not apply.

The present demands are an outcome of the fact that the government is willing to provide for “acts of God”, not for “acts of state”. The policy framework for farm loans has a provision that when the Centre declares a drought, farm loans in officially designated “affected districts” are rolled over, initially for a year, up to a maximum of three years. However, farmers’ problems in 2016-17 are almost entirely the outcome of demonetisation: there was no clear geographical demarcation, and there has been no rolling over of loans. Therefore, farmers across the country have to either agitate or face the prospect of default.

If loans are not waived...

Agricultural loans by banks in India are compulsorily insured by the Agricultural Insurance Company of India (AIC), whose liabilities are back-stopped by the Centre through budgetary support. Hence, even if loans aren’t waived, there is no loss to banks. In situations of widespread and acute farmer distress leading to substantial defaults, the Centre will have to step in and provide funds. This too will entail “transfer from taxpayers to borrowers” and increased “overall government borrowing”. The difference is that waivers are borne by states, and defaults are borne by the Centre. While government pay-outs are likely to be larger in case of waivers vis-à-vis defaults, the latter impose a heavy penalty on the most distressed and vulnerable, forcing them out of access to formal credit and possibly out of farming.

This is not just an ethical issue—it also has economic consequences. To improve farmer livelihoods and check food inflation, our agricultural strategy has been based upon persuading farmers to move away from traditional subsistence agriculture towards more commercial operations. This entails farmers investing much more and taking higher risks. Traditional farm finance sources like moneylenders can neither provide the requisite volume of funds nor do they allow enough margins to make risk-taking worthwhile. Forcing farmers back to moneylenders will retard diversification, thereby increasing the risk of accelerating food inflation.

The ‘sub-sovereign’ dilemma

At the heart of this problem are constitutional provisions whereby the health of the banks is the Centre’s concern while the health of the farmers is that of the states. This division of responsibility is asymmetric in that if states protect the interest of farmers, they also protect banks; while the Centre can protect banks without concern for farmers. The Centre and states need to work together to evolve a farm loan model which protects both farmers and banks without bringing politics into it. This is the essence of “cooperative federalism” that this government sets such store by. Until such time, farm loan waivers need to be viewed less ideologically and with more compassion.

Pronab Sen is country director, IGC (International Growth Centre) India.

Published with permission from Ideas for India, an economics and policy portal.

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