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Business News/ Opinion / Online-views/  Opinion | The equivalence of farm loan waivers and corporate NPAs

Opinion | The equivalence of farm loan waivers and corporate NPAs

The problem of the spendthrift farmer and that of the flagrant corporate firm are two sides of the same coin

Photo: Ramesh Pathania/MintPremium
Photo: Ramesh Pathania/Mint

A recent newspaper headline read: “Farmer Bijay Lallya arrested at IGI Airport trying to flee the country over non-payment of bank loans of 5 lakh." As you might have guessed, this headline is made up. An instinctive reaction would be to ask—“How can farm loan waivers have anything in common with corporates’ non-performing assets (NPAs)? Isn’t one decision entirely political and the other entirely commercial?" But first impressions can be deceptive.

A farm loan waiver is a sector-wide extinguishing of loans mandated by the government, usually before an election, with the exchequer compensating banks. On the other hand, a corporate NPA represents a business failure, for reasons internal and external, and triggers a bankruptcy process to recover dues by financial creditors to the maximum extent possible—either through resolution or through liquidation. A bankruptcy process does not imply any liability of the government, unless very large in magnitude. The government obligation can be more pressing if NPAs originate in public sector banks or are due from public sector corporations.

A key underpinning of bankruptcy procedures is the limited liability clause that protects the assets of promoters unless explicitly pledged. Corporate bankruptcy, therefore, is a simultaneous process of cleansing bank balance sheets and a mechanism allowing optimal risk-taking by entrepreneurs. Effective functioning of a bankruptcy law is expected to enable the generation of new cycles of credit, with credit flowing to better projects in similar or entirely new sectors. On the other hand, a farm loan waiver impedes the flow of such credit as structural problems besetting agriculture are typically not addressed. Couched in these terms, corporate bankruptcies and farm loan waivers appear to have nothing in common.

The equivalence arises when conditions warrant that the state must indirectly bear the burden of corporate NPAs by infusing funds into banks, as had happened in the US following the 2008 financial crisis and as is happening now in India. Equivalence can also be drawn when the problem of corporate NPAs repeats itself in the same sectors implying that, for some reason, banks keep lending to the same sectors even in the absence of structural improvements. Persistent problems in power and infrastructure sectors and the fate of development finance institutions before some of them converted to universal banks immediately come to mind.

The evidence of this equivalence would be a slowdown in both agricultural and corporate lending occasioned by farm loan waivers and NPA crises, respectively—something we have been witnessing in India for the last few years. Another ground for equivalence arises if the resources of the exchequer are used to buoy companies that would otherwise go into bankruptcy. The assumption is that the motivation of keeping a company afloat interferes with the objective of choosing the most efficient vendor, and hence represents a distortionary cost—as in the case of preferential access to inputs such as coal, and award of contracts without regard to expertise in areas such as defence.

It is true that there has been a marked increase in the share of large loans in agriculture since 1990. In the same vein, the top 12 corporate houses received close to 15% of 70-80 trillion in total advances to the corporate sector and accounted for approximately 25% of the NPAs. The share of these borrowers in credit from the formal sector is almost the same as that of the entire agriculture sector. Four of these have been resolved within a year with about 52% recovery, representing only 14% of the dues from these 12 accounts.

Thus, as in agriculture, the corporate NPA crisis is also sector-specific, dominated by large accounts, not accompanied by adequate structural reforms, and expensive for the public exchequer. If the recapitalization of banks is welcomed, why is a farm loan waiver not acceptable?

It seems that the criticism of farm loan waivers reflects a view of the proper relation between the farm versus the non-farm sectors. It is believed that food prices for consumers must be kept low through restrictions on farmers and subsidies to consumers. The Organization for Economic Co-operation and Development (OECD) estimates that the average yearly revenue lost by Indian farmers between 2014 and 2016 on account of export restrictions, net of subsidies received, is 1.65 trillion.

Historical performance shows that the credit quality of large corporate borrowers is not superior to that of agriculture/priority sector lending. In that context, interest rates charged by banks to large corporate borrowers have been kept artificially low and incommensurate with the risks involved. Low prices of agricultural products can also be achieved by reducing the role of the middlemen but for various reasons, including the political muscle involved, this does not happen.

This model of development is no longer tenable. First, India can no longer rely only on exports and will have to look towards domestic demand to power its growth. And skewing income distribution away from 50% of the population will not help. Second, cities are unable to manage the influx of refugees from agriculture. Third, the Swaminathan report of 2006 clearly states that India’s food security cannot be achieved through imports, thus emphasizing the imperative of a healthy agricultural sector. Finally, from an ethical point of view, taking care of the big farmer who, unlike the corporate promoter, risks losing personal assets in the event of a default, is as important as taking care of the big businessman.

In short, the problem of the spendthrift farmer and that of the flagrant corporate firm are two sides of the same coin. The difference is that unlike corporate honchos, farmers aren’t fleeing the country.

Rohit Prasad is a professor at MDI, Gurgaon. Game Sutra is a fortnightly column based on game theory.

Co-authored with Gaurav Gupta, a banker with an interest in economic development.

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Updated: 10 Jan 2019, 01:37 AM IST
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