Farm loan waiver is no solution for Indian agriculture4 min read . Updated: 28 Mar 2017, 02:52 AM IST
In the case of repeated farm loan waivers, it makes sense for borrowers to default strategically
Hope: The Narendra Modi government says it wants to double farm income by 2022 through the transformation of Indian agriculture.
Reality: The political discourse continues to focus perversely on farm loan waivers.
Here are some recent instances. The new Bharatiya Janata Party government in Uttar Pradesh is considering a farm loan waiver as promised in its election manifesto. Punjab chief minister Amarinder Singh met Prime Minister Narendra Modi and finance minister Arun Jaitley last week, reportedly to seek assistance for a loan waiver for farmers in the state. The Devendra Fadnavis government in Maharashtra is under pressure from its ally, the Shiv Sena, to do the same. It is, perhaps, just a matter of time before more states join the bandwagon.
Even though agriculture contributes about 15% to India’s gross domestic product, a majority of the population directly or indirectly depends on the sector for livelihood. But are farm loan waivers the right way of addressing the problems in Indian agriculture?
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It might make political sense in the short run—farmers are a sizeable and powerful vote base—but, as experience shows, it is unlikely to help the agriculture sector in the long run. In fact, loan waivers can lead to several adverse consequences. For example, Arundhati Bhattacharya, the head of the country’s largest lender, the State Bank of India (SBI), was bang on when she recently said that loan waivers affect credit discipline. But the comment did not go down well with the political class. The leader of the opposition in the Maharashtra assembly submitted a breach of privilege notice against her for “insulting farmers and the House". However, Bhattacharya is not the first banker to have said this. In 2012, her predecessor Pratip Chaudhuri was quoted in Mint as saying: “Agriculture is a bit of an issue. That is because of moral hazard that was created in 2008 when there was a write-off of large agriculture loans." Former Reserve Bank of India governor Raghuram Rajan had also flagged the issue, as repeated loan waivers affect credit pricing and disrupt the credit market.
Evidence from the 2008 farm loan waiver—implemented by the United Progressive Alliance government—shows that it can have unintended consequences. As Xavier Giné and Martin Kanz of the World Bank have shown in their study—The Economic Effects Of A Borrower Bailout: Evidence From An Emerging Market—bank lending moved away from districts with greater exposure to the loan waiver. Such outcomes can affect agricultural output in the medium to long run as banks may get more selective in extending credit.
It was also argued that farmers were not able to invest because of debt overhang. However, the study did not find any improvement in investment and noted: “...we find no evidence of greater investment, consumption or positive labor market outcomes in areas where debt relief led to a significant reduction of household debt. It is not surprising that, in the case of India, government efforts to stimulate the real economy through debt relief were largely in vain given that the bailout also led lenders to reallocate credit away from districts with high program exposure."
Shawn A. Cole of the Harvard Business School in a 2008 paper—Fixing Market Failures Or Fixing Elections? Agricultural Credit In India—showed that agricultural credit extended by government-owned banks goes up in an election year, while defaults also increase during election time. This again highlights that political intervention distorts the credit market. In fact, in the case of repeated waivers, it makes sense for borrowers to default strategically in anticipation of a waiver. But this can become a self-fulfilling cycle with long-term consequences—defaults would warrant loan waivers, and waivers will lead to more defaults.
Besides, there is a huge fiscal cost attached. Economists at SBI have calculated that loan waivers Uttar Pradesh will cost about Rs27,420 crore, or about 8% of the state’s revenue. Even though Jaitley has said that the fiscal onus of loan waivers will be on states, implementing waivers in other states or in the entire country will have a significant impact on general government finance and the combined deficit. The 2008 farm loan waiver, which benefited about 37 million farmers, resulted in a cost of over Rs52,000 crore to the exchequer.
To be sure, the agriculture sector needs government support but loan waivers are not the solution. On the contrary, expenditure on loan waivers will eventually leave less fiscal space for public expenditure in agriculture. India needs massive investment in areas such as irrigation, water conservation, better storage facilities, market connectivity and agricultural research. The problems in Indian agriculture are structural. They need long-term solutions. Loan waivers will only end up complicating the problem. The Indian economy has suffered a lot due to competitive populism in the past. It’s time parties and governments addressed the real issues.
Will farm loan waivers solve the problems in the agriculture sector? Tell us at email@example.com