Issue

Context:

• Recently, Madhya Pradesh and Chhattisgarh state Governments have announced farm loan waivers to benefit 3 million farmers.
• Earlier, Uttar Pradesh, Punjab and Maharashtra—had announced large-scale farm debt waivers. (Cumulative debt relief announced by the three states amounts to around 0.5% of India’s 2016-17 GDP).

About:

• The Indian agriculture sector with its complete dependency on the monsoons, poor and outdated technologies, and negligible development, has been facing a tough time.
• Non-repayment of loans could be due to income shocks, beyond the control of the households, which justifies policy intervention to ease temporary resource constraints.
• However, default could also be a reflection of moral hazard - inability to pay due unproductive expenditures incurred by the households.

Background:

• Eight state governments have given farm loan waivers worth ? 1.9 trillion since April 2018, amid massive farmer protests and promises made ahead of the recently concluded assembly elections in five states.
• Loan waivers prevent contract enforcement. With a precedence of loan waivers in agricultural markets, households expect formal institutions to intervene in credit contract enforcements and not seize collaterals in case of default.

Analysis

Why distress:

• Boom in produce lead to price crash, making it impossible for the farmers even to recover their investments, which are often sourced by loans because of cob-web nature of agricultural market.
• • The root causes of the weakening agricultural sector remains unaddressed.
  • If a loan waiver was the solution to the problems of the poor indebted farmers, there should not have been any farm distress after the 2008 debt relief program.Farmers took to streets to protest. Many dumped their produce on highways, and a few took the extreme step of committing suicide.
    
    

    The cobweb model or cobweb theory is an economic model that explains why prices might be subject to periodic fluctuations in certain types of   markets. It describes cyclical supply and demand in a market where the amount produced must be chosen before prices are observed.

    How farm loan waiver schemes impact the Indian economy:

    • The Monetary Policy Committee (MPC) of the RBI pointed out that the implementation of farm loan waivers across states could hurt the finances of states.
    • This will make them throw good money after bad, and stoke inflation.
    • The culture of loan waivers would create more wilful defaulters, disturb the credit discipline of the banking system, and impact the economy in the medium and long term.
    • Cumulative impact of farm loan waivers is likely to be lower than that of the power-restructuring package, Ujwal Discom Assurance Yojana (UDAY), unless they are extended to all Indian states.
    • State-wise outstanding farm debt has been estimated by using available break-up (for previous years) of agricultural loans extended by scheduled commercial banks and regional rural banks.
    • The estimates thus obtained have been scaled up to the total value of institutional farm loans at Rs 12.6 trillion.
    • The effect of increased public debt will play out over the long run but the increased interest burden due to higher debt will hit state finances immediately.
    • Interest payments of states are already quite high, and often eclipse their spending on important infrastructure areas such as roads and irrigation.
    • The impact on state finances could have been justified had the waivers provided meaningful relief to India’s distressed rural economy.
    • But, that is unlikely to happen since the poorest farmers in India typically rely on non-institutional sources of credit.
    • Farm loans will be transferred from the assets side of banks’ balance sheets to the liabilities side of government’s books as part of the loan waiver scheme.
    • Banks might gain in the short run as their loan book gets lighter and they get rid of some non-performing assets.

    Efficacy of Loan Waiver Programs:

    Analysing UP Rin Maafi Yojana

    • The UP “Rin Maafi Yojana” was one of the first agricultural borrower bailout program announced in the state of Uttar Pradesh.
    • The primary goal of the program was to free the collateral of farmers who had borrowed from the state’s Regional Rural Bank and the Land Mortgage Banks.
    • The loan waiver implementation pointed towards a presence of moral hazardin the behaviour of people when they expect waivers. Such waivers and their anticipation in future would damage credit culture.
    • Expectation of loan waiver households makes unproductive expenditures. Households that have actually received the waiver, those that are eligible and those with knowledge of waiver, exhibit an increased consumption and social spending.

    Economic fallout of loan waiver

    • If the loan waiver is accommodated within budgetary provisions, it will force cutbacks in other heads of expenditure.
    • Experience has shown that the most vulnerable category is capital expenditure.
    • In turn, this will entail deterioration in the quality of expenditure and among other things lead to adverse implications for productivity as an asset forming investment, including for the sector itself - e.g., irrigation works, cold storage chains etc., - is foregone.
    • According to a study by the Indian Council for Research on International Economic Relations, the years following the waiver announcement saw a decline in recovery rates and impacted rural credit to such an extent that banks took several years to recover.

    Political fallout

    • Apart from having a direct impact on the economy, these incidents have also rubbed off on the political stability in many states. The affected states were left with hardly any choice but to follow suit.

    Agricultural sector and compliance with priority sector norms

    • The agricultural sector has been identified as one of the priority sectors by RBI and scheduled commercial banks are required to extend 18 percent loans to this sector.
    • The banks which fail to meet these requirements will have to fund development programmes implemented in the sector, namely, Rural Infrastructure Development Fund (RIDF). Comparatively, this fund is not profitable, and banks do not prefer to invest in such programmes
    • Such waiver has however left a negative impact on the issue of fresh loans to the agricultural sector, fearing a repeat of last year's failure to repay.
    • But there is a room for manoeuvre:To calculate credit extended, banks are permitted to include credit facilities extended to horticulture and allied activities of agriculture, including infrastructure and storage.
    • To meet the targets, banks can instead extend credit facilities to better yielding options under horticulture and allied activities of agriculture.

    Issues persist even after the Loan waiver:

  Way forward:

  • Sustainable and long-term solution for issues in the farm sector in India requires concerted and urgent reforms in the areas of agricultural marketing, pricing, credit and extension systems, and an open trading regime.
  • As discussed in the above paragraphs/pointers, Loan waiver schemes mostly focus on “short term” painkiller moments, leaving the larger malaise to remain uncured. This hurts credit discipline and directly boosts NPA level and increases interest rates for fresh loans.
  • At economic parlance, what is crucial is to allow banks/ financial institutions to independently do Credit risk analysis and take necessary decisions.
  • Matters related to finance should not be delegated to the political brasses.
  • A rational and long term strategy is the need of the hour – something which can relieve the pain yet cure the cancer that has spread deep in the body of the rural- agricultural sector.

Learning Aid

Practice Question:

The RBI has time and again flagged the issue of farm loan waivers straining fiscal position of states. With UDAY scheme already in doldrums, do you think farm loan waiver schemes would end up doing more fiscal harm than political/short term good? Critically evaluate the whole mechanism and ideology behind these schemes and suggest way forward.