Perils of loan waivers

Political parties are once again busy wooing farmers ahead of the upcoming Assembly elections. The Congress, for instance, has promised farm loan waivers in both Haryana and Maharashtra. The incumbent Bharatiya Janata Party (BJP) has not gone that far in Haryana but has promised interest-free loans. It has already implemented a loan waiver in Maharashtra.

Loan waivers do have a clear political motive, and it could even be argued that they also reduce the debt burden and enable farmers to invest, which may increase productivity over time. However, things don’t work that way. Loan waivers create moral hazard and encourage borrowers to default. As reported by this newspaper on Monday, gross non-performing assets (GNPAs) in the agriculture sector have crossed the Rs 1-trillion mark. As a proportion of credit to the sector, GNPAs now stand at over 11 per cent and have gone up by about 30 per cent in the last two years. 

At a time when the banking system is dealing with higher NPAs in the industrial sector, the rise in bad farm loans would only add to the overall problem in the financial sector. It is possible that some borrowers in the agriculture sector may have defaulted because of a variety of factors, such as low output prices, but there is evidence that loan waivers play a role in adversely influencing credit culture. A recent report by the Internal Working Group to Review Agricultural Credit of the Reserve Bank of India (RBI), for instance, showed that the level of NPAs increased in all states that announced loan waivers in 2017-18 and 2018-19. Most other states either showed no significant change or even registered a decline in the level of NPAs. In this context, the report noted: “…this could be indicative of the presence of moral hazard, with borrowers defaulting strategically in anticipation of loan waiver.”

Loan waivers not only create problems for banks but also for borrowers and the government. They affect the flow of credit because banks are reluctant to lend to farmers in states that have announced a loan waiver in the past. The reduction in the flow of credit can affect farmers and force them to borrow from informal sources at much higher rates of interest. Further, even though a loan waiver is implemented over a period of time, it dents government finances. According to the RBI’s estimate, about a third of the overall slippage in the states’ revenue expenditure during 2017-18 can be attributed to loan waivers. They were partly responsible for the states’ fiscal slippage in 2018-19 too. Since governments have limited fiscal space, a loan waiver restricts the state capacity to make investment, including in agriculture, which can affect productivity in the medium term.

At the aggregate level, since the system does not benefit from loan waivers, the idea itself should be avoided. Also, it doesn’t address the core problems of the farm sector, which needs wider reforms. However, this is not to suggest that the government should not support the sector. A better way to support farmers is direct cash transfer, which the Union and some state governments have adopted. An added advantage of this idea is that such schemes bring more farmers within the banking net and will, over time, help them get credit on more favourable terms.

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