Loan waivers: An impediment to critical reforms

By Moin Qazi

Uttar Pradesh has heralded the season of loan waivers with a bumper financial harvest for farmers in the state. The waiver of loans up to Rs 1 lakh for each of the 2.3 crore small marginal farmers have come at a total cost of Rs 36,359 crore for the government. The Uttar Pradesh cabinet took this decision in fulfillment of a major electoral promise.
where PM Narendra Modi played the most magical card a politician can use to get farmers on board–waiver of loans. That may be just one of the many contributing factors for the resounding mandate his party received in Uttar Pradesh, India’s most populous state.

Palliatives: An anathema to development goals

In the ‘Lok Kalyan Sankalp Patra’ (Pledge for People’s Welfare), the party’s election manifesto, the BJP promised to waive all loans of small and marginal farmers (who have landholding up to 2.5 acres). The promise made good electoral sense but demonstrated bad economic wisdom. Such palliatives have a crippling impact on the economy and distract the state from much-needed reforms which are more prudent and sustainable solutions for the protracted crisis that plagues more than half of the country’s population.
The BJP knows quite well that loan waivers have scripted a story of unfinished reforms in India. The question is why is it that almost 55% of the population engaged in agriculture as the main occupation is producing only 14% of the country’s output. Until the problems of this huge swathe of the population are addressed with bold and comprehensive reforms, loan waivers will remain a constant feature of the landscape.

Loan waivers are the new cool!

But the winter of Uttar Pradesh will most likely be followed by the spring in Uttar Pradesh, Maharashtra, Karnataka, Punjab, Kerala, and Haryana where farmers are equally vulnerable. Maharashtra has already demanded waiver of farm loans worth Rs 30,500 crore. There are 1.18 crore farmers in the state with a debt of Rs 1.05 lakh crore. Of these, loans of around 31 lakh farmers amounting to Rs 30,500 crore are already due for repayment. Such populist measures will clearly dent Modi’s reformist agenda. What makes the populism v/s reforms tradeoff so stark is that while it is clear that Modi needs to increase investment levels in the economy for growth to pick up, this cannot happen till the problems of bad loans are fixed.

Waivers are a bitter pill for banks

Any large-scale farm-loan waiver will only worsen the situation for banks. Debt relief programs fail to provide assistance to landless farmers who do not have access to bank loans and some other farmers who depend on money lenders. The write-offs are a disincentive to the banking system because people have expectations of future waivers as well. The borrowers see value in strategic defaults. While it is important for banks to make credit available to farmers so that they can leverage and do better, it is also important to maintain a credit discipline. Loan waiver schemes vitiate the credit culture and make it tougher for banks to continue lending to these segments. They create moral hazards in the financial system by rewarding those farmers who default on their loans, offering nothing to those who pay.

Proud to be a defaulter!

Bankers rue that a large chunk of farm loans goes only to buy seeds or fertilizers, rather than to invest in mechanization. India is the world’s second-biggest producer of rice, wheat, cotton and sugar, but its productivity is way below the world average. Bankers bemoan the rise in ‘wilful’ defaults amongst those taking agricultural loans – and using them to marry off their daughters, become lenders themselves, build extensions for their farmhouses, or lavish these loans on social occasions. The farmers openly say that the government knows they will take out more loans in the end and fall into the same trap again and will withhold repayment of these loans and waiting for the next election for the loan to be waived.

Beware! Waivers may boomerang

In a recent note, Kotak Mahindra pointed out that loan waivers have become a trend in the run-up to elections. “It creates unnecessary friction between lenders and borrowers. Waivers aimed at delinquent or non-delinquent borrowers increase the risk for lenders as repayment behaviour could potentially deteriorate ahead of elections. A regular phenomenon of waivers would eventually result in banks silently pulling back lending a few quarters ahead of elections or look to increase interest rates to compensate any risk, both of which do not lead to the best outcomes.”

The author has a PhD in Economics and English.

Featured image source: metroindia.com