By Aniket Baksy
Edited by Namitha Sadanand, Associate vEditor, The Indian Economist
The possibility of the enactment of a massive loan waiver in a newly-formed state devoid of a State Capitol and starting out with a deficit of Rs 15,000 crore, would’ve been laughable in almost any socio-economic and political set-up other than, of course, India, the land of the possible. Loan waivers are nothing new to India; national-level loan waivers in 1989-90 and 2008-9 have incurred the approval of the populace (as seen in the mandate accorded to the UPA government which enacted the 2008 waiver) and the wrath of the business community, international media (The Economist 2008) and the academia in mainstream economics (Raja 2008). While Government-imposed debt relief and restructuring are not unique to India- Thailand enacted a US$ 2.9 billion bailout of its farmers in 2010, and over US$ 10 billion of Farmer debt has been restructured in Brazil (Kanz 2012)- nowhere does the scale begin to compare to India’s ambitions. The June 2008 waiver, benefiting around 36.8 million farmers, waived about INR 65,000 crore (US$ 14.4 billion) worth of loans, about 1.6% of India’s GDP in 2008 (Kanz 2012). Before N Chandrababu Naidu’s “flagship” electoral promise becomes reality- an INR 54,000 crore reality- it may be worthwhile to examine some questions related to loan waivers, to understand their true impacts and whether Andhra Pradesh (AP), the victim of a recent state division, really needs one.
The structure of Naidu’s proposed measure is, as of yet, unclear. The cost could be anywhere between INR 20,000 crore (if rich farmers and gold loans are excluded) and INR 60,000 crore (Reddy 2014). The indecisive attitude of the state regarding the exact details of the waiver, which are under review by an expert committee, has led to a collapse of formal sector lending in AP, compounding the possibility of an agricultural crisis in the current Kharif Season (The Hindu Business Line 2014). In a Cabinet meeting held in Vishakhapatnam on June 12, Naidu promised an interim report on the waiver by June 22, and directed officials to ensure that formal lending continues unabated (Reddy 2014). Banks have, in general, been unanimous in their opposition, claiming the destruction of the “lending and borrowing culture” in the country (CNBC- TV18 2014). At latest, on June 17, the Indian Banks’ Association (IBA) issued its formal opposition to the scheme, claiming that the waiver would “dent financial discipline (Press Trust of India 2014).”
IMPACTS OF LOAN WAIVERS- THE THEORY
Loan waivers are, of course, a debatable policy measure. Proponents of waivers argue that households that are heavily indebted may fail to have adequate income net of interest payments to invest in human capital, thus remaining in a low-productivity equilibrium (Banerjee 2000). Further, if the majority of the payoffs of an investment project go towards debt servicing, households may tend to pass up profitable investments since the Net Present Value after repayments is negative. Government interventions in credit markets can be Pareto-improving if they insure against non-insurable events (Bolton and Rosenthal 2002) or improve financial inclusion (Burgess and Pande 2005). Both of these theoretical studies, however, ignore the behavioural implications of a loan waiver.
Opponents of loan waivers cite the undeniable moral hazard created by waivers. In cases where the state enacts unconditional loan waivers, uncertainty regarding the level of enforcement of debt contracts can lead to a disincentive to lend in the first place. Imperfect information and poor monitoring imply that the effective “socialisation of losses” accompanying a waiver reduces the incentives to efficiently utilise funds borrowed, leading to lower levels of repayments. This leads to higher interest rates and thus, lower credit to marginal and small farmers in the first place. (The literature on moral hazards and the consequent impacts on credit rationing includes (Stiglitz and Weiss 1981), (Jafee and Russell 1976)). In addition, waivers appear to reward defaulters while not rewarding those who regularly repay loans; IBA Chief Officer Tanksale stated that “It [the loan waiver] creates ill will among those who are prompt payers, because debt waiver goes to only those who default the payment” (Press Trust of India 2014). The welfare implications of a loan waiver are usually based on models of partial equilibrium ignoring the consequent budget deficits and the negative implications for productive investments in agriculture. A government spending on debt relief must eventually reduce investments elsewhere, particularly in areas of human capital formation, infrastructure development (including agricultural infrastructure such as village roads and grain silos) and agricultural productivity (through reductions in the funding available to agricultural research).
THE ANDHRA PRADESH CASE
Arguments against loan waivers often emphasise the behavioural impacts of a waiver, neglecting the importance of agricultural credit. Agriculture is an investment project with a highly uncertain payoff contingent on unpredictable factors such as weather. The availability of credit to farmers is necessary to bridge the significant gap that exists between investments- occurring in the planting seasons- and the returns earned, which are only available during the harvest season. A result of this is that agricultural indebtedness does indeed impact agricultural productivity by restricting access to further credit, hence making out a case for debt relief, especially in AP. As of 2010, it was estimated that against the national level of INR 7,700, the average outstanding household debt in AP was INR 65,000, making the state’s rural populace one of India’s most indebted.
A backlash against Micro-Finance implies that a state once lauded for financial inclusion now faces a crisis of loan availability. Microfinance Institutions (MFIs) in AP had grown rapidly during 2005-10. Reports alleging malpractices (including unethical loan recovery practices and usurious interest rates) and the consequent rise in farmer suicides in rural AP led to the Andhra Pradesh Microfinance Institutions (Regulation of Money-Lending) Act, 2010. The failure of the Act to create any mechanism to guarantee repayment, while placing stringent restrictions on the operations of MFIs, led to catastrophic results for their financial status. The recovery rate fell from 99% to 10%, leaving many MFIs with a negative net worth and unable to finance their operations (Kaur and Dey 2013). The collapse of MFIs in AP and, consequently, across the nation has led to nearly 450 million people being affected by a credit crunch, and has further led to rising credit costs for borrowers and higher operating costs for MFIs themselves (Kaur and Dey 2013).
In an environment of mistrust against MFIs and uncertainty regarding the waiver, AP’s farmers are stuck in a position where they are unable to attain credit on easy terms from any source whatsoever, hence reverting to a dependence on informal moneylenders which worsens the situation beyond all measure (The Hindu Business Line 2014). The lack of availability of credit is disastrous especially for small and marginal farmers who are incapable of funding future agricultural projects out of past incomes or saving, and hence find themselves reduced to agricultural labour or forced migration to urban areas and in the most extreme cases, driven to suicide. In such a situation, debt relief may be a necessary measure to save individuals and prevent suicides.
Nonetheless, there are several arguments against a loan waiver, especially one as massive as Naidu’s proposed measure. Loan waivers may be thought of as inequality-increasing in the presence of an environment where formal credit is limited. If individuals who possess sufficient initial collateral to issue a Bank loan are the very individuals whose loans are waived, then the impact of a loan waiver is to exacerbate existing income inequality. Further, the fact that those who have access to Bank credit on easy terms are the very individuals receiving waivers may appear to be “unfair” in some sense, leading to consequent rise in social strife at the intra-village level.
Naidu’s waiver may adversely impact asset quality with Banks, already saddled with enormous stocks of Non-Performing Assets (NPAs) in Agriculture. Andhra Bank has a 5.29% gross NPA exposure (Bandhopadhyay 2014) and outstanding agricultural loans of INR 3,902 crore, with INR 1,472 crore in loans smaller than INR 1 lakh. Agricultural NPA’s are on the order of 8% at the industry level in AP (CNBC-TV18 2014). An insolvent banking sector will be an insurmountable impediment to any further development activity Naidu tries, not to mention causing an economic downturn that threatens to destabilise any hope the fledgling new state devoid of a capitol has of emerging as the industrial and economic hub Naidu envisions. Reimbursing banks with the total amount is expensive.
Naidu’s waiver is clearly something a state over INR 1.53 lakh crore in debt (as of 2012-13 (The Hindu 2014)) cannot afford. In 2013-14, banks in AP had lent INR 73,494 crore, with INR 51,955 crore for crop loans. Residual AP accounts for total outstanding agricultural debt to the tune of INR 87,612 crore (Business Standard 2014). AP has not, in the past, been a particularly thrifty state; the state’s debt stock recorded a 3-year CAGR of 14% between March 2008 and March 2011; as of 2011, AP has a Debt-to-GSDP ratio of 22.4% as of 2013 (Reserve Bank of India 2013). The consequences of a possible default by the fledgling AP Government on its outstanding debt aside, the state’s revenue deficit of INR 16,000 crore makes it unable to enact the waiver without amendments to the Fiscal Responsibility and Budget Management Act. While the AP Finance minister is confident that the requisite procedures can be enacted, this sets a dangerous precedent- the possibility of demands by other states to do the same, for political gain, may call into question the effectiveness and rationale behind the act itself as a restraint on policymakers. Other ways to finance the waiver- say, through a massive Bond issue backed by the RBI, as proposed by Naidu (CNBC-TV18 2014)- may prove inflationary, in an economy already afflicted by agricultural and general price rise.
The possibility of corruption in any programme as massive as the one proposed, given the established traditions of India’s bureaucracy, must be weighed in as well (for an account of irregularities in the 2008 scheme, see (Khetan 2013)), for their impacts on inflating the costs and deflating the impacts of the scheme.
The overall impact of a massive waiver is, in essence, therefore ambiguous; it is empirically necessary to visit the question of whether debt relief leads to the freeing-up of funds to enhance household saving and investment, or if the moral hazard impacts lead to the crowding-out of the most underprivileged sections of Indian borrowers from the formal credit system, encouraging the proliferation of moneylending. The merits and demerits must be weighed in reference to the specific circumstances in AP itself.
Empirical studies have confirmed that the positive results of a loan waiver in terms of encouraged investments are insignificant. A survey of 2,897 beneficiaries of the 2008 waiver (Kanz 2012) concludes that:
- Most beneficiaries did not use freed-up collateral to obtain new formal sector loans, leading to a persistent shift away from formal sector lending towards informal sources.
- Debt relief did not raise the productivity or investment of households. Relief is seen as a short-term benefit.
- Debt relief reduces levels of concern about the reputational concerns of a default, instead being concerned that debt forgiveness might reduce their future access to credit and lead to future borrowing constraints.
The above conclusions demonstrate the severity of the moral hazard and institutional framework problems faced by Indian agriculture, which renders an isolated attempt at generalised loan waivers an exercise in futility. The exclusion of individuals afflicted by collateral access from the formal credit sector does not appear to have been adequately addressed- while data on the fraction of loans obtained from the informal credit sector is scanty post 2002 (when credit from agricultural moneylenders stood at 10% of total agricultural loans (Government of India 2010)), it is plausible to expect that this fraction has not declined substantially in the post-waiver period.
Given the above evidence, it appears unlikely that AP will guarantee its agricultural sector a massive renewal through the proposed waiver. There are better ways to achieve the desired outcome- debt relief- than a massive short-term reprieve that destroys a good deal of resources that might be available to more core efforts, such as the creation of agricultural capital stock and of an industrial base. While the waiving of non-gold loans may be necessary to partially alleviate the misery of an overly indebted agricultural class, true agricultural progress requires AP to undertake long-term investments in knowledge and technology. Unfortunately, it is precisely these investments which will be crowded out by the burden of a loan waiver, guaranteeing the necessity for future waivers as well. Unlike India in 2008, AP does not have a booming economy and robust tax revenues; the result of mass expenditures could be tragic indeed.
The Politics of this Loan Waiver can best be understood by examining the key reason or Naidu’s defeat in 2004: his allegedly neoliberal agenda for AP (Vision 2020) was clearly confined to urban renewal, leading to non-inclusive growth which left behind agricultural classes (Kumar and Chandrakanth 2004). Nearly 10 years later, a popular mandate guarantees Naidu power which he must use to consolidate his support base among the agricultural classes- hence, a loan waiver, which runs contrary to the majority of his calculated growth-enhancing economic policy measures. Naidu’s need to recover support in the farming community makes it unlikely that the Waiver will be rolled back. Nonetheless, in this article, we attempt to discover the true nature of the pros and cons of the waiver, and conclude that the waiver’s proposed magnitude will set up hurdles a new state cannot hope to afford. While Naidu may enact the INR 20,000 waiver for the poorest sections, he should take a leaf out of Modi’s book, whose promise to undertake tough measures to restructure central debt to the exclusion of populism is worth emulating. Naidu needs to rebuild AP, not keep paying for its debts.
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Aniket Baksy is a third-year student at St. Stephen’s College, Delhi and an Editor of the Economics Society. His inclinations extend to economic issues, and macro-level socio-economic policies and their possible impacts. He is a prolific reader, with tastes for popular science, economics and policy, science fiction and historical fiction. An inherent urge to argue and avid debating aside, his passions include Economics, Instrumental Hindustani Classical Music, Gastronomy, and writing.