Loan waiver isn’t the solution for farmer issues; there are many things the governments can do

Uttar Pradesh chief minister, Yogi Adityanath and his party, the BJP, have indeed scored a big political point by announcing (read here) a Rs 36,359 crore farm loan waiver at its first cabinet meeting on Tuesday, but at the cost of good economics that’ll have lasting consequences both on the farmer and banking sector.

This is how the package looks like. A total of Rs 36,359-crore of loans will be waived for 2.15 crore farmers in the state. Of this, Rs 30,729 crore is loans of up to Rs 1 lakh and Rs 5,630 crore is write off of loans that are already bad or non-performing assets (NPAs), in banking parlance. Loan waiver is a promise made by the party’s star campaigner, Prime Minister Narendra Modi, during his poll campaign in the agrarian state that is also India’s most populous state.

What will happen now? These are the likely scenarios: One, banks that have exposure to the farming sector in the state will likely see a spurt in their NPAs immediately even honest borrowers (those who have been making regular repayments) will stop paying their dues to banks. Banks have an exposure of about Rs 86,241.20 crore to small farmers in the state with the average ticket size of Rs 1.34 lakh.

The deterioration in the credit culture will immediately punch holes in the agriculture loan portfolio of banks, in turn, making them stop all fresh funding to everyone who has ‘defaulted’ on payments. Farm loan NPAs are a big headache for many banks, already. According to senior bankers, the Rs 70,000 crore loan UPA-sponsored waiver in 2008 and those announced by the Andhra and Telangana governments in 2014 offer ample proof for the disastrous effects of the loan waivers. It takes years to clear the mess and reinstate the trust between the banker and the borrower.

Two, according to senior bankers, not all loans in the name of farm loans are taken for farming purposes. Since these loans are cheaper, people take such loans for consumption needs. Even such loans, falling under Rs 1 lakh limit, will have to be waived off.

Fiscal burden on UP

Since there is no central government assistance for waiver, Uttar Pradesh will have to find own resources to compensate the banks. The state government has said that it will float Kisan Rahat bonds to raise funds. But a look at past evidence in similar cases shows that such compensations have never reached banks on time. It has only burdened the banks even more.

A recent SBI research report had warned about this problem. Going by the report, the hit to the state would be approximately Rs 27,420 crore. “The UP government’s total revenue for FY17 was Rs 3,40,255 crore according to revised estimates. Thus, the amount of Rs 27,420 crore to be waived off is approximately 8 percent of total revenue. But, the final amount has come even higher. This will definitely cause some amount of stress for the state’s fiscal arithmetic in the coming year. The incumbent Government in UP has to go beyond the traditional solutions and find innovative ways of adding to its revenues,” the report said.

Remember, UP is already economically a weak state with fiscal deficit shooting to the highest level in at least four years in FY2016. The cost of the waiver, along with loss of revenue from other politically inspired measures such as banning of slaughter houses will return to haunt the state’s finances sooner or later.

"As such, while it may not add to the headline fiscal deficit (of UP) directly, the liability will remain and understate the headline fiscal deficit," Nomura said in a research report.

"The UP government has budgeted a fiscal deficit of INR415bn (~2.9% of state GDP on our estimates) in FY18, but with Seventh Pay Commission hikes also pending the risks of this rising (both above and below the line) is to the upside. Additionally, the farm loan waiver scheme could put pressure on other states to follow suit," the report said.

Moreover, the UP waiver will immediately trigger demands for similar packages in other agrarian states like Punjab, Maharashtra and Tamil Nadu. Already, in Tamil Nadu, the Madras High Court has asked (read here) the state government to waive loans of all farmers and restrained cooperative societies and banks from recovering their dues. The court did not stop there. It wants the central government too to share the state government's loan waiver burden. This further sets the stage for deterioration in credit discipline.

The politics of waiver

Loan waiver is not always a bad word. This can happen in extreme emergencies such as a natural calamity that inflicts significant damage to agriculture produce, but not definitely as a political tool to win elections.

This is one reason bankers and the Reserve Bank of India have always vehemently opposed the idea of farm loan waiver. Just last month, SBI chairman Arundhati Bhattacharaya warned (read here) against the loan waiver saying, such a move will disrupt the credit discipline of borrowers. “Today, the loans will come back as the government will pay for it but when we disburse loans again then the farmers will wait for the next election expecting another waiver," the SBI chairman said.

Bhattacharya is absolutely right.

In 2014, former RBI governor Raghuram Rajan asked (read here) an important question. “How effective these debt waivers have been? In fact the studies that we have typically show that they have been ineffective. In fact they have constrained the credit flow post waiver to the farmers."

The worst part is that once the banking system is shut for the farmer, he will then be forced to seek the assistance of the private moneylender, paying an astronomical rate of interest and thus putting his life’s savings, land and honor at risk. But the farmer, unfortunately, doesn’t realise this risk because it is human tendency to grab freebies without a second thought.

In the process even the good borrowers who used to pay back on time get into the bad list. When the Andhra-Telengana loan waiver announcements happened, rating agencies had warned about the serious repercussions such actions can have on the system.

"These schemes seem to have yielded electoral gains, similar announcements could be made in other states as well. The most vulnerable would be states in which elections are nearing," India Ratings had warned then.

Corporates vs farmers

One recurring question in favour of farm loan waivers is this: If corporate loans are waived off, why can’t farm loans be? However, this doesn’t hold much water. One mistake cannot correct another. As this writer has pointed out in earlier columns, if corporates have fooled the banking system and if bankers are party to it, the solution lies in investigations, legal action and recovery of loans — not repeating the mistake in another sector.

It is important to identify the reasons why, in the first place, the farmer needed a waiver. Certainly, lack of funds isn’t the issue here. Agriculture and allied activities is one of the segments where banks have taken biggest exposure (under priority sector lending norms and also to meet targets set in the Union budget) after loans to industries. To top this, the farm sector has been given interest rate rebates and moratoriums.

The point here is if the idea is to help the farmer, it should be done through assisting him with measures that do not harm him ultimately. The government can ensure the farmer gets minimum price for his produce and gets direct access to market to sell his produce and not through middlemen.

Also, instead of waiving loans, governments can promise free supply of fertilizer, seeds, equipment and warehouse facility instead of asking him not to pay back to banks. Of course, fresh funds can be made available on easier terms to the deserving farmers through nodal agencies such as National Bank for Agriculture and Rural Development.

But, loan waiver isn’t the solution.

By offering the Rs 36,000 crore waiver Yogi Adityanath has certainly scored a big political point, but at the cost of good economics.