Against the backdrop of two state governments writing off farm loans and others considering similar steps, Reserve Bank of India (RBI) governor Urjit Patel on Thursday cautioned about the moral consequences of loan waivers. He said such “waivers engender moral hazard."

“Waivers undermine an honest credit culture... It leads to crowding-out of private borrowers as high government borrowing tend to (impose) an increasing cost of borrowing for others," Patel said after Thursday’s monetary policy announcement. “I think we need to create a consensus such that loan waiver promises, otherwise sub-sovereign fiscal challenges in this context could eventually affect national balance sheet."

The Uttar Pradesh government on Tuesday decided to waive farm loans worth Rs36,369 crore. The same day, the Madras high court asked the Tamil Nadu government to waive crop loans to all farmers. Pressure has risen on the Maharashtra government to provide a similar waiver. Punjab is also working on a loan waiver.

For Uttar Pradesh, the impact of this waiver will be to the tune of 2.6% of its gross state domestic product (GSDP), according to estimates from India Ratings and Research.

A debt waiver for small and marginal farmers is not the long-term answer to any agrarian crisis, said the rating agency.

“While the solution to the agrarian crisis facing the country is not an easy one, providing a debt waiver to farmers will only provide short-term relief to distressed farmers, but will also lead to a bad credit culture, besides exerting pressure on state finances," Devendra Pant, India Ratings’ chief economist, wrote in a 6 April report.

While a farm loan waiver will not impact banks, lenders are up in arms as it will have an impact on credit culture and disincentivize future borrowers from repaying loans.

On 15 March, State Bank of India (SBI) chairman Arundhati Bhattacharya recently said support to farmers is necessary but not at the cost of credit discipline as people who benefit from loan waivers often expect further waivers in future, which leads to many more loans remaining unpaid.

A report by the Comptroller and Auditor General (CAG) in 2013 found that of the 80,229 accounts that were granted debt waiver or relief, the beneficiaries in 8.5% of the cases were not eligible for either.

The just-announced farm loan waiver, which is about 0.4% of gross domestic product (GDP) “supports our call of playing consumption over investment", Bank of America-Merrill Lynch economists said in a 6 April note.

“Still, it poses a serious fiscal worry as other States could also follow suit to waive the bulk of the (over) 2% of GDP of farm loans. We welcome governor (Urjit) Patel’s warning that farm loan waivers create moral hazard and pose interest rate risks," the investment bank said.

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