A spate of recent farm loan waivers by India’s states, says Adit Jain, threatens the country’s fiscal health, and is ineffective, to boot
In 2008, when the Government of India announced a Rs 60,000 crore farm loan waiver, the decision horrified economists and the financial markets. The waiver, amounting to 1.3 per cent of GDP, would cripple national finances and damage the credit culture. The moral hazard of penalising prudent borrowers would be systemic and enduring. However, its proponents argued that it would free farmers ‘from the suffocating clutches of endemic debt’ and, in the process, also provide a quick consumption stimulus to the economy.
The 2008 waiver did not reduce farmer indebtedness
Farm loan waivers do not work because they fail to tackle the underlying problem that creates indebtedness in the first place. In 2003, there were 89.4 million ‘farmer households’ (defined as a family with at least one member that qualifies as a farmer) in India. Of these, 43.4 million, or 48.6 per cent, were in debt. In 2013, this ratio increased to 51.9 per cent (see table). However, the problem is not so much the number or proportion of households in debt but the magnitude of the debt-servicing burden on an individual household. Here the picture is actually alarming. In 2003, an average farmer household had an outstanding debt of Rs 12,585. By 2013, this jumped to Rs 47,000, an increase of 14 per cent per annum. During the same period their income, which determines their debt-servicing ability, grew by only 11.8 per cent pa from Rs 25,380 pa to Rs 77,112 pa. As a result, the debt-to-income ratio of farmer households surged from 50 per cent to 61 per cent over the ten-year period. This is despite the massive bailout of 2008, suggesting that the waiver had no lasting impact on reducing structural indebtedness.
||HH in debt
|Source: Indebtedness of Farmer Households, NSS 59th Round, 2003; Situation of Agricultural Households in India, NSS 70th Round, 2013. Household figures in millions; indebtedness in %.
The consumption jab turned out to be a myth too
The second of benefit of the waiver – that it would provide a consumption boost – also failed to occur. A study by the World Bank revealed that there was no positive impact on household consumption after the bailout. In fact, it went to the extent of disproving all the other benefits that loan waiver proponents had claimed – that there would be an improvement in productivity as farmer balance sheets were now deleveraged; that there would be an increase in agricultural wages and employment; and that the future flow of bank credit would not be negatively impacted by the moral hazard created by the waiver. The paper argued that no wage benefits could be attributed to the waiver nor was there a noticeable increase in new investment or productivity. On the contrary, banks re-allocated fresh credit away from districts with a high exposure to the bailout fearing degeneration in their credit culture. Sure enough, loan repayment in the high-exposure districts fell in the months following the waiver even in borrower accounts that had previously been in good standing.
Why should it be any different this time?
Theoretically, you could argue that since the World Bank study was based on an empirical analysis, its findings would apply only to the specific environment in which it was undertaken. Future farm loan waivers may not suffer the same fate – ‘whilst it didn’t work in 2008, it could in 2017’. In actual fact, this premise is irresponsible and glosses over some compelling counter-arguments.
Secondly, loan waivers by definition apply only to institutional loans whereas the real stress for indebted farmers stems from loan sharks. Moneylenders, landlords and other informal sources of credit typically levy interest rates that are 200-300 per cent higher than the 6-15 per cent rates charged by banks . Moreover, they are known to resort to bullying and harassment to obtain repayment such as community shaming, intimidation and even physical violence. According to statistics, 40 per cent of all farmer loans were from non-institutional sources in 2013, only marginally lower than 42 per cent in 2003 (see table). Farmer suicides are inevitably concentrated amongst these borrowers and it is important to recognise that bank loan waivers do not fix this.
What is worse is that small and marginal farmers are the ones most dependent on non-institutional credit and therefore, the least benefited by waivers. They borrow 44 per cent of their loans from informal sources (see chart). Large farmers get 75 per cent of their loans from institutional sources and corner the majority of the waiver benefit. One could therefore argue that bailouts naively end up exacerbating the gap between rich and poor farmers.
The consumption impact will actually be negative
Since farmers have a high marginal propensity to consume it could be argued that they will spend most of the new found ‘wealth’, the result of loan write-offs. This logic is flawed on two counts. Firstly, behavioural economics suggests that households have a very different reaction to ‘income earned’ versus ‘expenditure avoided’. They may spend a high proportion of the former but are likely to spend a far lower proportion of the latter, since it is notional income with a psychologically different connotation. Some analysts have estimated the propensity to consume to be as low as 25 per cent for notional income , against 80-95 per cent for actual income.
The second flaw in the stimulus argument is simply that there will actually be no stimulus at all! In fact, there will be a net negative impact on consumption. To see why this is so, it is necessary to comprehend the macroeconomic principle at work. A loan waiver is nothing more than a transfer of liabilities from the household balance sheet to the Government’s balance sheet, since it is the latter that now pledges to repay banks. Since the public sector balance sheet has no ‘stored wealth’ to pay out from, it has only two choices – expand its fiscal deficit by the waiver amount or reduce expenditure/increase taxes thereby reducing aggregate consumption. In the case of state Governments, those that are below the 3 per cent of GDP deficit limit specified under fiscal responsibility recommendations of the 14th Finance Commission (FFC) can afford to borrow more while the others have no option but to cut expenditure to make fiscal space. The Economic Survey 2016- 17 offers some calculations for both categories.
Higher borrowing costs and credit reallocation
Additionally, there are second round effects of such a strategy – most obviously the fact that private borrowings will be crowded out if state Governments were to raise an additional Rs 1.9 trillion. The experience with Uday bonds shows what happens when a large volume of state development loans (SDLs) are issued in a short span of time. Spreads between SDLs and Government of India securities widened by almost 30 bps over a few months (see chart). SDL issuances to finance loan waivers will widen spreads further and raise the cost of borrowings for states. Unlike Uday bonds that had the implicit blessing of the federal Government, ‘waiver bonds’ are unlikely to carry any such assurances. The fiscal implications of high cost borrowings pose grave risks at a time when state balance sheets are already stretched .
Arguably, one positive outcome of a loan waiver would be an improvement in bank balance sheets to the extent that non performing farm loans are removed from their books. This may lead to some increase in fresh lending. However, given past experience, it is more than likely that such lending would be directed away from populations that received the bailout since such borrowers now present a higher credit risk due to the moral hazard phenomenon. Small and medium farmers will therefore find it harder to access formal sector credit in future and will be driven further into the clutches of local moneylenders.
Bailouts simply don’t work
In the ultimate analysis, while one could draw fine lines between assumptions and question the calculations, the fundamental argument is hard to refute. Loan waivers do not address the real problem plaguing farmer economics. At best, it has the effect of a painkiller administered to a patient with a chronic illness – the effectiveness of the analgesic is temporary and reduces over time while the underlying disease remains untreated, eventually killing the patient. Waivers impose a heavy growth and fiscal burden upon the economy and by denying future credit to bailout recipients, hurt the interests of the very population they were created to serve. If the right mix of policies to improve farmer profitability are implemented bailouts will not be necessary; if they are not, bailouts will not be effective. Either way, it is time policy makers realise that bailouts simply don’t work.