Seeds of Debt: How loan waivers affect the farmers and the economy

Farm loan waivers inadvertently cultivate a moral hazard problem by encouraging farmers to be less cautious while using loans for non-productive purposes as they expect new loan waiver schemes during elections. The expectation of waivers also incentivises them to borrow beyond their repayment capacity. The ripple effects of this practice are manifold:

1. Farmers switch to nationalised banks before elections to benefit from these schemes.
2. Landowners subdivide their holdings to increase eligibility for future reliefs.
3. The allure of waivers entices a surge in new agricultural borrowers[vi].

Moreover, farmers, who otherwise have the repayment capacity, are hesitant to fulfil their loan commitments since they expect a waiver, leading to a decline in loan performance and adversely impacting the credit discipline of borrowers.

Poor credit culture, in turn, hampers financial institutions' performance, necessitating provisions for loan losses. Provision delays can weaken banks' capital base, increase risk, and limit their ability to expand branches or disburse credit. Government capital infusions to stabilise banks burden taxpayers and elevate fiscal deficit. Former RBI governor Dr Urjit Patel emphasised that government delays in compensating financial institutions for waivers lower their liquidity for issuing loans and adversely impact their balance sheet. Consequently, loan waivers have a detrimental impact not only on the state exchequer and inflation but also on the broader credit culture, private corporate borrowings, and financial institutions' stability.

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Beneath the surface: Systemic barriers in credit delivery to the farmers

Farmers face several systemic hurdles in accessing credit due to supply-side issues. Firstly, the lengthy procedure to procure loans, which demands multiple documents and complex forms, alienates small and marginal farmers unfamiliar with technical jargon. Consequently, landless and tenant farmers who lack the requisite documentation are excluded from institutional lending and, thus, do not benefit from the farm loan waiver schemes.

The second issue pertains to classifying non-performing assets (NPAs) for crop loans. Per the RBI guidelines, a crop loan account is classified as an NPA when the instalment of interest (and principal) remains overdue for two crop seasons for short-duration crops and one for long-duration crops. Thus, if a farmer does not pay three instalments for a short-term (6-month) crop loan due to crop loss, their loan would be classified as an NPA. Crop losses would plunge their income close to zero during this period. To obtain fresh credit, the farmer would have to first pay the previous three instalments from the earnings of one crop season. As per the National Statistical Office, marginal farmers with 0.01 to 0.4 hectares of land earned an average monthly income of Rs7,522 in 2018-19; therefore, earning from one crop season would not suffice to pay the previous three instalments. Due to financial shortfall, the farmer would not be able to survive. In the absence of institutional sources, they will have to borrow from expensive non-institutional sources, leading to a debt trap.

Third, the government helps farmers in these situations via its refinancing policy, either by restructuring existing loans or sanctioning fresh loans. However, the policy depends on the state government declaring the area 'calamity-affected', with crop losses surpassing 33 percent. Thus, it leaves distressed farmers with losses of less than 33 percent or those in undesignated areas despite significant damage, without government support, exacerbating their financial vulnerability. 

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Beyond the waiver: Addressing the root cause of farmers' distress

State governments must acknowledge that indebtedness is a symptom of farmers' distress, not its primary cause. The underlying causes of farmers' distress include:

1. Income instability due to crop losses (caused by pest attacks, climatic conditions, and natural disasters).
2. Failure to get fair crop prices due to lack of storage facilities, excessive dependence on intermediaries, and lack of transparency.
3. Rising production costs are due to higher input costs and declining soil productivity.
4. Poor infrastructure (erratic power supplies, inadequate medical facilities for livestock, poor road network, lack of pasture lands).
5. Institutional roadblocks such as lack of crop insurance schemes or delay in insurance compensation, a lack of collateral to access institutional credit, the limited reach of government schemes to farmers, and corruption.

These factors create a vicious circle of poverty. Due to recurrent crop losses and increasing costs, farmers take on debt that they cannot pay off. The inability to pay debt causes distress and leads to farmers taking on further debt, perpetuating distress and further indebtedness. Therefore, farmers' indebtedness is inevitable if only farm loan waivers are used and the structural constraints of Indian agriculture remain unaddressed.

The government needs to look for sustainable options to mitigate farmer distress. To counter income instability, state governments need to provide incentives on inputs, enhance efficiency and transparency of the markets, ensure regular power and water supply, invest in research and development for creating scientific farming techniques and provide non-farm employment opportunities that the farmers can use to meet the expenses of agricultural inputs. Since farmers earn only during the crop season and have expenses throughout the year, training should be provided on financial management so that rural households can manage their expenses effectively. High dependence on rainfall can be countered by training farmers to adopt cropping patterns suitable to the climatic conditions.

Farmers should be encouraged to take crop insurance, and the procedure for taking crop insurance should be simplified along with prompt disbursement of claims. Instead of loan waivers, banks should consider lowering their margins, extending loan repayments, or restructuring loans for distressed farmers. Loan waivers should be reserved for exceptional circumstances, such as droughts and floods, to provide temporary relief till conditions improve. Further, the benefits of waivers should be distributed promptly before the oncoming crop season. Moreover, strict eligibility criteria should ensure that only distressed farmers get the waiver. Similar to insurance contracts, loans must have conditions that borrowers exercise prudence in conducting their farming business to prevent moral hazard issues. Finally, strict laws for the recovery of loans should be implemented to discourage wilful defaults. Agriculture is pivotal for India's economic development; therefore, addressing these challenges is crucial for the sustainable growth of India's agriculture sector and its economic contribution.

Prof. Juhi Gupta, Assistant Professor, Finance and Accounting, IMI (Delhi)