Express Economic History Series: In loan waivers, ‘moral hazard’ and continued hope for political gains

Urjit Patel has voiced concern publicly over the latest loan waiver — saying it engendered a moral hazard and undermined the honest credit culture.

Written by Shaji Vikraman | Updated: April 13, 2017 8:49 am
Farm loan waivers, RBI farm loan waivers, Loan waivers for farmers, debt writeoff govt, Modi farmers, Budget farmers, UP farm loan waiver, Urjit Patel farmer loan waiver, Indian Express, Express Explained, Indian Express Harischandra Sapkal (60), a farmer from Chincholi village of Latur district, breaks down while telling the story of his sugarcane crop ruined by drought last year. There is a strong demand for farm loan waivers in Maharashtra. (Express Photo by Pradip Das)

In February 1990, in the months preceding the build-up to the balance of payments crisis the next year, Madhu Dandavate, Finance Minister in V P Singh’s National Front government, announced a debt relief scheme for farmers to fulfill a promise made by the alliance in its election manifesto.

The scheme covered overdues or outstandings of farmers and artisans up to Rs 10,000 as on October 2, 1989 from public sector banks and Regional Rural Banks, and involved a fiscal cost of Rs.10,000 crore. In the Budget of 1990, Dandavate said the government would compensate banks suitably for writing off the debt, that the scheme would exclude wilful defaulters — those who had the financial capacity to pay but refused to do so — and that a “positive” measure like debt relief would contribute to better recoveries in the farm sector and better identification of wilful defaulters.

Banks, he said, were being told to put in a place a system to maintain a proper credit history of borrowers covered under the scheme. But the key point was the Budget’s assertion that the scheme would neither be extended nor repeated.

Since then, governments at both the Centre and the states have come up with loan waivers, the latest being the one by the Uttar Pradesh government, writing off farm loans aggregating Rs 36,359 crore. What makes it remarkable this time is that Prime Minister Narendra Modi, known to be conservative when it comes to meeting key fiscal targets, made the first pitch at a political rally where he said, “I will make sure that the first cabinet decision after forming the government in Lucknow is to waive farmers’ loans.” That pronouncement cast the die for UP, a state already struggling under a huge debt burden.

Soon after the Modi government took over, many bankers and the RBI had warned the Finance Ministry of the dangers of such writeoffs. Interestingly, there was little support then from Delhi for the huge loan waivers announced by the newly formed states of Andhra Pradesh and Telangana. As the Modi government worked on its first Budget, bankers, led by SBI chief Arundhati Bhattacharya and RBI Governor Raghuram Rajan, got together to stymie the proposal — finally forcing the state governments to settle for a rescheduling of the loans.

The Governor then cited the RBI’s master circular which lays down the ground rules for any such waiver. Writing off farm loans would be contingent on a failure of 50% or more in a catastrophe, and voluntary for banks — and they cannot be treated as bad loans, going by the circular. His point then was that these criteria had not been met in the cases of Andhra Pradesh and Telangana. Resistance from the regulator and banks managed to push back the populist impulse then.

Three years later, Rajan’s successor, Urjit Patel, has voiced concern publicly over the latest loan waiver — saying it engendered a moral hazard and undermined the honest credit culture.

The Governor’s views were in keeping with the RBI’s 3-decade-long track record of objecting to loan writeoffs — a poor credit culture that had started to develop from the 1980s when a junior Finance Minister in the Congress governments, Janardhan Poojary, pushed “loan melas” at several places — and especially in his home state, Karnataka — forcing bankers to disburse funds without checking the antecedents of borrowers.

In 2014, the Indian Banks Association, the lobbying arm of Indian banks, cautioned the Finance Ministry about the negative impact on the loan repayment culture and credit discipline in the country. However, it is not that political leaders did not already realise the “moral hazard” of writeoffs encouraging borrowers to default in the future too — witness Dandavate’s solemn reference back in 1990 to the need to ensure there was no erosion of the credibility of the banking system as a result of the waiver scheme.

In 2008, when Manmohan Singh was Prime Minister, there were discussions with the RBI on a debt relief scheme. The central bank wasn’t in favour of the proposal. A committee headed by R Radhakrishna did not recommend a waiver of farm loans. But a political decision was taken, and Finance Minister P Chidambaram announced a debt waiver scheme in the 2008-09 Budget.

The government said it was conscious of the problems in the farm sector and sensitive to the difficulties of small and marginal farmers, and had taken the decision after weighing the pros and cons of the move, and after having taken the resource position of the government into account. The scheme featured a full waiver for marginal farmers and small farmers. The total value of overdue loans waived was estimated at Rs 50,000 crore, and the one-time settlement scheme relief on overdue loans at Rs 10,000 crore. That was the year when growth topped 8% and the revenue and fiscal deficits had declined.

Interestingly, once the decision was announced, there was no public voicing of any concern by then RBI Governor Y V Reddy. That appears to have been in keeping with his overall stance of restricting his concerns on policy choices, or voicing them only with the Finance Minister or the Ministry. Indeed, at the World Leaders Forum at Columbia University in April 2008, Reddy, during a discussion which also featured economist Jagdish Bhagwati, defended the government’s move, pointing out that the farm sector, which provided livelihood to 50% of India’s population, had seen a growth of just 1% when the rest of the economy was growing at near double digits.

A few days ago, when former Maharashtra Chief Minister Prithviraj Chavan invited former RBI Governor C Rangarajan to Satara to attend a function and sought his views on a farm loan waiver — a demand that his party has been pressing — Rangarajan said that an option could be to allow a moratorium on payment for a year so that the farmer would not be treated as a defaulter, and to try and restructure the loans over a longer period of time rather than a blanket writeoff. The other suggestion was to consider a graded waiver — and not a 100% writeoff.

The context too matters. As pressure mounts on the government to sort out the mess in the banking sector — marked by a huge portfolio of bad loans on the books of many banks — rationalising the sop to the farm community will be a major political challenge. Clearly, these debt waiver schemes are unsustainable, especially at a time when some of the largest states in India are weighed down by the burden of debt and the ongoing slowdown. Urjit Patel spoke on the need to create a consensus on promises of loan waivers — in the context of it eventually impacting the balance sheet of the sovereign. Whether the Finance Ministry resists such runaway schemes — and whether that succeeds in creating a dampener — remains to be seen.

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  1. Pramod Kaimal
    Jun 17, 2017 at 10:00 am
    Farm Loan waiver is a BLOT on the indian policy system, and Demanding waivers a sheer act of day light robbery, goodaism. Above ALL this, A LAW must be passed and severely executed that all who Spill Milk or throw farm products on to roads in PROTEST, to be canned well and sentenced to LIFE IN PRISON. Such CONgress Communist (expletives) (on whose culture indians have been weened till yesterday) acts thus brought to severe end. pramodkaimalat
    1. S
      Sreesheel Sreekumar
      Apr 15, 2017 at 3:57 pm
      Waiving off loans is indeed economically a burden for the country. Having said that, a farmer who has lost his crops due to drought or floods, needs support ! Just waiving off the loans alone would not suffice since he has lost all his money ! His day to day expenses is also a problem ! Again, what is the guarantee, that the next year / season would be a good one ? Farming dependent on the whims and fancies of mother nature is a risky affair ! Science should come up with some solutions to offset this risk ! Cloud Seeding (i don't know how successful it is ), crops which withstand various variations in climate, etc. ! Some ins ute should come up with solution or a spectacular invention / discovery !
      1. T
        Apr 15, 2017 at 12:48 pm
        Wavinhbloan would result in the Encouragement of tax evasion by every decent tax payers .Already they are opposing the rate of tax they had to pay from their hard earned money as they don't get any benefit in their life even after their retirement ..And the waiver is done it s going to iriate them and force them to look out for option to evade tax
        1. K
          Kuldeep Saxena
          Apr 14, 2017 at 10:24 am
          It is true that loan waivers will definitely be a burden on economy but we need to see the lives of our farmers first. There have been draughts in various parts of the country for last few years but the various state governments have miserably failed on creation of water harvesting system as we allow millions of gallons of water every year to go waste on one hand on the other there has been constantly falling levels of water able. Another important question that rises that every year the central Governments have been allocating funds for irrigation as well water harvesting system but the progress seems to be very slow or negligible. On the one hand the nation has huge labour force to work for MNREGA what has been real out put. We need to care for the farmers as they are also human beings not robots. So the nation as well banking segment must extend a helping hand to support.
          1. B
            Apr 14, 2017 at 9:08 am
            Waiving loan is a wrong example. In the process we will create more loan defaulter. Finally it will be a more difficult issue to handle in long run. It is the immature decision of greedy & power loving political party . For coming to power they are promising anything. As if they spending their own money. They are forgetting ,it is the public money. Govt is taking money from one section of public & spending money as a lotera for the sake of their party gain. Govt should not initiate the policy which can have a bad effect on the Govt in long run. Now time has come to create a guide line for the parties in election to declare their election promise. What they can declare & what they can not declare ,as their election promise, should be decided by the group of wise men. Govt action should be limited to only infra development & the policy which is applicable to all citizen ,not the section of the citizen. Govt should create the employment opportunity & encourage the person to start work
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