Sunday, March 16, 2008

Farmer Debt Waivers: The Ongoing Debate

This year’s Budget, which was presented by the Financial Minister Mr. P. Chidambaram in Parliament a couple of weeks ago, has been termed a populist and an election-year budget. One aspect of the Budget that has been subject to intense scrutiny and debate pertains to the waivers and one-time settlements offered to certain farmers who have obtained agricultural loans from scheduled commercial banks, regional rural banks and cooperative credit institutions.

Budget Terms

In his Budget speech, the Finance Minister stated (in paragraph 73):

Debt Waiver and Debt Relief

73. Sir, while I am confident that the schemes and measures that I have listed above will give a boost to the agriculture sector, the question that still looms large is what we should do about the indebtedness of farmers. Honourable members will recall that Government had appointed a Committee under Dr. R. Radhakrishna to examine all aspects of agricultural indebtedness. The Committee has since submitted its report and it is in the public domain. The Committee had made a number of recommendations but stopped short of recommending waiver of agricultural loans. However, Government is conscious of the dimensions of the problem and is sensitive to the difficulties of the farming community, especially the small and marginal farmers. Having carefully weighed the pros and cons of debt waiver and having taken into account the resource position, I place before this House a scheme of debt waiver and debt relief for farmers:

(i) All agricultural loans disbursed by scheduled commercial banks, regional rural banks and cooperative credit institutions up to March 31, 2007 and overdue as on December 31, 2007 will be covered under the scheme.

(ii) For marginal farmers (i.e., holding upto 1 hectare) and small farmers (1-2 hectare), there will be a complete waiver of all loans that were overdue on December 31, 2007 and which remained unpaid until February 29, 2008. In respect of other farmers, there will be a one time settlement (OTS) scheme for all loans that were overdue on December 31, 2007 and which remained unpaid until February 29, 2008. Under the OTS, a rebate of 25 per cent will be given against payment of the balance of 75 per cent.
…”

The Budget estimates the total figure of the debt waiver to be in the region of Rs. 60,000 crore (Rs. 600 billion).

Some of the key features of the debt waiver are as follows: (i) they are applicable to agricultural loans disbursed by scheduled commercial banks, regional rural banks and cooperative credit institutions; (ii) marginal and small farmers get a complete waiver of the loans; (iii) other farmers are entitled to a one-time settlement under which they get a rebate of 25% of the loan outstanding, while they are required to pay the balance 75%.

Public Interest Litigation

This farmer debt waiver was challenged in the Supreme Court in a public interest litigation (PIL) within days of the Budget announcement. The petitioner, ML Sharma, alleged that the amount of debt held by small and marginal farmers was way below the Rs. 60,000-crore figure suggested by the Government. Further, the PIL sought that the waiver not be limited to farmers who have taken loans from nationalised banks, but also be extended to farmers who have obtained finances from private banks and private money lenders.

The Supreme Court, however, refused urgent hearing on the petition on the ground that the waiver was still a proposal pending before Parliament, and that the Court would not interfere on an issue that is still being discussed in Parliament. The Supreme Court’s approach seems appropriate at this stage because the petition is premature – the proposal is still being discussed in Parliament, and there is not certainty that the debt waiver will assume the nature of a binding law in the same form that it has been proposed, if at all.

However, since the matter has assumed importance, not only due to several legal and economic issues that it raises, but also because of the significant political overtones surrounding it, there is strong reason to suspect that the issue will not die down so easily that that the matter will spring up in further litigation at a later stage.

It would therefore not be out of place to discuss some of the key issues that emerge from the debt waivers proposed. The purpose of this post is only to raise the issues and highlight the arguments from different points of view, but no attempt is being made to proffer any final solutions (as that may not only be premature yet, but will necessarily involve a far more detailed exercise).

Implications

1. Size of the Problem

A key challenge to the proposal has been the alleged incongruity in the numbers disclosed by the Government. It is believed that the amount of loans borrowed by farmers from public sectors banks is far less than the numbers (i.e. Rs. 60,000 crores) arrived at by the Government. For example, the Economic Times reports today that the non-performing assets/ loans (NPAs) of all scheduled commercial banks stood at Rs. 20,100 crore, the NPAs of the cooperative sector at Rs. 32,500 crores and the NPAs of the regional rural banks at Rs. 1,000 crores. Therefore, all the NPAs of the affected set of banks totals only to Rs. 53,600 crores. Now, these figures include all loans that are non-performing in the books of the banks that arise from all types of activities, including agricultural and non-agricultural activities. Then, it seems curious at a first glance as to how the agricultural non-performing loans as proposed in the Budget stand at Rs. 60,000 crores, when the entire non-performing loans (from all sectors) of the scheduled commercial banks, cooperative banks and regional rural banks stand only at a lesser figure of Rs. 53,600 crores. This defies logic, and the anomaly in the figures requires further explanation, failing which the proposal could be susceptible to serious challenge on the ground that the proposal seeks to address an illusory problem that does not exist at all.

2. Issues of Classification

Any challenge to the proposal is likely to involve issues of classification that constitutional lawyers are entirely familiar with. Has there been any arbitrariness in determining the class of farmers that are eligible to the waiver benefit? For instance, why are only loans borrowed from scheduled commercial banks, regional rural banks and cooperative credit institutions eligible for the waiver? Why not the loans borrowed from private commercial banks or private money lenders? In fact, commentators have stated that the agriculture sector is quite substantially funded by private money lenders whose terms of lending (such as exorbitant interest rates) and harsh recovery methods cause unbearable harassment to poor farmers, sometimes even resulting in farmer suicides. Certainly, the public sector banks are likely to be softer on borrowers than private money lenders. Now, if the Budget proposal is to address the issue of farmer harassment, one issue that may arise is why the private money lenders have been left out of the waivers. The legal approach to dealing with private money lenders may be somewhat different because that would involve cancellation of the loan contracts they have entered into with borrowers, unlike in the case of public sector banks where the Government has direct authority over the activities of these banks themselves which can forego their rights under the loan contracts without involving a cancellation of the contracts. But, that may not necessarily explain the reasons for leaving the private money lenders out of the scheme.

There may potentially be challenges to the types of farmers who are eligible to benefit from the waiver. For example, there have already been calls from members of parliament such as Rahul Gandhi to increase the threshold limits of landholding that determine which farmers are entitled to the benefits.

3. Moral Hazard

This is a problem that arises in economics where one of the parties to a contract has entered into the contract without good faith or has the incentive to take unusual risks without any attendant consequences. In the context of loan transactions, this involves cases where borrowers have taken loans, made risky investments and defaulted on the loans, but have been rescued either by government intervention or other circumstances thereby excusing them from fully performing the contract, as they would have been required to had the intervention not occurred. The problem with moral hazard is that it induces risky behaviour in other borrowers who, having witnessed their peers being bailed out, generate expectations in themselves of being similarly bailed out and hence indulge in risky investments.

Applying this (implicitly) in the context of farmer debt waivers, Gurcharan Das, a well-known commentator on the Indian economy, notes that such waivers are likely to result in large scale defaults by farmers that will impose an unbearable burden on the Indian public banking system. However, others have countered this point by arguing that bail-outs and the moral hazard problem are not unique to the farming sector. It ubiquitous in the industrial sector. That is indeed a fact hardly capable of being disputed. We witness bail-outs all the time of different industrial groups or banks that have gone into the red, and usually such bail-outs have been the result of governmental intervention either directly or through the involvement of central banks. For instance, we are seeing such bail-outs unfold before us in the sub-prime crisis where several banks and economies themselves (the United States for one) have seen interventions by the central banks (such as the Federal Reserve in the case of the United States). Such industrial bail-outs are common in India too. It is probably too hard to disagree with the proponents of the farmer debt waiver measures that the moral hazard problem is universal and should not be held up as a red-flag to scuttle the waiver of farmers’ debts.

Despite all the legalities and economic aspects involved in this ongoing issue, one thing seems clear. The debt waiver is perhaps only a short term measure to extricate some farmers out of their financial misery. It does not, however, address long-term issues on how agriculture can grow through proper methods of financing the farmers. There are several other long-term measures that need to taken to improve the situation of farmers. However, as far as financing is concerned, there is a need to find ways of more sustained lending measures that properly support the farmers in their activities so as to enable them to repay their loans without imposing too high a burden and thereby keeping the non-performing loans at a low rate. It may even be necessary to replicate the success of the micro-credit financing schemes in the agricultural sector in the longer term.

2 comments:

jyotsna said...

Thanks for giving such a good overview of the various arguments.

Regarding bail-outs and the moral hazard argument, isn't there a fundamental difference between the mass, generally applicable loan waiver doled out by the UPA and the case-specific individualized bail-outs happening in the U.S.? The bank bail-outs are invariably either conditioned on a change in management (as in Bear Stearns) or tighter monitoring & controls. Moreover, since it is case-specific there is invariably reputational harm to the bank. Also, the Fed.Bank will only come in if it sees that the harm to the markets will be great. By contrast, our mass bail out is applicable to everyone without regard to financial need, the harm caused and in no way penalises bad lending judgment. It might have been a good idea if it applied to the worst affected farmer suicide districts but the present framework just seems ill thought out and a waste of public money with more deletrious long term consequences.

Umakanth V said...

Jyotsna,

Thanks for your comment. The moral hazard issue could apply in different ways depending on the circumstance of the situation. You are absolutely right that in the industry bail-out situation, the government intervenes selectively and such intervention may relate to specific banks or institutions, rather than the farmer situation where the waiver is across the board to all farmers falling within the requisite bracket. But, we must also remember that industry bail-outs pertain to loans given to sophisticated players who have the expertise in dealing with financial matters, in spite of which they have failed and the government has had to intervene. In the case of farmers, apart from mismanagement of finances on their part that may sometimes occur, there are several other circumstances beyond their control that result in their failure to repay - adverse weather conditions, drastic fall in price of produce, and so on. That being said, I agree with your observation that the Budget waiver proposal may be more meaningful if it is confined to specific areas or specific types of farmers who have justifiable reasons for failure to repay (such as drought, etc) rather than making the waiver available to all farmers. It seems to me that the Government's proposal effectively allows a farmer who is doing well to seek the benefit of the waiver even though such farmer is very much capable of repaying the loan.