Loan waiver schemes are back with a bang, thanks to the elections and the populist schemes they bring in their wake.

In the recent past, several States have waived agricultural loans as part of their populist outreach to win over farmers in distress. Political parties have also been crying themselves hoarse for a Centre-sponsored nationwide loan waiver.

The Karnataka government, in its most recent budget, announced a farm loan waiver of ₹34,000 crore with an individual cap at ₹2 lakh. Last year, the Uttar Pradesh and Maharashtra governments announced waivers of ₹7,500 crore and ₹35,000 crore respectively.

Domino effect

According to RBI estimates, what began in Tamil Nadu in 2016 had a domino effect on several States in 2017. The total cost of loan waivers announced to date amounts to ₹1,30,000 crore (not counting the Karnataka waiver), which translates into 0.8 per cent of GDP.

While loan waivers are an easy way to win political support, they are not without negative consequences.

For one, there is no certainty that the benefit of the waivers will reach those who really need it. For another, it could significantly impact a State’s finances.

A study by SBI economists last year said States that have waived loans, or are set to do so, have a tough time borrowing from the markets.

Also, according to the 14th Finance Commission, all States are required to keep their fiscal deficit under 3 per cent of State GDP from FY16 to FY20. Loan waivers can lead to more market borrowings, skewing the deficit ratio.

For banks already beleaguered by stressed assets, any talk of loan waiver could spell more trouble. Senior bankers say that as elections draw near, even farmers who can repay their loans tend to sit back and wait for a waiver. This ‘moral hazard’ trend is evident in some States. Further, demands for similar waivers could spread to borrowers in other segments such as self-help groups and microfinance institutions.

RBI’s stance

The central bank has been vocal in opposing loan waivers. RBI Governor Urjit Patel recently said the “most vulnerable” is capital expenditure by the government, which will take a major hit from loan waivers.

The diversion of funds to waivers will have an “adverse impact on sectors such as irrigation works and cold storage chains”, the RBI has said.

The RBI also thinks loan waivers may at best be a short-term remedy for farmers’ distress but cannot be regarded as a long-term solution.

There is a need to move away from such populist schemes and take up concerted and urgent reforms in capacity-building in agriculture by addressing issues in marketing, pricing, credit and extension services.

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