A fiscally prudent solution to farm loan crisis

Direct institutional credit extended to agriculture and allied activities in India stood at ₹10,48,222 lakh crore ( around $150 billion) as of end-2017. While this figure has more than trebled from ₹3,01,678 lakh crore since end-March 2008, agricultural non-performing assets (NPAs) accumulated by scheduled commercial banks (SCBs) grew by more than six times to ₹60,200 crore as of end-March 2017 from ₹9,735 crore in end-March 2008.

SCBs are the largest providers of institutional agricultural credit, accounting for 63.7 per cent of agricultural loans outstanding as of end-March 2017, followed by co-operatives (21.6 per cent) and regional rural banks (14.6 per cent).

With the BJP losing the State legislature elections in Chhattisgarh, Madhya Pradesh and Rajasthan, the Indian National Congress (INC) governments that assumed power in three States have announced farm loan waivers. The BJP government in Assam has also jumped onto the bandwagon. As of end-March 2017, the share of these four States in aggregate agricultural credit extended by SCBs was 14.8 per cent (₹1.55 lakh crore).

While Prime Minister Modi promised debt relief to farmers ahead of the February 2017 Uttar Pradesh elections (he has now indicated his disapproval of waivers), Rahul Gandhi has committed to waive all farm loans if the Congress is voted to power in 2019 union elections. Eight State governments have announced ₹1.9 lakh crore farm loan waivers since April 2017.

These announcements are not without precedence and would undoubtedly yield immense positive political mileage. The Congress-led United Progressive Alliance was after all re-elected to power in 2009 on the back of the ₹52,260 crore farm loan waivers announced in 2008.

Though farm loan waivers do not exempt all outstanding dues and are subject to a cap in rupee terms, bankers and economists are opposed to farm loan waivers for multiple reasons.

First, farm loan waivers are a quick-fix solution that do not address the fundamental problems of Indian agriculture — rising costs and falling profitability. Farm loan waivers may temporarily alleviate the problems of farmers with access to formal banking and ignore the needs of the most indigent who rely on moneylenders. Besides, there have been glitches in implementation.

Second, these waivers destroy the country’s credit culture as certain borrowers tend to default in anticipation of the waiver. As the exchequer compensates the banks for the quantum of loans waived, the latter does not lose on account of waivers.

Third, fresh lending to defaulting borrowers is stalled as banking regulations prohibit disbursement of fresh loans to defaulters unless the loans are restructured.

Fourth, governments fund loan waivers through borrowings, which result in increased sovereign indebtedness, higher interest expenses and deteriorating fiscal deficit.

And, fifth, farm loan waivers crowd out agriculture-related investments in areas such as irrigation and research.

Institutional mechanisms like crop insurance and interest subvention are far more effective in tackling India’s farm loan crisis. State Bank of India has recommended an income support scheme for small and marginal farmers in lieu of loan waivers and has estimated the annual cost to be ₹50,000 crore or 0.3 per cent of GDP — a fraction of the ₹1.9 lakh crore farm loan waivers announced since April 2017.

Income support is a superior mechanism than loan waiver as it is a direct benefit transfer (DBT) to targeted recipients and will increase banking penetration in rural India.

Telengana launching the ‘farmer investment scheme’ under which each farmer receives ₹8,000 per acre payable in two equal instalments ahead of the kharif and rabi season to meet their seed, fertiliser, pesticide and field-preparation expenses is a step in the right direction.

Financing agricultural DBTs

Consolidated fiscal deficit is under stress on account of the increase in crude oil prices, demand for farm loan waivers and the political compulsion of announcing populist schemes ahead of the 2019 general elections.

However, it is important for the government of India (GoI) not to lose sight of the wood for the trees at the current juncture.

The Indian stock market has been choppy in the recent months, mirroring global trends. The government must forthwith stop the ongoing fire sale of family silver aka the divestment of central public sector enterprises (CPSEs).

Notwithstanding the strategic reasons driving Oil and Natural Gas Corporation’s (ONGC’s) ₹36,915 crore acquisition of Hindustan Petroleum Corporation in February 2018, the ₹17,000 crore raised from Reliance Mutual Fund’s recently concluded CPSE ETF, the proposed merger of Power Finance Corporation and Rural Electrification Corporation, and ONGC’s proposed share buyback, the timing is clearly sub-optimal, especially when the government may raise substantial funds by rationalising CPSE balance sheets.

The 27 largest listed CPSEs accumulated ₹2,06,837 crore of bank deposits, loans, and investments as of end-March 2017 that yield a lower return than their core businesses. CPSEs may dispose these assets along with the vast surplus property holdings to reduce their debt, enhance their dividend and tax-paying ability and improve their return on assets and valuation.

By streamlining CPSEs’ balance sheets, the government will be able to address the farm loan crisis without impairing the fiscal deficit and realise higher divestment proceeds during a bull market.

The bond route

That the government is likely to borrow to finance farm loan waivers and oil subsidies is a foregone conclusion. The government may save cash outgo arising from higher interest expenses through the issue of listed callable deep discount bonds (CDDBs). Deep discount bonds are bonds whose interest is accrued during the tenor of the instrument and paid at maturity along with the principal repayment.

While corporates report income and expenditures on accrual basis, GoI accounts for its revenues and expenditures on a cash basis. The government may issue CDDBs of multiple tenors, like five-year, 10-year, and 15-year, targeted at retail and institutional investors. The issue of CDDBs will enable the government save on cash interest outgo during the tenor of the instrument, thereby moderating the consolidated fiscal deficit.

Embedding the call option in the bonds will incentivise the government to reduce indebtedness. Along with this, utilising the proceeds of opportunistic divestments and streamlining of CPSEs can work as an important signalling mechanism of the government’s commitment to fiscal discipline.

It is imperative the government transitions from a fire-fighting mode whenever an agrarian crisis erupts and focusses on long-term initiatives. There is an urgent need for large-scale investments in agricultural storage, processing, marketing, transportation, financing and insurance.

Water management needs to be moved to the concurrent list to improve agricultural productivity and reduce inter-State disputes.

The writer is an independent analyst who blogs at www.litintrans.com.

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