Commodity Analysis

Are farm-loan waivers unhealthy?

Sathya Raghu V Mokkapati | Updated on September 26, 2018 Published on September 24, 2018

Vicious cycle: For 50% of rural India, debt payable equals annual income, making it theoretically impossible for farmers to repay debt   - undefined

The next big banking crisis could stem from the unorganised sector, warn experts

Former RBI Governor Raghuram Rajan recently cautioned that the next crisis in India’s banking sector could come from loans given to unorganised businesses, including Kisan Credit Card. Why are farmers indebted? Why does the government declare loan waivers, is it just political motivation? Let’s demystify this.

Rural economy can be visualised as a series of simple transactions such as sale of goods and services, repeated over and over. Just the way a buyer and seller do a transaction, even the borrower and lender do one. Farmers, agri businesses, banks, government and other rural actors are involved in different transactions which ultimately impact the rural economy. This buying and selling may happen in cash or credit.

How it works

One of the biggest transaction-makers in any economy, including India, is the government, which collects taxes. On the other hand, the RBI controls the credit in the economy by influencing interest rates and printing money. Further, the government can also decide to waive off farmers’ debt.

Say, a farmer Krishanamma receives loan from a bank. She pays tractor rent to Veeresh. Krishnamma’s spending is Veeresh’s earning, which makes him more credit-worthy of loan. So, increased income allows increased borrowing, which, in turn, allows increased spending. This self-reinforcing process of one person’s spending being another person’s income creates rural economic cycles.

In a transaction, a farmer sells produce and gets money which will be used for spending. Krishnamma could earn more money and spend. Alternatively, she could borrow from a bank and spend. The latter is easier in the short run, allowing farmers to consume or spend more than what they produce. When farmers have to pay it back, they spend more than what they earn. This is why we see economy as cycles, than it being an uptrending line. Farmers’ debt burden tend to increase gradually. In the short term, when credit is easily available, there is economic expansion. If financing from banks dry up, rural India is sure to go into recession.

For 50 per cent of rural India, debt payable equals annual income, making it theoretically impossible for them to repay debt. Farmers stand credit-worthy for more debt if their income and assets increase. We do not have enough evidence to show that incomes of farmers are rising enough to be able to make this vicious cycle of debt a virtuous one.

Enforcement of collateral is no easy task. Constant increase of real-estate prices in agriculture may help farmers clear off the debt burden at some point in their life. Over decades, accumulation of debt leads farmers to a point where debt repayment will be more than income — spending shrinks and growth cycle reverses as it reaches long-term debt peak. This is what Rajan is concerned about. It happened in Japan in 1989, and the US in 1929 and 2008.

What next?

In the medium term, farming can be made profitable. But what should we do for the short term? If we don’t take this warning signal seriously, we will enter a deleveraging phase where spending drops, incomes fall, credit disappears, banks get squeezed and rural economy suffers. In deleveraging, interest-rate reduction is not an option.

One of the following four actions will be required — spending cut, wealth redistribution, printing of money or reduction of debt burden. Spending cuts shrink economy and may result in job losses, which the government can’t afford. Redistribution of wealth includes freebies such as cash distribution, like what the Telangana government did recently. But there is a risk of the budget deficit exploding if every government does that. Printing money may shoot inflation up.

Now, it is obvious why governments prefer loan waivers over the other three options. When farmers can’t move debt out of their life, they expect a magic move from the government. That gives rise to the expectation of debt waiver, a short-term pain killer. Our politicians understand this pain point well and have made this a regular item in election manifestos.

Rajan is right. Something is going wrong. Who will correct it — the Centre, the RBI, or the next party in power by announcing loan waivers?

The writer is co-founder and president of Kheyti, an agri-tech start-up

Published on September 24, 2018

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