Waiving Farm Loans is Not the Answer for Indian Agriculture

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India's agriculture sector is the backbone of the country's rural economy. Even though agriculture contributes about 15% to India's gross domestic product, a majority of the population directly or indirectly depends on the sector for their livelihood.

Small and marginal farmers which make a bulk of the sector today, face myriad problems including, lower crop yields, erratic monsoons, and more importantly, the rising burden of farm loans.

The incumbent government envisioned doubling farm income by 2022 by transforming Indian agriculture. However, the political discourse continues to focus on waiving off farm loans rather than any other productive solution.

In the run up to the assembly elections in Uttar Pradesh, the Bhartiya Janata Party (BJP) had promised that it would waive off crop loans taken by the small and marginal farmers of the state.

Political parties promising to waive off crop loans is nothing new. Before the 2009, Lok Sabha elections, the Congress led United Progressive Alliance government had carried out a similar exercise.

Following the example set in Uttar Pradesh, other state governments could be mulling a farm loan waiver programme.

It is perhaps just a matter of time before more states join the bandwagon.

But are farm loan waivers the right way of addressing the problems in Indian agriculture?

According to numbers released by the State Bank of India, if the Uttar Pradesh government goes ahead with its poll promise of waiving off loans to small and marginal farmers, it would cost banks as much as Rs 27.4 billion.

But of course, the banks won't bear the load of the loans waived off and the state government will step in to compensate them. However, when you look at the numbers closely, the Rs 27.4 billion outlay accounts for about 8% of Uttar Pradesh government's revenue. Which is a significantly high number.

Apart from the monetary impact, there is also the question of moral hazard in loan waivers.

Our big picture expert Vivek Kaul explains it succinctly in his Diary:

• The economist Alan Blinder in his book After the Music Stopped writes that the "central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it."
  
  This basically means that once the farmer sees a loan being waived off today, he will wait for elections in the future for the newer loans he takes on to be waived off as well. Essentially, he will see little incentive in repaying loans that he takes on in the future.

SBI Chairperson Arundhati Bhattacharya too echoes Vivek's views. The head of the country's largest lender, was bang on when she recently said that loan waivers affect credit discipline, as farmers will wait for the next elections and the next government to waive off their loans.

An argument in favour of waiving off farm loans is that it reduces the debt overhang on farmers, which helps them invest again. However, a World Bank study - The Economic Effects Of A Borrower Bailout: Evidence From An Emerging Market, did not find any improvement in investment in areas where a significant amount of debt was waived off.

To be sure, India's agriculture sector needs the government's support but loan waivers cannot be the solution as they are only focused on the short-term. Moreover, expenditure on loan waivers will leave the government with less fiscal space for productive infrastructure spending.

The problems in Indian agriculture are structural. Loan waivers will not do much but to appease the masses in the short-term. If the government aims to meet its double farm income target by 2022, investments in irrigation, water conservation, better storage facilities, among others need to be given prime focus.

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