The Moral Hazard of Loan Waiver: Farmers and Beyond

Thu, 13 Apr Pre-Open

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If the Centre's casual approach to management of fiscal and budgetary deficits was not enough, the state governments seem to have taken these yardsticks with a pinch of salt. We're referring to the recent farm loan waiver announced by the Yogi Adityanath-led BJP government in Uttar Pradesh.

The state announced writing off crop loans of up to Rs 1 lakh for about 21.5 million small and marginal farmers. The total waiver on the back of this development stands at Rs 363 billion. This is one of the highest waiver promised by a state.

Was this a good move?

We've shared our views on that question in one of our recent write-ups.

So what new are we bringing on the table today?

It's the kind of credit indiscipline the move is likely to unleash in the long run. Allow us to explain...

The recent farm loan waiver of Rs 307 billion by the newly elected Uttar Pradesh government has certainly set a precedent of sorts.

As per an article in Livemint, farmers from Tamil Nadu, Karnataka, Madhya Pradesh, and Rajasthan have made protests for farm loan waiver from the government.

Furthermore, Punjab is likely to announce a loan waiver. As per the news, the Congress had promised to write-off loans and the Amarinder Singh-led government is under pressure to stick to this commitment.

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.

And the above situation is evident today. The recent farm loan waiver by the UP government have spoiled the credit discipline and set the wrong precedents.

The displeasure of the above play was also expressed by Reserve Bank of India (RBI) governor Urjit Patel recently. But there's more to it than just that.

As Vivek Kaul points out that if there is a moral hazard for the farmer, there is also one for corporates. And if the RBI governor has pointed out one, he should have pointed out the other as well. Here's a snippet of what Vivek wrote in his Diary titled: Dear Mr Urjit Patel, Have You Ever Heard of Wasim Barelvi?

• "corporate loan write-offs have led to the situation of diminishing bank capital. This has led to the central government having to recapitalise the PSBs over the years. This money is ultimately borrowed by the government and leads to crowding out, higher interest rates and a weaker national balance sheet. All these issues pointed out by Patel in case of farm loan waive-offs apply to corporate write-offs as well."

What all of this means is the practice of loan waivers could lead to more serious problems and optimize the ongoing moral hazards. More so, it would very well hurt the economic growth in the long run.

But this is just one of the trends that is set to hurt the Indian economy. If you have been a reader of The Vivek Kaul's Diary, you already know that he has identified an underlying trend that holds the potential to derail the Indian economy.

And this trend is growing worse by the day.

Vivek believes it could trigger a crisis having a big impact on all of us. And he has revealed it all in his latest book. We've made it extremely easy for you to claim a copy.

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