GS-III: RBI report on Loan Waivers' impact

News

Recently the RBI shared the report of an Internal Working Group (IWG), which was set up in February to look at, among other things, the impact of farm loan waivers on state finances. Since 2014-15, many state governments have announced farm loan waivers.

Highlights of the report

• The report has shown how to farm loan waivers dented state finances and urged governments both central and state to avoid resorting to farming loan waivers.
• This was done for a variety of reasons including relieving distressed farmers struggling with lower incomes in the wake of repeated droughts and demonetization.
• Also crucial in this regard was the timing of elections and several observers of the economy including the RBI warned against the use of farm loan waivers.

Impact of Loan Waivers:

• Chart 1 from the RBI report details the impact on state finances in successive years.
• Typically, once announced, farm loan waivers are staggered over three to five years.
• Between 2014-15 and 2018-19, the total farm loan waiver announced by different state governments was Rs 2.36 trillion. Of this, Rs 1.5 trillion has already been waived.
• For perspective, the last big farm loan waiver was announced by the UPA government in 2008-09 and it was Rs 0.72 trillion. Of this, actual waivers were only Rs 0.53 trillion staggered between 2008-09 and 2011-12.
• In other words, in the past five years, just a handful of states have already waived three times the amount waived by the central government in 2008-09.

Impact on economic growth

• In essence, a farm loan waiver by the government implies that the government settles the private debt that a farmer owes to a bank.
• But doing so eats into the government’s resources, which, in turn, leads to one of the following two things: either the concerned government’s fiscal deficit goes up or it has to cut down its expenditure.
• A higher fiscal deficit, even if it is at the state level, implies that the amount of money available for lending to private businesses both big and small will be lower.
• It also means the cost at which this money would be lent (or the interest rate) would be higher. If fresh credit is costly, there will be fewer new companies and less job creation.
• If the state government doesn’t want to borrow the money from the market and wants to stick to its fiscal deficit target, it will be forced to accommodate by cutting expenditure.

Overall impact

As such, farm loan waivers are not considered prudent because they hurt overall economic growth apart from ruining the credit culture in the economy since they incentivise defaulters and penalise those who pay back their loans.

Recommendations

• The IWG recommends that GoI and state governments should undertake a holistic review of the agricultural policies and their implementation.

• Both should evaluate the effectiveness of current subsidy policies with regard to agri inputs and credit in a manner which will improve the overall viability of agriculture in a sustainable manner.
• It stated that loan waivers should be avoided.