India: Rural Loan Waiver or Moral Hazard?


For almost a decade or so, the news of suicides by debt-ridden farmers has been constantly hogging the headlines of Indian newspapers. These suicides have been taking place largely in relatively more advanced states like Punjab, Maharashtra, Andhra Pradesh, Karnataka, etc. The relatively backward states like Orissa, Bihar, U.P., Jharkhand, Assam, Chhattisgarh, etc. have been largely immune from this epidemic. This may be because the relatively advanced states have been more closely linked up with national and international markets, and traditional peasants have given way to farmers who, by and large, produce for sale, not for self-consumption.

Ever since the beginning of economic reforms, based on Washington Consensus, the troubles in rural areas have been increasing. They are reflected, among others, in growing debt burdens on farmers, leading to incidents of suicides by them. Keeping in view likely disastrous political consequences, the finance minister of the Congress-led United Progressive Alliance (UPA) government of India, while presenting his Union Budget for 2008-09 before Parliament, outlined a scheme to waive the outstanding loans of farmers. This scheme was by and large welcomed by various sections of the society though some put forth their suggestions.

According to the latest data, this scheme is to bring relief from debt burden to as many as 36.9 million marginal and small farmers and 5.97 million ‘other farmers’. The government has defined a marginal farmer as one whose landholding is less than one hectare and a small farmer as one who cultivates one to two hectares of land. ‘Other farmer’ is one that possesses more than two hectares of land.

Under the proposed scheme, all outstanding loans of marginal and small farmers will be written off, no matter whether they are short term crop loans or borrowings for investment purposes. Roughly speaking, in most states, marginal and small farmers account for 70 to 94 per cent of the entire farming community. The ‘other farmers’ will get relief only up to a particular proportion of their total debt burdens. Initially, this scheme was to cost the public exchequer Rs 600,000 million, but now it is estimated to be around Rs 716,800 million.

Even though, people at large have welcomed the scheme, some economists whose thing has been more influenced by Uncle Miltie (Milton Friedman) are unhappy with it. Among them is Raghuram Rajan. He was born in Bhopal in the 1960s and was trained as electrical engineering at Delhi IIT. He secured his MBA degree from IIM, Ahmedabad. Shifting to Economics, he did his Ph. D. from MIT. Teaching for a while at various places, he was appointed Economic Counselor and Director of research, in short, Chief Economist, at the International Monetary Fund in September 2003 after Ken Rogoff left. He was just about 40 then. He continued there almost three years and then became Eric J. Gleacher Distinguished Service Professor of Finance at the Graduate School of Business at Chicago. He is a firm believer in Uncle Miltie’s free market philosophy. In a book “Saving Capitalism from Capitalists,” co-authored with Luigi Zingales, it is asserted, “free markets are perhaps the most important tools for lifting the huddled masses out of poverty.”

This philosophy is reflected in the “Draft Report of the High Level Committee on Financial sector Reforms,” headed by him. This committee, set up by the Planning Commission of India, is to submit its final report shortly. One of the recommendations of this Committee is privatization of all nationalized commercial banks!

Coming to rural loan waiver scheme, Rajan is vehemently opposed to it. He thinks, this move is disastrous and will spoil India’s credit culture. Delivering a special lecture at the Indian Banking Conference Organized by the Indian School of Business in Hyderabad on June 8, he held that the Rs 720,000 million loan waiver for farmers “is a disaster. It spoils the credit culture in the country.” To him, the loan waiver was not the way to go in the future. It would mean penalizing the people who paid off their debts even though they suffered difficulties. He asserted that such populist measures would prove detrimental to the Indian economy in the future. He advised the government to work for improving credit recovery and, to that end, it should bring in a modern bankruptcy code and work towards extending the Securitisation and Reconstruction of Financial Assets and Enforcements of Security Interest Act, 2002 (Safaesi) to all institutional lenders.

Another well-known economist, A. Vaidyanathan, writing in The Hindu (March 6) had expressed almost the identical views. To quote:”Experience shows that waivers encouraged borrowers to presume that they can sooner or later get away without repaying loans. It reinforces the culture of willful default, which has resulted in huge over dues and defaults in all segments of organized financial institutions. The deterioration in the cooperative credit system is, in large measure, due to the conscious state policy of interference in the grant and recovery of loans.” To him, loan waiver scheme was against the very spirit of economic reforms.

The line of thinking thus evinced by Rajan, Vaidyanathan and the like of them is not new. Every student of economics knows it by ‘Moral Hazard’. This term dates back to the 17th century and was frequently used by English insurance companies towards the last quarter of the 19th century. It denoted fraud or immoral behavior on the part of the insured party. Some researchers hold that ‘moral’ actually meant ‘subjective’ without ethical considerations.

It means, if an insurance company is liberal or lax in enforcing the terms and conditions agreed upon between the insurer and the insured, the latter may default in payment of the premium or, if his car is insured, he may not take care while parking or locking it. In driving too, he may be careless because he is confident that the insurer will compensate him for the loss without much fuss. On the contrary, if the insurance company is strict in enforcing the terms and conditions agreed upon, the insured will be careful and the company will not suffer.

Rajan, Vaidyanathan and others of their tribe forget that many a time a farmer is not able to repay his loans because of circumstances beyond his control. If one looks back, one finds a number of instances. To begin with, in the 1860s when American civil war began the supply of raw cotton from the USA to textile mills in England stopped and the prices increased. The English turned their attention to India and farmers in Maharashtra and other nearby areas began growing cotton and reaping handsome returns. Labouring under the illusion that this boom would continue, they increased their consumption expenditures and borrowed heavily from money lenders. Once the American civil war came to an end and the supply of raw cotton to England resumed, cotton prices in India collapsed and growers were not able to repay their loans. Money lenders started legal proceedings and riots followed that are known as Deccan Riots. Ultimately, the government had to intervene and it brought in a number of measures to give relief to indebted farmers. Obviously, the farmers could know the future behavior of the market, which was influenced by extra market forces.

Similarly, in the early 1930s, agricultural prices in India collapsed in the wake of the Great Depression that originated in America. Landlords started proceedings for recovery of rent and in case the tenants failed to pay up their land holdings were auctioned. This led to peasant uprisings in Bihar, U.P. and elsewhere. Obviously, the collapse of agricultural leading to the inability of tenants to discharge their rent obligations was not due to the factors within their control. As a result, the government was forced to intervene.

While Rajan and company are unhappy with the scheme of rural loan waiver, they have not uttered a single word about the phenomenon of non-performing assets of banks, which has arisen because India’s big traders and industrialists have borrowed from banks and have not repaid. The Reserve Bank of India has published the details. These unpaid loans run into billions and billions of rupees.

Lastly, these economists are oblivious of the political implications of sufferings of indebted farmers, leading to suicides. In India, neither the economists like Rajan nor the media whether print or electronic can influence the marginal and small farmers.

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