The Threat of Generosity—Loan Waivers Need to be Better Handled

Agriculture is the heart of all the civilizations that has thrived. It is an uncompromisable sector, which employs about 42% of the population according to ILO in 2019 (Employment). The farmers engaged in the sector deserve to be thanked countlessly for exposing themselves to the heat and cold as they cater to our basic needs. Despite being the legendary men of the nation, their plight at times go unnoticed, leading to the 11,379-farmer suicide in 2016 as per National Crime Records Bureau.

Not to mention, the government over time has paid some attention to the gripping crisis and has rolled out policies for the welfare of the farmers. Agricultural loan waivers, schemes that spring under times of unprecedented crisis and for political motives are one among the many other programs. Although many defend the scheme for the hope it brings to distraught farmers, there are questions concerning the effectiveness of the scheme. The following pages will throw light on the effectiveness of the scheme, using the example of the 2008 ADWDRS and look closely at the problem of moral hazard that worries economists, thereby understand the need to rejig the current schemes.

The Agricultural Debt Waiver and Debt Relief Scheme of 2008 expected to achieve more than just offering a reassuring solution to the unsustainable level of debts that plagued India’s rural economy. Those who had pledged under two hectares, at the time when the loan was disbursed were eligible for a 100% unconditional waiver, whereas those who pledged over two hectares could avail themselves of a conditional 25% waiver, if they repaid the other 75% in the stipulated time. It wanted to incentivize productive investment that was hampered by the existing huge debt, through clearing borrower’s collateral, which they could use to avail themselves of new credit. Those who received full waivers were expected to respond in a more positive way than those with partial waiver, but the outcome was different.

Observations by Martin Kanz in his paper published in American Economic Journal revealed that, the household debt decreased significantly by about 30%, however, the number of new loans taken out by those who received full and partial waiver remained almost the same. Those who receive full waiver after about a year and half showed an 8% decline in debts from formal banks and a 6% increase in debts from the informal sector—friends and family taking a larger proportion than the high-interest lenders. Also, household who received full waiver were less willing to invest further and they had a greater decline in agricultural yield than those who received partial waiver. 

Furthermore, it created unexpected impact on the future expectations of the people. It changed the people’s belief about the consequence that defaulting would have on reputation; the scheme proved that those who received the most waiver, were less bothered about the effect on reputation. However, they were more concerned about access to future credit because of the default status. Therefore, those who received full waiver saw the debt relief as a short-term relief, which was bad for their future credit needs.

Today, RBI reports allude to the increasing NPA in anticipation of loan waivers. The gross NPA of the sector stood at 8.44% as on March 31, 2019. This emphasizes the problem of moral hazard—the tendency to take more risk when protected from the cost of the action. When such loan waivers are declared, borrowers are inclined to default payment, thus accumulating non-performing assets. This harmful trend undermines the credit culture and hampers the credit system, which is sustained by a line of trust that rests between the lender and borrower. It is true that such relief package can brighten the life of many, however, without dealing with moral hazard, the scheme will do more harm, than good.

Nevertheless, that is not a reason to condemn the policy. Prasad and Gupta write that the cost of loan defaults from corporates imposes a greater cost on the sate than that of the farmers. When industrialists are given the luxury of allowance, arguably farmers too deserve one. Instead of debates to end such schemes, it is essential to engage in a healthy deliberation to alter the same to be efficient.

One suggestion could be that, waivers must be targeted to the needy, instead of making it universal. It must be done by assessing the sources of income and performance of farmer and then deciding on the waiver. Care needs to be taken when examining the case, as the task must be delegated to a third person other than bank representatives. This is because the waiver is good for the bank and it has the incentive to tag the farmer as deserving a waiver. It is expensive; the process of identifying and evaluating whom a needy is, as it also requires defining characteristic of a needy farmer. Yet, by targeting, it is possible to control the extent of spread of moral hazard.

Secondly, from what The Economic Times reported, the government can pay the farmers the amount they owe, which they must in return use to repay the loan. The effect of this is to maintain the borrower and lender relationship, as the borrower must take the initiative of paying back. This retains the trust and bond and prevents migrating to high-cost informal lenders.

Relief schemes such as loan waivers, at times, are the only means to address certain calamity. Nonetheless, it depends on how effectively the policy is planned. When building new set of policies, which is inevitable post-pandemic, policy makers must be careful enough to account for previous failures and not make the same mistake again. Only when designed thus, it can foster positive change.

Gby Atee is a second-year Economics student at Ashoka University

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