Image Source: Asia Times
The full article “Yogi Adityanath fulfills poll promise” can be found at the following link https://goo.gl/bGvV1U
Earlier this month, Uttar Pradesh’s newly elected Banathiya Janata Party Chief Minister, Yogi Adithyanath, implemented a plan to relieve the debts of over 21.5 million small and marginal farmers. This program will cost the UP government $5.6 billion (INR 36,359 crore). The bill allows for the waiver of loans of up to $1,500 (INR 1 lakh). Due to this policy’s popularity among farmers, other states in India are planning to also follow suit in enacting similar policies. (1 USD 65 INR).
Lending And Income For Farmers
This program is to help relieve the stresses due to the many uncertainties of farming in India. These stresses are the result of the fact that they make revenue through a seasonal income, in that they spend most of their money at the beginning of the season and only make money during the harvest. Farmers can acquire this startup money in a few ways , namely through loans from banks and informal moneylenders or savings from the previous years. The size of formal bank loans and savings helps with startup costs and the flexibility of informal moneylenders helps with management of purchases through the rest of the season. However, with some risk brought upon by weather inconsistency and other shocks, these debts will sometimes build up. High costs of borrowing sometimes of up to 50%  interest from informal money lenders cause debts that become so large that farmers will have pay off those loans with other lower interest loans, forcing them into a cycle of indebtedness. These debts can often be detrimental to the mental health of the farmers as numerous suicides farmer suicides  are often the linked to the amount of debt owed.
Effect on Credit Reallocation
UP’s new loan waiver plan is the largest in India since the Agricultural Debt Waiver and Debt Relief Scheme (ADWDRS) passed in 2008. The UP government has justified the program by citing the need for relief to the 700,000 farmers who remain in debt. The idea here being that any returns on investment are used to pay off previous debts and farmers’ incentives for investment are driven down by their current debt situation. By waiving these debts, the Indian government targets the economic stagnation caused by the burden on farmers and thus they have more freedom to make economic decisions and thus encouraging more economic activity. A World Bank study  on the effects of ADWDRS, shows that it did not have an effect on productivity, wages, or consumption successful in reallocating capital more efficiently.
With a historical context in mind, there are benefits of credit reallocation that we should also expect from the new UP loan waiver. Banks are more conservative to whom they chose to give loans, thus leading to an increase in the ratio of “safe” over “risky” lenders. Assuming that the banker can determine the reliability of the borrower, the new policy should cause interest rates to decrease safe borrowers no longer subsidize those with bad credit—the risky type. With lower interest rates the cost of investment is lower and farmers will be willing to consume and invest more, spurring economic growth.
While there may be benefits in this credit reallocation, the ADWDRS study also found that there were increasing defaults on loans. Specifically, that “Banks that received a greater share of bailout funds are significantly more likely to experience an increase in defaults after the program, and districts in which bank branches were more exposed to the bailout experience a decline in loan performance after the program” (51). The paper shows that an increasing deviation in the bailout exposure corresponds to an approximately 1.6% increase in the shares of non-performing loans and 2.4% increase in the share of non-performing credit.
These results are likely due to a behavioral change caused by the loan waiver, which changes the mindset of borrowers so that they begin to think that future loans will also be waived. This behavioral uncertainty is an example of ex-post moral hazard as the lenders do not know if the borrower’s project is successful and therefore cannot tell when the borrower does default if he/she is doing it willfully. The UP’s new loan waiver program can only exacerbate this problem of moral hazard as more people will be exposed to debt waiver and therefore loan performance will decrease even more drastically. Since there were already issues about growth previously according to the analysis of ADWDRS, the behavior will only further be affected by another debt waiver. Since that idea of there being more waivers down the line, the probability of someone willfully defaults.
The new debt relief plan in Uttar Pradesh can have positive impacts on helping farmers trapped in cyclic debt work their way up helping improve morale and mental health of farmers. Though their economic effects in the longer run may introduce problems in increased defaults on loans, costing the government and banks even more and negating the positive effects of consumption and production. It will be interesting to see how the other states the nation responds, knowing that the desires of farmers contradict the historical outcomes of similar debt relief programs.
- Miller, Emily. “Looking at rural debt through the eyes of India’s farmers.” (2017) http://scid.stanford.edu/news/looking-rural-debt-through-eyes-indias-farmers
- Giné, Xavier, and Martin Kanz. “The economic effects of a borrower bailout: evidence from an emerging market.” (2014). https://ssrn.com/abstract=2524163
- Behere, Prakash B., and Manik C. Bhise. “Farmers’ suicide: Across culture.” Indian journal of psychiatry51, no. 4 (2009): 242. http://www.indianjpsychiatry.org/text.asp?2009/51/4/242/58286