Understanding Loan Waivers in India

The costs and benefits of waiving debt to farmers and banks. By Sarang Yeola

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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 [1], 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% [2] 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 [2] 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 [3] 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.

Moral Hazard

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.

Conclusions

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.

References

  1. 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
  2. Giné, Xavier, and Martin Kanz. “The economic effects of a borrower bailout: evidence from an emerging market.” (2014). https://ssrn.com/abstract=2524163
  3. 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

4 thoughts on “Understanding Loan Waivers in India”

  1. I thought that this was really interesting. Loan forgiveness is usually not a good thing, but I know that in certain cases it is necessary. I’m glad that the government is doing something about this problem.

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  2. Like the previous commenter said this is a very interesting topic. Given the situation the farmers are in, it’s pretty clear that something like this program was necessary. The most interesting questions for me, are what will the government or banks do to deal with the moral hazard and what level of default is acceptable. I would imagine one way of discouraging intentionally defaulting is to track the number of defaults of the individual and set some number beyond which there are real repercussions. However, given the nature of the situation and the intent of the policy, this would probably be the wrong type of method.

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  3. In general I found this article interesting. One question I have is the program is designed for poor households who cannot repay their loan, if the government waive the farmer’s debt, would this remove the incentive of farmer to work, as they no longer need to work hard to pay debt. So instead of just giving the money to farmer, would the government strengthen regulation on financial market, which reduce the existence of high-interest lending, can be a more ideal result for the poor household?

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  4. I greatly enjoyed how this post directly related to the material covered in our Theories of Economic Development class. The concern of seasonal income with the uncertainty of crop production in India is a large barrier to the overall wellbeing of farmers and their families. Ideally, consumption would be at a constant level throughout all 12 months of a year, as households want to maintain nutrition and lifestyle by spreading out their consumption levels across the seasons where they have steady income and the seasons where they do not. Settling the debt of many of these farmers will allow for those who have good loan repayment history, but were unfortunate enough to have crop failure in recent seasons to have a second chance. If the banks analyze past credit and loan history, and notice a trend of accumulating debt, many individuals may not receive future loans. The concern related to moral hazard comes into play when individuals carelessly continue to borrow thinking that future loans will be waived if stuck by failure again, potentially creating a greater national debt in the future.

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