Context:

In recent state elections in UP winning political party had made a promise to waive farm loan. This has raised farmers expectation in other states as well, especially poll bounded states. Secondly, there has been increase in farmer agitation due to prevailing conditions in agriculture sector, in various states including Madhya Pradesh and Maharashtra on the demand of farm loan waiver. Consequently, Uttar Pradesh and Maharashtra, the country’s largest states by population, have announced waivers on more than Rs665 billion ($10.3 billion) in agricultural loans since April. 
In this context we shall try to analyze the issue by looking at it’s recent history, reasons for increase in demand for farm loan waiver and macroeconomic effects of Farm loan waiver.

Recent History

Farm loan waivers are not new to the Indian economy. In 2008-09, the UPA-I government announced a farm loan waiver of ?60,000 crore. It hit the exchequer, and not the banks, but it distorted the credit culture since it discouraged farmers from paying up their dues. In addition, when one State offered a waiver, it raised expectations in other States too. Since 2014, starting with Andhra Pradesh, several States have joined the farm loan waiver bandwagon, with Uttar Pradesh and Maharashtra being the most recent ones, though Centre has maintained that states have to deal with farm loan waiver from their own budget and Centre would not assist states in this matter.

Immediate causes of Farm Distress and call for loan waiver

Two successive years of below normal rainfall, in FY14 and FY15, are being seen as the main reason for the loan waiver demand. Secondly, a good monsoon in FY16 resulted in a bumper crop and crash in prices of crop. Thirdly, prices of farm produce came under pressure because of demonetisation as there were distress sale of crops especially perishables like. The sharp decline in food prices in the consumer price index-based inflation was evident. Retail inflation dropped to 2.18% in May as the decline in the prices of food and beverages was sharper in May than April (-0.22% in May against 1.21% in April).

Macro Economic Effects of Farm Loan Waiver

Reserve Bank of India (RBI) warned about the deteriorating fiscal position of the States. According to Economic Survey 2016-17, fiscal health of States is deteriorating with rise in Fiscal Deficit, and Primary deficit. In its recent report on the States’ finances, the RBI also pointed to the worsening position of their financial health. It noted that the consolidated finance of the States had deteriorated in recent years, with the gross fiscal deficit to GDP ratio averaging 2.5% in the last five years (from 2011-12 to 2015-16), compared with 2.1% during the previous five-year period. According to a report by the State Bank of India, the impact on Punjab will be the maximum, with the State’s fiscal deficit jumping by an additional 4.8% of the GSDP.

A farm loan waiver in this context may lead to breach of 3% threshold of fiscal deficit as given in state level FRBM acts. A prolonged increase in fiscal deficit would increase debt in long run. Secondly, a farm loan waiver would mean diversion of resources away from other capital expenditures like infrastructure building. In case of a farm loan waiver, there is always a fall in credit discipline because the people who get the waiver have expectations of future waivers. Future loans given often remain unpaid.
A increase in borrowing by states to waive farm loans would increase demand for loanable funds in financial market. This would increase the cost of loanable funds in market. In a cascading effect, this would crowd out private borrowers as higher interest rates would make new investment unviable.
This would be significant given that due to ‘twin balance sheet’ problem, private investment has been declining. A further increase in interest rates would further discourage any improvement in corporate investment, Make in India program and future growth prospects.

Does Farm Loan Waiver helps?

The success of the loan waiver lies on the extent to which the benefits reach the needy farmers. Loan waivers suffer from several drawbacks in this respect. First, it covers only a tiny fraction of farmers. Secondly, farmers investing from their own savings and those borrowing from non-institutional sources are outside the purview of loan waiver. Loan waiving excludes agricultural labourers who are even weaker than cultivators in bearing the consequences of economic distress. The scheme is prone to serious exclusion and inclusion errors, as evidenced by the Comptroller and Auditor General’s (CAG) findings in the Agricultural Debt Waiver and Debt Relief Scheme, 2008.
It appears that loan waiving can provide a short-term relief to a limited section of farmers; it has a meagre chance of bringing farmers out of the vicious cycle of indebtedness. There is no concrete evidence on reduction in agrarian distress following the first spell of all-India farm loan waiver in 2008.

Sustainable Solutions

In the longer run, strengthening the repayment capacity of the farmers by improving and stabilising their income is the only way to keep them out of distress. The sustainable solution to indebtedness and agrarian distress is to raise income from agricultural activities and enhance access to non-farm sources of income.

The long term solution to the problem lies in improving productivity in agriculture through improvement in irrigation, mechanization, availability of quality seeds, fertilizers, pesticides, crop diversification towards high-value crops and solving ethical dilemma related to GM crops. Secondly, we need to undertake agriculture market reforms to ensure that farmers get reasonable prices for their produce, this includes amendment to state level APMC acts. Thirdly, we need to increase the coverage of PM fasal bima yojana so that farmers are guarded against the risk of crop failure. Fourthly, there is a need to encourage non farm income avenues like animal husbandry.

Conclusion

Farm loan waiver may give immediate relief to farmers from mounting debt. This might be necessary as it is not farmer’s fault but bad monsoon and faulty market structure of output which has increased farm distress with consequences like increased farmer suicide. However, farm loan waiver could not be use as a state policy as it increases debt; shatters credit payment culture and make farmers dependent on states. The sustainable solution lies in structural agriculture reforms.