Bad debt

As ambitious targets are being set for credit flow to agriculture, the loan waiver with its insensitive concern for incentive and justice sets the clock backward

Nilabja Ghosh Delhi

Finance Minister P Chidambaram's apparent generosity to farmers to the tune of Rs 60,000 crore can be described as both topical and paradoxical. On the positive side, it comes at a time when Indian agriculture is growing at an extremely slow pace while other sectors are making steady progress and contributing to the overall growth of the economy. In an electoral climate, the contrast is too glaring.
It is undisputable that agriculture, the country's largest source of livelihood, was crying for budgetary support. The loan waiver was in some sense the much needed support. On the other hand, this was also a time when the banking system's failure to reach out to the poor was becoming evidently clear.
Questions, therefore, can be raised about the loan waiver for those sections of the rural poor who were hardly procuring loans in the first place. A budgetary support was definitely needed, but doing it through loan waivers was possibly the worst way.
Then there are two groups of farmers who had taken loans, but have been overlooked by the finance minister. In the first group are those who had taken loans from banks and other financial institutions but had duly repaid them. What is the message that the government is trying to give out to them? If there is any lesson for them to learn it is simply this: "In the future, think twice before you repay your loans."
In the second group are those farmers who borrowed money from private sources and not from banks or any financial institutions. The government's loan waivers do not affect them since only loans taken from rural banks and other government agencies are going to be written off. According to estimates, the loans taken from private sources that include money-lenders, traders and relatives, add up to nearly Rs 50,000 crore.
The money lender's role in the Indian farmers' life and business is an old story. Their usurious practices have been documented from colonial times in official reports of the Central Banking Enquiry Committee (CBEC) and the Madras Provincial Banking Enquiry Committee (NPBEC) of 1929. After Independence, the All India Rural Credit Survey of the Reserve Bank of India (RBI) exposed a grim reality. The formal credit system made up of the government, banks and cooperative societies of the time contributed less than 9 per cent of all rural credit. More alarmingly, there was nearly no regulation on money lending. The interest rates charged were exploitatively high and the lenders also happened to be the landlords as well as the grain-traders. As a result, their power over the poor peasants was much more than that of an ordinary creditor. The farmers borrowed from the money lender and then had to borrow yet again from the same person to repay the loan - the ideal story of a debt-trap.
At the time of Independence, only a few villages in India had banks. After the All India Rural Credit Survey, the RBI directed all other banks to open branches in rural areas and start providing loans to farmers. In 1955, the Imperial Bank of India, which later became the State Bank of India, opened 400 branches in rural areas to facilitate credit to agriculturists. A cooperative credit system was thus built up in rural India which possibly today has become the largest financial system in the world. Fourteen large commercial banks were nationalised and the apex bank, named NABARD, was established by a parliamentary act in 1982 to facilitate credit for agriculture. Finally, a specific target was set for a group of priority sectors in 1975 and subsequently a sub-target was also set for agriculture landing.
The result of all these developments was clearly visible. Rural bank branches increased from around 700 in 1970 to nearly 3,500 in 1990 and most notably, the money lenders' activities declined significantly in the first 20 years after nationalisation of banks. Predictably, agriculture flourished during this period and that became possible because the government pursued an effective credit policy for farmers.
Agriculture is undoubtedly a risky business. Droughts, storms, floods, untimely rainfall and pests could negate all investment. Moreover, Indian farmers are mostly poor and hold small pieces of land. Natural calamities can plunge them into destitution and leave them in conditions where they are unable to repay their debts. Agricultural lending increasingly became associated with non-performing assets accumulated by the banks and this led to the erosion of their capital base.
The banking industry was not insulated from the economic liberalisation of the 1990s. The Narsimhan Committee Report of 1991 proposed a vibrant and competitive financial sector in India. A circular issued by the Reserve Bank in 1992 called for prudential norms for banking. This paradigm shift helped in reviving the bank's health but the consequences for agriculture were not positive. Rural branches shrunk and banks preferred to direct their credit to the urban elite.
The rural share of credit also came down drastically. In the wake of much criticism and an evident stagnation in agricultural performance, a farm credit package was created in 2004, which aimed to double the flow of institutional credit for agriculture in the ensuring three years. This was accomplished in two years. In fact, the credit deposit ratio, a comprehensive indicator of the rural population's share in financial inflow, went up from 52 per cent in 2005 to 56 per cent in 2006. On the surface, the picture looked rosy enough. But a deeper look at RBI data revealed that though credit flow had accelerated after 2000, much of the flow was through an indirect path and not through the farmers. Underlying the success was a continuous widening of the definition of priority sector under agriculture and much of the credit actually went to various agri-business and service providers. This certainly was a practical way of meeting commitments. But the ultimate "proof of the pudding" will come when it brings improvement in the performance of agriculture - something that has not yet happened.
Not surprisingly perhaps, the crisis of rural credit in the wake of market liberalisation has re-opened a nearly forgotten saga. Rural moneylenders have returned with their offers and high interest rates. The National Sample Survey (NSS) has shown that rural people's dependence on informal sources for borrowing has once again started increasing. It also found that institutional sources held only 61 per cent of the cultivator's debts in 2002, while it was 66 per cent in 1991.
More disturbingly, the NSS also reported that only a small proportion among the poorer households borrowed from institutional sources as compared to richer households in villages. Though the debt burden (measured by the debt asset ratio) was also higher among the rural poor, institutional debt was only a part of it.
The NSSO also conducted a 'Situation Assessment Survey of Farmers' in 2003 and found that out of the average outstanding debt held by a farmer, over a quarter came from professional moneylenders, 5.2 per cent came from traders and 8.5 per cent from friends and relatives. But if the high interest rate that they charge is anything to go by, then these friends and relatives are no different from the moneylenders.
The overpowering presence of moneylenders was also evident in different surveys conducted to address the problem of farmers' suicides. The moneylenders who doubled as input suppliers as well as advisors increased the vulnerability of the farmers to a debt-trap.
The loan waiver is meant primarily for the marginal and small land holders. They make up 80 per cent of the farmers in the country and also claim the same share of the total debts from all sources. While addressing the problems of the least privileged is appropriate, the attempt to link the income of a farmer on the basis of the size of plot can be misleading. Land often gets divided among siblings in a farmer's family. But agriculture may not be the only source of income for them. Land is only one form of asset, but machines, tractors and other transport vehicles can be assets as well. The growing demand for real estate has also turned land into a valuable asset in rural areas. The NSS has reported debt statistics after classification of households by a composite asset holding measure. All such assets improve the credit-worthiness of an individual and are relevant in assessing his economic status. What discourages the institutions from lending to the poor is the perceived risk. Now, risk by itself need not deter a lender. After all, a banker's business involves future returns which necessarily are uncertain, and the cost of risk can readily be factored in the interest charges. Loans to the poor in India are supposed to be at a concessional rate and a cap of seven per cent in the interest rate was especially put on farm loans. But the low interest rate rarely covers the cost to the bank. A national survey shows that while the poor borrower is charged a little more than 10 per cent on his principal, the cost to the bank, and that includes bad debt provisioning and processing cost, comes to over 25 per cent. The bankers' reluctance to lend to the poor and the needy is hardly surprising.
The farmer also feels the reluctance when he seeks a loan from the bank. The local moneylender on the other hand, despite the high interest rate, mostly turns out to be the better option. Because he is prepared to the risk, offers fast and simple transaction and is easily approachable. He is ready even when the bank considers the farmer ineligible for loan on account of a recent default. This is not a rare occasion at all, given that the crop insurance in operation is of use in very specific conditions and is mostly insensitive to an individual's problems.
Directing credit to the rural people, the poor and the farming classes constitutes an important component of what is now known as financial 'inclusion'. In the last one decade or more, the government had taken recommendations from several expert committees in an attempt to fill the credit void. A number of innovative models and techniques are being explored. A number of new ideas are pouring in. This is certainly an area witnessing a lot of activity and deliberation.
Ambitious targets are being set for credit flow to agriculture. But on top of it comes the loan waiver, which sets the clock backward. Strengthening the credit delivery institution is the central issue today. It is more important than achieving higher targets that are "superimposed on a weak structure", as the Radhakrishna Report of 2008 pointed out. Such target chasing can end in low quality loan use and poor recovery. Loan waiver possibly completes the process with its insensitive concern for incentive and justice.

The writer is associate professor at the Institute of Economic Growth, Delhi