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Mainstream, Vol XLVI No 28

Rural Loan Waiver or Moral Hazard?

Monday 30 June 2008, by Girish Mishra


For almost a decade or so, the news of suicides by debt-ridden farmers has been constantly hogging the headlines of Indian newspapers. These suicides have been taking place largely in relatively more advanced States like Punjab, Maharashtra, Andhra Pradesh, Karnataka etc. The relatively backward States like Orissa, Bihar, UP, Jharkhand, Assam, Chhattisgarh etc. have been largely immune from this epidemic. This may be because the relatively advanced States have been more closely linked up with national and international markets, and traditional peasants have given way to farmers who by and large produce for sale, not for self-consumption.

Ever since the beginning of economic reforms, based on the Washington Consensus, the troubles in rural areas have been increasing. They are reflected, among others, in growing debt burdens on farmers, leading to incidents of suicides by them. Keeping in view the likely disastrous political consequences, the Finance Minister of the Congress-led United Progressive Alliance (UPA) Government, while presenting his Union Budget for 2008-09 before Parliament, outlined a scheme to waive the outstanding loans of farmers. This scheme was by and large welcomed by various sections of the society though some put forth their suggestions.

According to the latest data, this scheme is to bring relief from debt burden to as many as 36.9 million marginal and small farmers and 5.97 million ‘other farmers’. The government has defined a marginal farmer as one whose landholding is less than one hectare and a small farmer as one who cultivates one to two hectares of land. The ‘other farmer’ is one who possesses more than two hectares of land.

Under the proposed scheme, all outstanding loans of marginal and small farmers will be written off, no matter whether they are short term crop loans or borrowings for investment purposes. Roughly speaking, in most States marginal and small farmers account for 70 to 94 per cent of the entire farming community. The ‘other farmers’ will get relief only up to a particular proportion of their total debt burdens. Initially, this scheme was to cost the public exchequer Rs 600,000 million, but now it is estimated to be around Rs 716,800 million.

Even though people at large have welcomed the scheme, some economists, whose thoughts have been more influenced by Uncle Miltie (Milton Friedman), are unhappy with it. Among them is Raghuram Rajan. He was born in Bhopal in the 1960s and was trained as an electrical engineer at the Delhi IIT. He secured his MBA degree from the IIM, Ahmedabad. Shifting to Economics, he did his Ph.D from the MIT. Teaching for a while at various places, he was appointed the Economic Counsellor and Director of Research, in short, Chief Economist, at the International Monetary Fund in September 2003 after Ken Rogoff left. He was just about 40 then. He continued there almost three years and then became the Eric J. Gleacher Distinguished Service Professor of Finance at the Graduate School of Business at Chicago. He is a firm believer in Uncle Miltie’s free market philosophy. In a book Saving Capitalism from Capitalists, co-authored with Luigi Zingales, it is asserted: “Free markets are perhaps the most important tools for lifting the huddled masses out of poverty.”

This philosophy is reflected in the “Draft Report of the High Level Committee on Financial sector Reforms”, headed by him. This Committee, set up by the Planning Commission of India, is to submit its final report shortly. One of the recommendations of this Committee is privatisation of all nationalised commercial banks!

COMING to the rural loan waiver scheme, Rajan is vehemently opposed to it. He thinks that this move is disastrous and will spoil India’s credit culture. Delivering a special lecture at the Indian Banking Conference, organised by the Indian School of Business in Hyderabad, on June 8, he held that the
Rs 720,000 million loan waiver for farmers “is a disaster. It spoils the credit culture in the country.” To him, the loan waiver was not the way to go in the future. It would mean penalising the people who paid off their debts even though they suffered difficulties. He asserted that such populist measures would prove detrimental to the Indian economy in the future. He advised the government to work for improving credit recovery and, to that end, it should bring in a modern bankruptcy code and work towards extending the Securitisation and Reconstruction of Financial Assets and Enforcements of Security Interest (SAFAESI) Act, 2002 to all institutional lenders.

Another well-known economist, A. Vaidyanathan, writing in The Hindu (March 6), had expressed almost identical views. To quote:

Experience shows that waivers encouraged borrowers to presume that they can sooner or later get away without repaying loans. It reinforces the culture of willful default, which has resulted in huge over dues and defaults in all segments of organised financial institutions. The deterioration in the cooperative credit system is, in large measure, due to the conscious state policy of interference in the grant and recovery of loans.

To him, the loan waiver scheme was against the very spirit of economic reforms.

The line of thinking thus evinced by Rajan, Vaidyanathan and the like is not new. Every student of economics knows it by ‘Moral Hazard’. This term dates back to the 17th century and was frequently used by English insurance companies towards the last quarter of the 19th century. It denoted fraud or immoral behaviour on the part of the insured party. Some researchers hold that ‘moral’ actually meant ‘subjective’ without ethical considerations.

It means that if an insurance company is liberal or lax in enforcing the terms and conditions agreed upon between the insurer and the insured, the latter may default in payment of the premium or, if his car is insured, he may not take care while parking or locking it. In driving, too, he may be careless because he is confident that the insurer will compensate him for the loss without much fuss. On the contrary, if the insurance company is strict in enforcing the terms and conditions agreed upon, the insured will be careful and the company will not suffer.

Rajan, Vaidyanathan and others of their tribe forget that many a time a farmer is not able to repay his loans because of circumstances beyond his control. If one looks back, one finds a number of instances. To begin with, in the 1860s, when the American civil war began, the supply of raw cotton from the USA to the textile mills in England stopped and the prices increased, and the English turned their attention to India and farmers in Maharashtra and other nearby areas began growing cotton and reaping handsome returns. Labouring under the illusion that this boom would continue, they increased their consumption expenditures and borrowed heavily from moneylenders. Once the American civil war came to an end and the supply of raw cotton to England resumed, cotton prices in India collapsed and growers were not able to repay their loans. Moneylenders started legal proceedings and the riots that followed were known as the Deccan Riots. Ultimately, the government had to intervene and it brought in a number of measures to give relief to the indebted farmers. Obviously, the farmers could not know the future behaviour of the market which was influenced by extra market forces.

Similarly, in the early 1930s, agricultural prices in India collapsed in the wake of the Great Depression that originated in America. Landlords started proceedings for recovery of rent and in case the tenants failed to pay up their landholdings were auctioned. This led to peasant uprisings in Bihar, UP and elsewhere. Obviously, the collapse of agricultural prices leading to the inability of tenants to discharge their rent obligations was not due to factors within their control. As a result, the government was forced to intervene.

While Rajan and company are unhappy with the scheme of rural loan waiver, they have not uttered a single word about the phenomenon of non-performing assets of banks which have risen because India’s big traders and industrialists have borrowed from banks and have not repaid. The Reserve Bank of India has published the details. These unpaid loans run into billions and billions of rupees.

Lastly, these economists are oblivious of the political implications of the sufferings of indebted farmers, leading to suicides. In India, neither the economists like Rajan nor the media, whether print or electronic, can influence the marginal and small farmers.

The author, a well-known economist, used to teach Economics in Kirorimal College, University of Delhi before his retirement a few years ago. He can be contacted at:

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