Farmer agitations are spreading across large Indian states with demands that include increase in minimum support prices and loan waivers. States are buckling under pressure. Maharashtra’s recent announcement of a farm loan waiver is the second this year after Uttar Pradesh’s in April. In Punjab, the Congress had promised a farm loan waiver in its manifesto in January 2017. Farmers agitating in Madhya Pradesh, too, are demanding the same concession. In April, the Madras High Court directed the Tamil Nadu government to waive agricultural loans taken by all farmers.

Moral hazard

The plight of farmers who cannot repay their loans and are driven to suicide is heart-rending. No one can morally ignore it. Large-scale farmer agitations across India have brought this problem into the limelight yet again after the high-profile loan waiver by the United Progressive Alliance government in 2008. On the face of it, writing off a distressed farmer’s loan seems to be an immediate solution.

Unfortunately, loan waivers are not a permanent solution. On the contrary, they create moral hazards. The economist Paul Krugman has described moral hazard as “any situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly”.

The farmer repaying his loan on time is short-changed and an incentive is created to stop repaying loans. Already there are reports of farmers willfully defaulting on loans in the hope of waivers. Former Reserve Bank of India Governor Raghuram Rajan had called for an end to the culture of loan waivers. Recently, current RBI Governor Urijit Patel also spoke against farm loan waivers saying, “Waivers undermine an honest credit culture...It leads to crowding out of private borrowers as high government borrowing tends to [impose] an increasing cost of borrowing for others.”

Thus, a loan waiver might be the right thing to do morally to help distressed farmers, but the longer term consequences of creating moral hazards cannot be ignored.

Botched policies

The contribution of agriculture to India’s economic growth has steadily declined over the decades. From 55% of the Gross Domestic Product in 1952, its share has fallen to 15% in 2016-17. But this drop is only half the story. Agriculture employs nearly 45% of India’s workforce. And given their sheer numbers, farmers are a sensitive group of voters for politicians. Agricultural income remains exempt from tax and minimum support prices for farm produce have played an important role in handling farmer expectations. No politician from any party can ignore the plight of farmers for long, least of all in today’s emotionally charged, social media-driven environment.

However, politics and politicians seem to have failed farmers this time. While Prime Minister Narendra Modi has ambitious plans of doubling farm income by 2022, policy action has been dismal. An IndiaSpend report listed plentiful harvest, imports, and a shortage of cash because of demonetisation as the reasons for the farmer protests. The government cannot control rains but it surely can control its policies.

On imports, the report states:

Across many states growing pulses, such as Maharashtra, Karnataka, Telangana and Gujarat, markets were flooded with produce, especially tur (pigeon pea), which witnessed the highest growth among all pulses, an important source of protein for a majority of Indians. India is the world’s largest pulses producer. 

However, an influx of pulses from Myanmar, Tanzania, Mozambique and Malawi – growing 20% over two financial quarters, from September 2016 to March 2017, the Business Standard reported on March 3, 2017 – caused the price of Indian tur to plunge. 

On demonetisation, the report states:

With little respite more than six months later, the experiment has aggravated the circumstances leading to the current farmers’ strike and upset agricultural markets nationwide. The RBI acknowledged that “fire sales” during the demonetisation period accentuated the price drops and the effects continue.    

Complicated economics

Finally, farm loan waivers make for bad economics. While bankers are cut off from the grim realities of farmers, they do have a point. In 2014, Rajan had said, “Clearly this is another form of transfer but again waiving loans does widespread damage. It does damage to the credit culture…it makes it hard to let the flow of credit to happen.”

The Mint quoted a study by Xavier Giné and Martin Kanz of the World Bank as finding that “bank lending moved away from districts with greater exposure to the loan waiver. Such outcomes can affect agricultural output in the medium to long run as banks may get more selective in extending credit”.

As state budgets get stretched, deficits increase and put pressure on expenditures for infrastructure and investment. If replicated by other states, India’s overall finances would come under pressure. As The Economist noted in May, “The new chief minister of Uttar Pradesh, a state with some 220 million people, wants to waive the repayment of loans to farmers, a ruinous policy, which if copied elsewhere, would increase the combined federal and state deficit by 2% of GDP.”

Likely solutions

The problems of India’s agricultural sector are not new. But solutions to them have been ignored, come rain or drought. From supply chain improvement to land reforms to support prices, experts have suggested enough ways to address these problems. Rajan had suggested measures such as loan restructuring for people affected by calamities as possible alternatives to loan waivers.

Prakash Bakshi, former chairman of the National Bank for Agriculture and Rural Development, writes:

India must urgently rethink its agricultural land lease policy. It should ensure that land tenancy laws are immediately transformed, allowing farmers to lease out their land even for long periods without the fear of losing ownership. Easy-to-use administrative mechanisms can be used to restore the land to the owner on termination of the tenancy. 

The agricultural economist Ashok Gulati suggests many possible solutions in his book Getting India Back On Track, including:

...treat food processing as a priority sector and remove it from the list of small-scale industry reservation, which limits the investment and scale of operations in these units. Large modern plants are what is needed.

Tackling problems as deep-rooted as the farm crisis requires a firmer resolve from the ruling class. But are they prepared?