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In loan waivers, 'moral hazard' and continued hope for political gains -Shaji Vikraman
-The Indian Express

Urjit Patel has voiced concern publicly over the latest loan waiver — saying it engendered a moral hazard and undermined the honest credit culture.

In February 1990, in the months preceding the build-up to the balance of payments crisis the next year, Madhu Dandavate, Finance Minister in V P Singh’s National Front government, announced a debt relief scheme for farmers to fulfill a promise made by the alliance in its election manifesto.

The scheme covered overdues or outstandings of farmers and artisans up to Rs 10,000 as on October 2, 1989 from public sector banks and Regional Rural Banks, and involved a fiscal cost of Rs.10,000 crore. In the Budget of 1990, Dandavate said the government would compensate banks suitably for writing off the debt, that the scheme would exclude wilful defaulters — those who had the financial capacity to pay but refused to do so — and that a “positive” measure like debt relief would contribute to better recoveries in the farm sector and better identification of wilful defaulters.

Banks, he said, were being told to put in a place a system to maintain a proper credit history of borrowers covered under the scheme. But the key point was the Budget’s assertion that the scheme would neither be extended nor repeated.

Since then, governments at both the Centre and the states have come up with loan waivers, the latest being the one by the Uttar Pradesh government, writing off farm loans aggregating Rs 36,359 crore. What makes it remarkable this time is that Prime Minister Narendra Modi, known to be conservative when it comes to meeting key fiscal targets, made the first pitch at a political rally where he said, “I will make sure that the first cabinet decision after forming the government in Lucknow is to waive farmers’ loans.” That pronouncement cast the die for UP, a state already struggling under a huge debt burden.

Soon after the Modi government took over, many bankers and the RBI had warned the Finance Ministry of the dangers of such writeoffs. Interestingly, there was little support then from Delhi for the huge loan waivers announced by the newly formed states of Andhra Pradesh and Telangana. As the Modi government worked on its first Budget, bankers, led by SBI chief Arundhati Bhattacharya and RBI Governor Raghuram Rajan, got together to stymie the proposal — finally forcing the state governments to settle for a rescheduling of the loans.

The Governor then cited the RBI’s master circular which lays down the ground rules for any such waiver. Writing off farm loans would be contingent on a failure of 50% or more in a catastrophe, and voluntary for banks — and they cannot be treated as bad loans, going by the circular. His point then was that these criteria had not been met in the cases of Andhra Pradesh and Telangana. Resistance from the regulator and banks managed to push back the populist impulse then.

Three years later, Rajan’s successor, Urjit Patel, has voiced concern publicly over the latest loan waiver — saying it engendered a moral hazard and undermined the honest credit culture.

The Governor’s views were in keeping with the RBI’s 3-decade-long track record of objecting to loan writeoffs — a poor credit culture that had started to develop from the 1980s when a junior Finance Minister in the Congress governments, Janardhan Poojary, pushed “loan melas” at several places — and especially in his home state, Karnataka — forcing bankers to disburse funds without checking the antecedents of borrowers.

In 2014, the Indian Banks Association, the lobbying arm of Indian banks, cautioned the Finance Ministry about the negative impact on the loan repayment culture and credit discipline in the country. However, it is not that political leaders did not already realise the “moral hazard” of writeoffs encouraging borrowers to default in the future too — witness Dandavate’s solemn reference back in 1990 to the need to ensure there was no erosion of the credibility of the banking system as a result of the waiver scheme.

In 2008, when Manmohan Singh was Prime Minister, there were discussions with the RBI on a debt relief scheme. The central bank wasn’t in favour of the proposal. A committee headed by R Radhakrishna did not recommend a waiver of farm loans. But a political decision was taken, and Finance Minister P Chidambaram announced a debt waiver scheme in the 2008-09 Budget.

The government said it was conscious of the problems in the farm sector and sensitive to the difficulties of small and marginal farmers, and had taken the decision after weighing the pros and cons of the move, and after having taken the resource position of the government into account. The scheme featured a full waiver for marginal farmers and small farmers. The total value of overdue loans waived was estimated at Rs 50,000 crore, and the one-time settlement scheme relief on overdue loans at Rs 10,000 crore. That was the year when growth topped 8% and the revenue and fiscal deficits had declined.

Interestingly, once the decision was announced, there was no public voicing of any concern by then RBI Governor Y V Reddy. That appears to have been in keeping with his overall stance of restricting his concerns on policy choices, or voicing them only with the Finance Minister or the Ministry. Indeed, at the World Leaders Forum at Columbia University in April 2008, Reddy, during a discussion which also featured economist Jagdish Bhagwati, defended the government’s move, pointing out that the farm sector, which provided livelihood to 50% of India’s population, had seen a growth of just 1% when the rest of the economy was growing at near double digits.

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