Politically driven, financially unsound: The loan waivers offered by India’s political parties will only serve to worsen the country’s bad loan crisis

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• One of the major reasons the Congress was able to wrest three very important states from the ruling BJP in the recent round of elections is because of its promises to write off farmers loans.
  
• After a loan waiver is announced, farmers stop servicing their loans. As banks won’t be able to recover these debts, the waiver leads to a buildup in their bad loans and shortage in liquidity.
  
• The state government writing off the loans usually compensates the banks, but it can take a number of years for the funds to reach the banks.
  
• Raghuram Rajan, the former governor of the Reserve Bank of India, has written to the Election Commission to recommend a ban on pre-election announcements relating to loan waivers.
  

It has become a common, albeit alarming, practice by India’s political parties in recent months to offer loan waivers to farmers while on the campaign trail. The move makes sense. Farmers are a huge vote bank and can be easily swayed by promises that their debts will go away.

But, ultimately, when the party makes good on its electoral promises, it’s the banks, taxpayers and most importantly, future governments that end up inheriting the problem. It’s the classic conundrum of short-term gain vs long-term instability.

Farm loan waivers offer immediate relief but don’t solve the problem of high input costs and weak prices of agricultural commodities. While they’ve been mooted as solution to preventing farmer suicides, the waivers actually apply to farmers with relatively large landholdings since they have the ability to secure loans from formal institutions. Smallholder farmers do not usually get covered under waiver schemes since they borrow money from loan sharks.

Loan waivers also prevent productive investments by the government in agricultural research and innovation. More importantly, based on the regularity of such handouts, farmers are disincentivised from servicing their loans in the first place.

One of the major reasons the Congress was able to wrest three very important states from the ruling BJP in the recent round of elections is because of its promises to write off farmers loans. It did, to be fair, take a cue from BJP governments in Maharashtra and Uttar Pradesh, which wrote off loans last year.

Within days of assuming power, the new governments of both Madhya Pradesh and Chattisgarh announced the waiver of loans with Rajasthan also following suit. The decisions endanger the recovery of a significant proportion of the ₹1.47 trillion worth of farmer loans outstanding in these three states.

After a loan waiver is announced, farmers stop servicing their loans. As banks won’t be able to recover these debts, the waiver portends a buildup in their bad loans and shortage in funds for the purpose of extending further loans. In addition, banks become reluctant to grant large loans to the agricultural sector.

The state government writing off the loans usually compensates the banks, but it can take a number of years for the funds to reach the banks.

And where do these funds come from? The coffers of the state government, or if it doesn’t have enough cash on hand, it raises the money from debt markets by issuing bonds. In essence, the government is currying favour from the electorate by taking a loan from taxpayers and future state governments, which will inevitably struggle to govern amid financial pressure.

Last week, Raghuram Rajan, the former governor of the Reserve Bank of India, said that he had written to the Election Commission to recommend a ban on pre-election announcements relating to loan waivers.

Despite Rajan’s efforts, the trend looks set to continue. Following their election losses, the Narendra Modi-led BJP government is reportedly planning their own handouts to farmers ahead of general elections in mid-2019.

Following a pledge from the Congress to provide a national loan waiver, the party in power at the centre is expected to write off ₹4 trillion worth of farmer loans over the next couple of months, which will exacerbate their fiscal deficit.

However, they will cross that bridge when they come to it. The immediate priority is of course, re-election and that means, playing into the demands of rural voters.


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