RBI policy: Why Urjit Patel’s perfect U-turn on the impact of farm loan waivers is really hard to understand

Reserve Bank of India (RBI) Governor Urjit Patel, a man of few words, used to be a vocal critic of the very idea of farm loan waivers. Whenever confronted with questions on farm loan waivers, Patel has spoken out, in public and on multiple occasions, against its ill effects on the banking system.

That, however, wasn’t the case on Wednesday.

At the post monetary policy announcement presser, responding to a question, Patel seemed to play down the impact of farm loan waivers on the banking system, saying that there is no direct impact on bank NPAs (non-performing assets) since state governments have provided for such schemes in their respective budgets.

This is what Patel said, "Farm loan waiver has been given through Budget of individual state governments so far. Therefore, implications on the banks' NPA directly are not there.”

What Patel is saying is only half truth and works only in theory. Technically, it sounds alright to say that if states make provisions for loan waivers in their budgets, banks needn’t worry since the money will come from government to compensate their losses.

A file photo of RBI Governor Urjit Patel. AFP

A file photo of RBI Governor Urjit Patel. AFP

But, in the real world, things do not happen that smoothly. The indirect impact on banks’ balance sheets, by way of large-scale destruction of the credit culture, post the announcement of farm loan waivers is much more than any direct impact.

None other than Patel has explained the hazards of farm loan waivers in the past. Let’s revisit his comment on the issue in April 2017. "I think it (loan waiver schemes) undermines an honest credit culture. It impacts credit discipline. It (impacts) incentives for future borrowers to repay. In another words, waivers engender moral hazard,” he said after announcing the first bi-monthly monetary policy for financial year 2017-18.

“If on account of this overall government borrowing goes up, yields on government bonds also get impacted. Thereafter, it can also lead to crowding of the private borrowers as higher government borrowing can lead to increasing cost of borrowing for others,” Patel had said.

On another occasion, Patel had warned the states about the likely fiscal pressure on state governments using budget allocations for farm loan waivers. In August, 2017, Patel said farm loan waivers lead to “higher than budgeted revenue expenditure” since state governments utilise public money to repay banks holding the farm loans, thus stretching fiscal deficits and steering money away from needed functions such as capital spending.

Further, Patel also warned that banks are impacted as they must wait for governments to repay farmer loans, preventing lenders from  providing new loans in the interim period.

Now, read this in conjunction with what Patel said on Wednesday. “Farm loan waiver has been given through Budget of individual state governments so far. Therefore, implications on the banks' NPA directly are not there.” Meaning, Patel contradicted his previous warning that bank finances may get impacted due to the wait for refunds from state governments.

It is quite surprising that Patel chose to play down the impact of farm loan waivers now. Particularly at a time when many state governments are announcing farm loan waivers one after another, raising serious challenges to the banking system.

As empirical evidence from the past shows, even if governments provide for a farm loan waiver, banks do not get compensated in time, which leads to capital shortage for fresh lending to productive sectors.

The double whammy is that the credit culture, the discipline even among honest borrowers, takes a hit. People stop repayments on day one of the waiver announcement irrespective of whether the waiver actually happens or not. The biggest hit will be on state-run banks that typically have to bear the burden of all state-sponsored farm loan waivers.

The farm loan waiver became a popular tool of political populism after former finance minister P Chdamabaram set the ball rolling in 2008 with a Rs 70,000 crore farm loan waiver. Since then, many states have walked into the debt trap.

Karnataka’s new JDS-Congress government has just announced a Rs 53,000 crore farm loan waiver. The state doesn’t have the fiscal wherewithal to fund the waiver, probably one reason why the newly appointed chief minister, HD Kumaraswamy, has announced an austerity drive asking all ministers to cut down all ‘unnecessary expenditure'.

Rajasthan has announced a Rs 8,500 crore farm loan waiver, Maharashtra is struggling to walk the talk on its Rs 34,000 crore loan waiver and Uttar Pradesh has made a similar waiver announcement. Here again, implementation has met with myriad issues. According to rating agency India Ratings, farm loan waivers are likely to raise the states' deficits by Rs 1.08 lakh crore.

Patel knows of the full impact of the ‘moral hazard’ that a farm loan waiver causes, and of the direct and indirect impact on the banking system.

Yet, his statement on Wednesday appeared like he is taking a perfect U-turn on the issue. The governor's move raises more questions on the central bank’s new stance on the impact of fiscally imprudent, politically populist policies on the banking system.

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Updated Date: Jun 07, 2018 11:31:30 IST

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