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C L Dadhich: Rural castles built at farmers' cost

The Rural Infrastructure Development Fund has ended up effectively diverting mandatory credit from farmers to state governments

C L Dadhich 

C L Dadhich

Please read the clarification at the end.

The (RIDF) scheme was instituted in 1995 within the National Bank for Agriculture and Rural Development (Nabard) to mobilise funds from domestic commercial banks to the extent of the shortfall they incurred in meeting priority sector lending stipulations for agricultural and allied activities. Under the scheme, commercial banks deposit with the amount equivalent to the shortfall in the mandatory stipulation at an interest lower than the prevailing interest rates on priority sector advances.

was expected to provide low-cost fund support to state governments and state-owned corporations to quickly complete rural infrastructure development projects, including social development projects. The main objective of the scheme is to indirectly pressure the banks to achieve the priority sector obligations. The underlying objective is to provide funds to the state governments to develop rural infrastructure. However, the latter objective has effectively deprived of credit facilities from banks for investment in agriculture.

The corpus is announced every year in the Union Budget in the form of an aggregate allocation, which is then allocated to banks during the year on the basis of the level of their shortfall in meeting the mandatory stipulations for priority sector lending. Since its inception, the scheme has made rapid strides in terms of allocations (see table). With an initial allocation of Rs 2,000 crore, under I for the year 1995-96, the annual allocation gradually increased to Rs 20,000 crore under XVIII (2012-13).

Over the years, shortfalls have increased manifold in absolute terms. Consequently, thousands of the Indian missed the opportunity to avail of bank credit. Assuming an average loan amount per account at Rs 10,000, the diversion of Rs 20,000 crore to means that about 200,000 missed the opportunity to enter the banking network. Depriving from their earmarked share in credit and diverting this money to the state government is like robbing Peter to pay Paul. In India where out of the 140 million farm families only 50 per cent have access to institutional credit, the scheme has done untold damage to distributional justice.

This has happened mainly because banks prefer to invest in since these deposits fetch higher returns vis-à-vis priority sector lending. It goes without saying that priority sector lending is a somewhat losing proposition owing to the higher transaction cost of financing of a large number of small-sized loans involving higher credit risks, whereas at the existing interest rates on deposits, the investment in is a highly paying business proposition.

Of late, although interest rates on deposits have been linked to the Bank Rate, depending on the level of shortfall (the lower the shortfall, the higher the interest rate and vice versa) banks earn about 6.5 per cent interest at the lower end of the shortfall spectrum compared with a net return of about 4.5 per cent on priority sector loans to

Against this backdrop, it is no surprise that the shortfall continued unabated. It is interesting to note that as on the last reporting Friday of 2012, the advances of public sector banks to agriculture and allied sector under the priority sector was 15.5 per cent and that of private sector banks was 14.5 per cent against the target of 18 per cent. At a disaggregate level, 15 out of 26 public sector banks could not meet the target, while 13 private sector banks failed to do so. The growing incidence of shortfalls in meeting the priority sector target led to a higher demand for allocation.

Fortunately, wise counsel still prevails and allocations under are limited and restrictive in nature, otherwise banks would have preferred to invest more and more in instead of financing Since we cannot afford the luxury of financing states for building rural infrastructure, it is high time interest rates on deposits were reduced substantially to compel banks to finance under priority sector lending stipulations. One enduring solution would be to penalise heavily banks that do not meet the mandatory stipulations relating to priority sector lending as is being done in case of cash reserve ratio defaults.

In short, the scheme is being implemented at the cost of poorer It must be revisited further in view of the introduction of the trading facility in priority sector advances (transfer of excess priority sector advances to banks having a shortfall). Also, with the introduction of the under the financial inclusion programme, the is no longer relevant, even for banks that do not have an adequate rural branch network. As far as financing of rural infrastructure projects is concerned, it should be accomplished through budgetary resources rather than by grabbing priority sector advances. This apart, a unique public-private partnership project for rural infrastructure as explored by may be tried with advantage on a large scale to augment not only financial resources but the organisational capabilities of state governments as well.
A clarification
(RIDF) deposits are drawn from banks that have already defaulted in priority sector lending and not vice versa. Further, only investments in deposit do not count for priority sector lending. According to the Reserve Bank of India (RBI) guidelines on deposits, the interest paid on bank deposits varies from the Bank rate minus two to five per cent depending on the shortfall in priority sector lending, which ranges from seven to four per cent (gross), and the author’s contention of deposit rates at 6.5 per cent is erroneous.

Further, the author has illogically compared the gross interest rates on deposits (6.5 per cent) with net return on priority sector lending (4.5 per cent). If we consider the weighted average cost of deposits, the return from deposits would even be negative, thus making it a disincentive to invest in deposits for the banks.

The corpus at Rs 20,000 crore for 2013-14 constitutes only 12.7 per cent compared to the priority sector shortfall by public and private sector banks at Rs 1.35 lakh-crore and Rs 0.22 lakh-crore based on the data published in the RBI Annual Report 2012-13.

loans have been utilised by state governments to create much-needed capital formation in agriculture and critical rural infrastructure. Since inception, Rs 1,40,948 crore has been disbursed under creating 21.6 million ha of irrigation potential, 3,74,000 km of rural roads and over 10.9 million regular rural employment. Impact evaluation studies by IIM-Bangalore, IIM-Lucknow, IIT-Roorkee and Mitcon have reported significant improvements in cropping intensity, yield, income and in living standards, apart from credit flow by commercial banks, regional rural banks and co-operative banks in project areas.

Thus, has actually enhanced the enabling environment for priority sector credit, rather than depriving of their share as argued by the author.

P V S Suryakumar, Chief General Manager Corporate Communications, Nabard, Mumbai

C L Dadich replies:
On the point that deposits are derived from the default (shortfall) in mandatory stipulations, my point is that rather than instituting RIDF, RBI should have taken stringent actions to ensure that get mandatory credit. Second, taking into account the average interest paid during 2012-13, according to Nabard’s Annual Report, interest paid on deposits was Rs 4,414 crore (Page 108) and deposits were Rs 78,758 crore, so average rate of interest works out to 5.6, say six per cent, which is marginally lower than 6.5 per cent in my original article. Third, it is well known that interest on crop loans up to Rs 3 lakh is four per cent plus three per cent interest subvention minus 2.5 transaction cost. That makes 4.5 per cent net returns on agricultural advances under the priority sector. If the interest on deposits is negative, why is there a beeline by banks to deposit in Third, I agree that investments in rural infrastructure projects are critical but these should be taken up through budgetary resources, rather than through a shortfall in mandatory credit. Rural infrastructure projects cannot substitute farmer-centric projects. As far as the benefits of the evaluation studies are concerned, the benefits of farmer-centric projects refinanced by are similar. There is no substitute for RBI enforcing the mandatory stipulations in letters and spirits to ensure credit to

The writer is former director of rural economics, RBI. The views are personal.