Avoid blanket loan waivers

Such populist measures affect credit discipline

In the wake of the Bharatiya Janata Party’s sweeping victory in the Uttar Pradesh Assembly elections, one particular campaign promise has received particular attention and led to political upheavals across the country. The BJP had promised that, if it came to power in Uttar Pradesh, it would waive loans taken by small and marginal farmers. Not surprisingly, other states — not to mention other political parties — have also got into the act and competitive populism reigns. The Congress has demanded a nationwide loan waiver. Though his state’s budget did not make any provisions for a farm loan waiver, the chief minister of Maharashtra, Devendra Fadnavis, did lead a delegation to New Delhi to demand similar measures for farmers in his state. Other states like Punjab are also desirous of seeking the Centre’s help. However, in a series of tweets, Union Agriculture Minister Radha Mohan Singh refuted reports claiming that state-level farm loan waiver costs would be borne by the Centre. It is a different matter, though, that such a decision may change if the political climate requires it to. But the larger point is that, regardless of whether or not they are sold as a decision by a state government or the Centre or whether the cost is borne by the state government or the Centre, blanket loan waivers are not advisable.

Policymakers must evaluate the merits of this course of action because the problems with such a waiver are substantial. For one, it will stress a banking system that requires no further shocks after it has been rendered fragile by a build-up of non-performing assets. A further escalation in such unpaid loans following the declaration of a loan waiver — and the behavioural changes in its wake — might be one step too far for the most troubled banks. As State Bank of India Chairman Arundhati Bhattacharya said recently, in case of a loan waiver there is always a fall in credit discipline because the people who get the waiver have expectations of future waivers as well. The moral hazard associated with frequent waivers is deeply problematic; it incentivises the worst kind of borrower behaviour. Each successive loan waiver increases the number of irresponsible borrowers. Not to mention the cost of such waivers. For instance, according to an SBI estimate, at Rs 27,420 crore, the proposed farm loan waiver in UP will eat up 8 per cent of the total revenue and upset the state’s fiscal math for the coming financial year. 

There is extensive experience of such moral hazard situations, and it is clear that while the relief is modest and temporary, the long-term ill-effects are many, severe and far more lasting. The 2008 loan waiver undertaken by the Congress-led United Progressive Alliance government cost over Rs 70 lakh crore and helped drive up the fiscal deficit by a record amount that year. The trouble is that the same waiver was seen by many as the key reason for the UPA’s returning to power in the 2009 general elections. But apart from naked political ambition driven by populism, there is little economic reasoning backing the introduction of loan waivers into the policy mix again. This is not to say there cannot be specific cases, such as the occurrence of a natural calamity, that may merit some relief. However, blanket loan waivers are a poor policy choice and should be avoided.