The loan waiver: A primer
Its time for the government to reconsider its anti-poverty programmes. The subsidies can readily finance generous direct cash transfers, vouchers for primary education, and health insurance for the poor, says Arvind Panagariya.
THERE has been much confusion on the implications and desirability of the loan waiver programme announced by finance minister P Chidambaram in his 2008-09 Budget. There is need for clarity of thought so that each of us can arrive at an informed judgement on whether the proposal is a net plus or minus for India.
My own bottom line is that given the daily hardships marginal and small farmers face, virtual absence of formal social safety nets, and 8-9% overall growth per year, the waiver is justified. At the same time, politicians on both sides of the aisle need to use the occasion for serious soul searching on devising the right policies to help the poor. Are repeated loan waivers the right instrument? Should borrowing and lending not be based entirely on commercial terms with better-targeted instruments deployed to aid the poor?
The budget proposes to waive in entirety all loans disbursed to marginal and small farmers by scheduled commercial banks, regional rural banks and cooperative credit institutions up to March 31, 2007 and overdue as on December 31, 2007. Marginal farmers are defined as those with less than one hectare of land and small farmers those with one to two hectares of land.
The budget also offers larger farmers a one-time settlement scheme (OTS) for loans overdue on December 31, 2007. Under the scheme, the budget gives a rebate of 25% provided the farmer pays the remaining 75% of overdue loan. The budget estimates the volume of overdue loans of small and marginal farmers at Rs 50,000 crore ($12.5 billion) and places the cost of the OTS at Rs 10,000 crore ($2.5 billion). The sum of these numbers is a little below 1.5% of the GDP.
Four distinct criticisms of the waiver have appeared in the press. First, some have questioned the value of the waiver to the truly distressed arguing that the latter borrow mostly from informal sources such as the village moneylender. Therefore, those truly distressed reap no benefit from the waiver. This is an erroneous argument for two reasons. First, informal sector borrowing is likely to be the last rather than the first resort for most borrowers. Data will likely support the hypothesis that the vast majority of those who borrow from informal sources (moneylender) have already exhausted their ability to borrow from formal sources (banks). The loan waiver restores the access of these borrowers to the formal sector and, thus, enhances their ability to repay their informal sector lenders. Second, the vast majority of marginal and small farmers live hand to mouth. As such the waiver does redistribute income in favour of those in the bottom deciles of the population.
Second criticism concerns the impact of the waiver on fiscal deficit. Here it is not clear what the finance minister would have done, absent the waiver. Would he have cut expenditures by an equivalent amount or chosen to spend the savings on alternative items? Besides, if deficit is to be cut further, there are other items more deserving of the FMs axe: why not go after some other subsidies that are far more regressive?
THIRD, it has been suggested that the waiver will have an adverse impact on the balance sheet of banks. Writing in the immediate aftermath of the budget, one commentator went so far as to attribute a 4% decline in the bank index to the waiver. While loan waivers make bad financial policy for a different set of reasons, this argument is outright wrong. From the viewpoint of banks, the funds offered by the government to finance the waiver will convert bad loans into good ones. Their net worth will rise, not fall.
The final criticism is attributed to the EU trade commissioner Peter Mandelson who is reported to have told commerce minister Kamal Nath that the waiver amounts to an agricultural subsidy. If correctly reported, this is an astonishing assertion by the EU trade commissioner. The waiver is entirely consistent with the WTO rules: it is unrelated to agricultural production in any way and therefore legal under the socalled Green Box.
While many of the criticisms are thus refuted and the waiver defended as an aid to the poor and destitute, in the long run, it makes a poor instrument of income redistribution. For example, it is bound to encourage both borrower and lender to engage in non-viable loan contacts in the hope that a future waiver will bail them out. It will also encourage borrowers capable of repayment to default. The current waiver also has a clear regressive element in it: it adjusts downward the debt of even larger farmers by 25% at the cost of Rs 10,000 crore ($2.5 billion) to the exchequer.
Many other subsidies offered with the intention to help the poor suffer from similar deficiencies. Subsidies on fertiliser, power, food procurement and water systematically go to richer farmers. Who but the owners of large farms can avail of these subsidies in vast volumes? Even in the area of health, only 20% of the patients in rural areas avail of publicly provided services due to rampant absenteeism of health care workers at public health centres.
It is time for the government to carefully reconsider its anti-poverty programmes. The existing subsidies can readily finance generous direct cash transfers, vouchers for primary education, and health insurance for in-patient care to the bottom 30% of the population. The current budget makes an excellent beginning on the last of these items but much more needs to be done. Once these direct instruments are deployed to redistribute income to the poor, loan transactions, food procurement, fertiliser sales and electricity and water provision can be done on commercial terms. The experience of Brazil, Chile and Mexico may be worthwhile to study in this context.
(The author is a professor at Columbia Univesrsity and senior Non-resident Fellow
at the Brookings Institution)
at the Brookings Institution)