Economy: Farm loan waivers: Economic costs and other effects - Kotak

Farm loan waivers: Economic costs and other effects. Policies such as farm loan waivers do not address the fundamental problems of the Indian agriculture sector. In fact, it creates moral hazard problems leading to expectation of such waivers and inducing demonstration effects1 at the national level even if the economic impact is restricted to specific states. We believe, if major agricultural states resort to such loan waivers, the impact on consolidated fiscal deficit could be 1.0 to 1.3% of GDP. This impact is likely to be spread out over three to five years, cushioning the near term economic impact to 0.2-0.4% of GDP.

Fiscal impact of 1.0 to 1.3% of GDP could be spread out over three to five years

According to unconfirmed media reports, Karnataka, Madhya Pradesh, Maharashtra, Punjab, and Uttar Pradesh are looking at farm loan waivers. Obviously, the structure of the schemes will vary across the states. We estimate that around Rs1.6 tn of farm loans (0.9% of GDP) could come up for waiver. Given the fiscal position of some states and the likely impact of these loans, they may stagger the payout over three to five years. Consequently, slippages to consolidated fiscal in FY2018 will be around 0.2 to 0.4%% of GDP and could lead to higher borrowing if no expenditure adjustments are made. Loan waivers could increase to Rs2.2 tn if other prominent agricultural states Bihar, Haryana, and West Bengal also opt for it.

Adverse volume and price effects could have affected farmers' incomes

Two consecutively weak monsoons followed by a good one may have led to a combination of adverse impact on volume (due to weak monsoons) and prices (due to good monsoon) for the farmers. These effects have likely hurt most farmers, especially in perennially drought affected districts. Across cereals, pulses and oilseeds farmers' profitability would have increased significantly over FY2015 levels (except for paddy). But, we note that the calculations are based on MSPs which have seen secular increase. In reality, prices, especially of pulses and vegetables, fell sharply from the highs in early-2016 as the volumes improved hurting margins significantly. On the other hand, there have been positive externalities for farmers from recent initiatives (e-NAM, hoarding curbs, etc.) to minimize leakages from their value chain. Overall, farm loan waivers may seem justified for some areas, but itremains a fallout of the shortfall in adequate supply side measures.

History keeps repeating

In India farm loans were waived by the central government in 1990 (~Rs100 bn) and 2008 (~Rs600 bn) and by state governments such as Andhra Pradesh (~Rs240 bn) and Telengana (Rs170 bn) in 2014. But, these did not have any long term positive impact. In fact, it possibly created a negative environment for farmers where banks showed reluctance to lend to them again. Further, these waivers do not address the fundamental problem of raising agricultural productivity which in turn will be much more remunerative to them. On the contrary, they bear economic costs in the form of likely fiscal slippages leading to higher borrowings and/or lower developmental expenditure.

How to mitigate farmers' distress?

Key problem areas for the agriculture sector are (1) low productivity, (2) "leakages" in the value chain, and (3) inefficiencies in factors of production (land, labor, and capital) which lead to agrarian distress and demand for waivers in times of crisis. We note some methods and areas where adequate focus should be given. We note that most issues have been pending for long with solutions being implemented at a laggard pace.

- Increasing productivity. One of the most problematic issues in Indian agriculture is to increase productivity with low average productivity at the national level and high regional variations. To increase productivity, the focus should be on three broad areas: (1) quality and usage of key inputs such as fertilizers, pesticides, seeds, and irrigation; (2) usage of modern technology in terms of equipment as well as seeds, especially the genetically modified ones which could reduce uncertainties due to weather and yield better produce; and (3) shift farm jobs to more remunerative ones such as horticulture and animal husbandry. It is now well established that India's agriculture sector faces severe problems from inadequate irrigation facilities, sub-optimal usage of fertilizers and pesticides, and need for better quality seeds to increase productivity.

- Leakages in value chain. We believe that the problem of inadequate remuneration for the farmers is also due to the existence of middlemen and hence the absence of efficient price discovery mechanism. Some anecdotal evidences and estimates indicate that the farmers receive only around 25-30% of retail prices, especially for perishable crops. Archaic APMC laws have been blamed for this institutionalization of middlemen in the value chain. Some states have amended the APMC Acts in the last few years. Additionally, the government has launched the e-NAM portal which aims to unify agricultural markets across India. There are around 2480 APMCs and 4850 sub-market yards regulated by the APMCs. Even though the e-NAM project is at a nascent stage (needs amendment to APMC Acts in states), it can effectively weed out middlemen and enable farmers to directly negotiate with retailers enabling better remuneration and price discovery.

Further, the logistics space in terms of warehouses and cold storages will need to improve and expand to incentivize production of perishable crops and improve the procurement system. Even as the government announces MSPs for a variety of crops, it effectively procures only cereals and, more recently, pulses. In times of domestic supply glut, the government also needs to be open to the idea of exports (even if controlled but proactive) such that farmers do not lose out their produce. The role of the private sector in collection, distribution, and retailing could also be explored on a much larger scale similar to that of dairy cooperatives.

- Factors of production. The biggest challenge to productivity gains for Indian agriculture has been the increasingly fragmented land holding patterns. This has hindered large-scale mechanization as well as capitalizing on economies of scale. Hence, the subsistence, small and marginal farming continues to form the bulk of the farming community. This also keeps disguised unemployment high as labor continues to remain an essential factor even though it increases cost (or imputed cost in case it is not hired labor). Capital intensive farming remains contained to larger land sizes. However, there is no easy solution to this problem. Land leasing laws have led to concealed and unofficial tenancy records. Hence, identification of actual farmers rather than just the land owners has been a major problem. This creates distortions in public policy while aiming at DBT and disaster reliefs. The size of the land as well as land ownership rights have created a problem for resale of land and development of a more transparent and vibrant market.

[1] Demonstration effects are effects on individual behavior caused by observation of behavior of other individuals (peers, community, etc.)

Source : Equity Bulls

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