Policy Watch: Teaching the honest to become dishonest

The Comptroller and Auditor General (CAG) of India has indicted the government for not ensuring loan waiver schemes benefit the right people. Its sample survey of the agriculture debt waiver and debt relief (ADWDR) scheme of 2008 showed that around 17% of the loans were waived off in violation of guidelines.

The loan waiver involved a staggering Rs 65,318 crore. Going by the survey yardstick of 17%, this undue benefit could have exceeded Rs 11,000 crore. Outlook India put the figure at around Rs 35,000 crore, or almost half the entire outlay.

In truth, loans waivers hurt both farmers and bankers. This is because banking works on the fundamental principle that debt obligations must be met. If any person cannot meet his debt obligations, the state must allow creditors to promptly attach the defaulter’s assets, or to penalise the defaulter as a means to deter other people from defaulting.

But when a government announces a loan waiver, it is actually telling honest people to become dishonest. Such a move corrodes value systems in a society. It also savagely rocks the very foundations of a banking system.

When such a waiver is extended to a farming sector, the government does more damage. It tells farmers to forget their belief that not repaying loans is bad; that they should not take pride in telling the world that they have repaid the debts of their family.

If the government wants to help poor farmers and the under-privileged, it should instead give them money to repay the loans to banks. That way, assistance does not result in corrosion of a value system on the one hand, and the institution of banking on the other.

As a result, see what has happened. This table below, taken from the Reserve Bank of India, shows how repayments are progressively getting worse.

After the 2008 loan waiver, almost 24% of the loans given were not returned. This grew to 26% in 2010 and 27% in 2011. More farmers began to delay repayments, confident that some politician would announce another waiver. They were not entirely wrong. Rahul Gandhi did announce a loan waiver to weavers in Uttar Pradesh, just before the elections were announced there.

A 24% default rate is a very serious situation. HDFC, which gives home loans to householders and is thus a lender to the priority sector, saw defaults of barely around 2%. NGOs which lend money to the underprivileged have default rates of just around 2-5%. Obviously, a 25% default rate is horrifying.

The consequences are inevitable. Banks are now unwilling to lend to the agricultural sector, unless backed by collateral, which can be easily sold off. As a result, marginal farmers, who do not have collateral to offer, are compelled to borrow money from moneylenders at usurious rates.

In other words, the government’s loan waiver actually promotes money lenders as well.