The Rs 716.8-billion waiver of farm loans, among the largest financial handouts in Indian history, has attracted both critics and admirers. While some like the Finance Minister, P Chidamabaram see it as a “remarkable and unprecedented success” giving relief to 40 million families in the country, others see it as adding to the country’s fiscal stress, pushing the government deeper into the red.

But there is another group of economists, who while not disputing the scheme, have raised questions about its timeliness, the singularity of its approach and the government’s failure to package it with other reforms leading to greater financial inclusion of the rural people.

Defending the loan waiver package, Prime Minister Manmohan Singh said his government took the “historic initiative to waive farmers’ loans on an unprecedented scale” because of the “unpaid distress bill” left behind by the NDA government. But, the question that arises here is why did the government not announce the measure in its earlier years in power? Supporters of the scheme argue that this one-time relief is a necessary measure to address the current agrarian crisis and that it will enable farmers to restart on a clean state.

Leading bankers too feel that the scheme would not have any adverse affect on the public sector banks (PSBs), the major lenders to the farmers. “We are confident there will not be any negative impact on the PSBs when the settlement modalities are finalised. The government will take care of the interests of the PSBs,” feels T S Narayanasami, Chairman, Bank of India.

But, experience shows that such schemes only encourage willful defaults; do not reach the intended beneficiaries; and if not accompanied by other measures almost always result in long-term loss. This, experts say, is evident if one looks at how the cooperative credit system has been affected by the conscious state policy of interference in the grant and recovery of loans.

Rural India is today facing problems on two fronts – one, the decelerating growth in agricultural production that leads to reduced income and two, the lack of sufficient employment opportunities that makes livelihood uncertain for millions. Both of these do not lend themselves to a quick-fix solution, something that the farm loan waiver scheme is seeking to achieve. But as Punjab National Bank Chairman and Managing Director K C Chakrabarty recently said on the sidelines of an industry conference, “we are not talking about loan waivers for willful defaulters.”

Seconding him, P P Mallya, Chairman & Managing Director sought to dispel the popular notion that most farm loans end up as non-performing assets. He said that his bank recovered nearly 80 per cent the loans to the agriculture sector. “We are now seeking to substantially increase our portfolio of lending to the agriculture sector.”

While it is true that there has been no widespread agricultural distress emanating from massive crop failures, what is also true is that rural households today are caught in a price spiral and that too at a time of declining incomes. In such a scenario, it is the small and marginal farmers that are the worst hit. As the Radhakrishna Committee report on rural indebtedness noted, as more than half of the farm households did not borrow from institutional sources and that they were paying usurious rates of interest to moneylenders, it wanted the banks to make one-time term loans to such farmers to free themselves from their clutches. Similarly, it also mooted a Moneylenders Debt Redemption Fund with a corpus of Rs 100 crore.

As Chidamabram admitted in his budget speech – when he also announced the farm loan waiver scheme – “the Radhakrishna Committee had examined rural indebtedness in all its aspects but had stopped short of recommending waiver of agricultural loans.” Instead, what the committee suggested was that institutional sources must expand their reach. It said timely and adequate credit could be ensured by toning up the rural financial architecture and for this, it proposed the creation of a Rural Infrastructure Development Fund. The Committee noted that: “the root cause of the current crisis (in Indian agriculture) is not indebtedness alone – indebtedness is just a symptom. The underlying causes are stagnation in agriculture, increasing production and marketing risks, institutional vacuum and lack of alternative livelihood opportunities…”

And to treat these causes what is needed is to take growth to the countryside. This means promoting greater financial and social inclusion. In terms of financial inclusion, what is needed is that the government first takes savings, payments and insurance facilities to the poor, and follows this with credit. But, as the farm loan waiver scheme shows, it is credit facilities that are reaching the rural poor. In such a scenario, schemes like waiver of farm loans will only have a palliative effect, with little long-term benefits to the rural populace.

The government does not have to provide the services to the poor, but they need to make sure that what is provided works effectively, and sometimes they have to pay for that provision. For example, a real problem in the rural areas is how to ensure that the existing facilities are functioning effectively. This can be possible only if one puts purchasing power in the hands of the poor.

So, what were the reforms that the government could have packaged with the farm loan waiver and which would not have attracted much criticism from their then alliance partners, the Left parties or even the Opposition? As the World Bank’s Martien van Nieuwkoop, Lead Rural Development Specialist, and Dipak Dasgupta, Lead Economist, spell out, what is needed is to shift use of central funds to transform the rural areas with roads, water supply, electrification, research and extension, market support and other facilities. “Such transition may, however, not be easy because of the long years of reliance on the system, the modest gains that farmers currently receive, and the lack of confidence in taking bold measures.”

Another step could be organising farmers so that they are better positioned to capture economies of scale in agricultural marketing and value addition, by doing away with regulatory barriers to domestic marketing and trade. A related issue is facilitating agricultural diversification, together with an integrated extension and research system that emphasises on-farm practices. While the computerisation of land records is progressing, a comprehensive effort is needed to improve land administration. Also, there is need to strengthen the monitoring and evaluation system. Reliable learning of what works and what does not will allow cutting out the duplication and fragmentation of many existing schemes.

As another agriculture scientist pointed out the government could have used the farm loan waiver announcement to also establish institutional linkages to provide products the farming community misses sorely. For example, funds could also have been used to upgrade the crop insurance programme from yieldbased insurance to rainfall / weather index-based insurance. This could have provided some kind of a permanent solution to the beleaguered farmers.

Says Devinder Sharma, a New Delhi-based food and trade policy analyst, “although three years late, the loan waiver is a good first step in helping the agrarian economy recover. It should help improve the declining sustainability and the economic viability of farming. What is needed today is that the government comes out with a plan to rejuvenate agriculture so that indebtedness does not become a recurring phenomenon.”

Again, the government could also have put in place a network of credible warehouse agents, including assayers. This could help the farming community in availing of increased post-harvest credit and reducing price risks. Of course, prompt passage of the Warehousing Regulation and Development Authority Bill is needed but this does not warrant any investment on the part of the government.

In an address on financial inclusion at the Administrative Staff College in Hyderabad, Vijay Kelkar, one of the architects of the economic reforms, noted that access to finance has a positive impact on poverty alleviation and improving access to risk-mitigating products has to be a key part of any policy that seeks to increase financial inclusion. In this case, he suggested that financial inclusion can be promoted by coupling it with the delivery of various government subsidies through a smart card. The establishment of a universal, national ID system based on smartcards holds enormous potential to increase the efficiency of delivery of both government services and financial inclusion.

Here, however, improving financial literacy of the rural populace is very important as financial products are different from the usual products because of information asymmetry. And the poor is more conscious of the asymmetry because of volatile incomes. Thus, while finance may help lower income volatility, the poor are not aware of or even in the know of availing such services.