Just heart alone won’t suffice

Resolving the ‘agrarian crisis’ requires understanding the laws of economics

P Sainath’s years of experience covering India’s countryside lends a credibility to his voice. How unfortunate it is then that he should expend it on framing the issue in partisan, rich vs poor, urban vs rural terms. Here’s an excerpt from a recent interview he gave Tehelka

(The ‘agrarian crisis’) happened because through the reform years, we’ve been diverting resources, we’ve been robbing the poor to pay the rich. Now I cover guys who commit suicide because they’re not able to get less than 10% interest on Rs 8000 crop loan. I go back to my urban middle-class home in Mumbai where I get an invitation from my bank ‘buy a Mercedes Benz, no collateral at 4% interest’. So if you’re buying a Mercedes Benz – unproductive expenditure – you pay virtually no interest. If you are the food producers, you’re paying two to three times that interest. That’s the sheer injustice of it. [Tehelka, via Amit Varma]

In the interview he rails against the government (especially the previous one) for not doing enough, against journalists for being more interested in covering India Fashion Week and, quite unsurprisingly, at multinationals and genetically modified cotton for undermining the farmer.

It has been the The Acorn’s case that this crisis is caused by the government’s determined refusal to allow market forces to play in the agriculture sector. Its policies have created perverse incentives: leading to a scarcity in formal sources of credit that is the primary financial cause of farmer suicides. (See this post on Amar Akbar Anthony). The solution to India’s ‘agrarian crisis’, therefore, lies not in government largesse, but in its retreat. It lies in making rural and agricultural markets work.

Supporters of Sainath’s view may be quick to dismiss such proposals, coming as they do from people who have ‘not been there’. So here’s an article from someone who has (and still is) .

The discomfiting fact is that interest rates of informal lenders are difficult to control, whereas formal institutions which are under public scrutiny have to keep their interest rates low. Thus formal institutions tend to ration credit to small farmers since they are not able to meet their full costs. Transaction costs on small loans are necessarily higher than for large loans, when expressed as a percentage of the loan amount. The pricing should cover the cost of funds, the transaction costs and the risk costs (likelihood of bad debts). Most arguments in favour of lower interest rates for small farmers do not take this into account. As a result, banks find it unprofitable to lend to small farmers and effectively cut their losses by lending as little as they can get by without incurring regulatory wrath.

In India, though interest rates on small loans by RRBs and cooperative banks were deregulated in 1996, the amount of credit by these banks has not gone up significantly. This is because the regulatory cap was never removed for the largest channel of rural credit, the commercial banks, thus ensuring that RRBs and cooperatives could never significantly increase their interest rates. More recently, the government has been asking (though it has refrained from getting the RBI to direct) banks to reduce interest rates to farmers to 9%, on the grounds that interest rates on housing loans to the urban middle class were down to 7-8%. Though it is acceptable to compare these rates, what is not discussed is that the transaction cost of an urban housing loan is much lower because of high volumes per branch and much lower risk levels. Bad debts for housing loans are a fraction of one percent while those for agricultural loans are anywhere from 3-5%, even without the risk of politically motivated loan waivers, and with those included, the bad debt costs are much too high to be built into any reasonable interest rates.

Politicians, intellectuals and farmers all need to accept that small loans are more expensive and must be priced accordingly. Thus an answer to the credit needs of small farmers in India is to free up interest rates, not just in terms of regulation but in terms of acceptability. At the same time, the government should permit a whole spectrum of credit providers, formal and informal, to enter the field and compete with each other so that they can enhance the total credit flow and eventually bring down costs. No regulation can control supply and price simultaneously. So if more credit has to flow to farmers, the price (interest rate) must be deregulated. Initially it may go up, attract more players and then they will compete and bring down the rates. Ironically, this lesson from the housing and consumer finance market has been missed by our policy-makers. [Seminar]

This post also appears on The Indian Economy Blog.

8 thoughts on “Just heart alone won’t suffice”

  1. Nitin,

    IMO There is even more fundtamental issues.
    And that is there are too many persons involved in agriculture.
    This means
    1. Land holdings are fragmented (our land usage laws help in that ofcourse)
    2. Productivity is low.
    3. The scope of productivity enhancement through capital investment and technological upgradation is minimal

    The result is that as of now investing in agriculture doesn’t seem to be very attractive proposal.

    So if the aim is to see growth of rural population, even more urgent step is to encourage the migration from villaegs, which in turn is possible only with development of manufacturing industry and basic infrastructure.

    I think RISC model proposed by Atanu should work for that case.

    Regards

  2. “It has been the The Acorn’s case that this crisis is caused by the government’s determined refusal to allow market forces to play in the agriculture sector. Its policies have created perverse incentives: leading to a scarcity in formal sources of credit that is the primary financial cause of farmer suicides… The solution to India’s ‘agrarian crisis’, therefore, lies not in government largesse, but in its retreat. It lies in making rural and agricultural markets work.”

    I see a logical flaw in your argument. You agree that it is the government that ruined Vidarbha. It popularised a kind of seed that was disastrous for the farmers. It forced them to sell the produce at lower rates. Yes, the government has messed it up big time. Now, who must bear the cost of its mistakes? The farmers who have nothing to live on?

    A loan waiver would not be government largesse but compensation. I am sure that neither Sainath nor anyone else would object if the government pays the sum of money directly to the farmer hence enabling the farmer to pay back his loans. That way the loans will not become bad debts. Instead, the prospects of repayment will increase drastically.

    It is nobody’s contention that in normal circumstances, it is the government’s job to bail out anyone who’s gotten himself into trouble. But when the circumstances are such that the poverty itself is a result of bad government policies, isn’t it the government’s job to bail them out?

    I find it tough to follow all the economics behind the issue, but it seems to make sense to me that if it isn’t their fault that the crops failed, then the farmers shouldn’t be dying.

  3. Karthik,

    Directly paying off debts seems to be such a straightforward thing to do. Surely doing so may prevent farmers from committing suicide this year. But wait, government’s financial resources are limited. If we are not to raise taxes and get the whole country to come to the aid of the farmers, then the very same money could be used for example, to provide proper care during pregnancy, to vaccinate children against killer diseases, to build shelters for disaster victims, to equip counter-terrorism departments to prevent another major terror attack etc. If say Rs X Crore can save N lives, then there are plenty of choices for N.

    And writing off loans will just defer the problem only for a year or so.

    So merely paying the farmer to settle his loan is simple enough (and our politicians have done that before) but is not a solution. In fact, it’s part of the problem. Govt routinely forces rural banks to write off small loans, which makes them reluctant to lend money. They ration loans by hiking interest rates (and that is exactly the problem Sainath is pointing out). Farmers turn to moneylenders. Government bans private moneylenders. Interest rates go up even further as supply of credit dries up. Farmers take out loans at higher rates of interest to pay off older (cheaper) loans.

    So, the real solution is increase the supply of credit, ie bring lenders in—rural banks, micro-credit institutions and private moneylenders. (This addresses one part of the issue, I’ve outlined others in my earlier post)

    But yes, there is a need for emergency measures. Those may include the government purchasing outstanding loans from the rural banks, but only as part of a larger reform programme.

    As for failed crops…we must face the fact that the crop failure is a risk that farmers take in doing their jobs. Every job has risks, and unless people are forced into the job, they take those risks consciously. In many jobs, it is easy to mitigate those risks (through insurance, for example). The issue is not about whose fault it is when crops fail, but rather, what ways they have to mitigate the risk of crop failure.

  4. “The solution to India’s ‘agrarian crisis’, therefore, lies not in government largesse, but in its retreat.”

    As long as politics is alive (not a bad thing) the retreat won’t happen. I have a longer comment on IEB.

  5. Mr. Pai,

    I don’t understand your logic. Do you agree when I say that the loan waiver/purchase is compensation and not largesse? If you do, then why must the compensation be necessarily linked to the reform programme?

    Consider this anology. There is an accident in a factory due to negligence of the owners and n people are hurt. Should a thorough revamping of the safety apparatus in the factory be a pre-condition to the payment of compensation to those hurt?

  6. Karthik,

    It’s not compensation. It’s relief assistance, a form of aid. It has to be linked with the reform programme in order not to waste taxpayers money on fruitless tasks. If you do as you’ve always done, you’ll get what you’ve always got. Fixing the bucket should be a prerequisite before pouring more water into it.

    I don’t think the analogy is suitable in this case. But if you are an insurance company insurance two similar factories, one with good safety processes and one without, you are likely to find the one with good safety processes more insurable.

  7. Karthik, why do you say government is responsible for farmers failed crops? Do you know they are paid below market prices? Do you know they were provided substandard seeds by government?

    As far as I know, government makes market for food products, not cotton, and pays above market prices and lets FCI to store and distribute the purchased food – a very inefficient and bureaucratic process. And there is nothing that suggests that seeds were bad or Monstano supplied genetically modified seeds – I can just see the anti-global & anti-GMO NGOs falling over themselves to crucify Monstano or its cohorts, if this were true.

    It’s a credit and failed crops issue and risk (and return) primarily has to be borne by farmers themselves. Govt can help, but its approach to the problem is piece meal and its not providing a long-term solution as persistent suicides year after year indicate.

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