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Even as various state governments implement debt waiver schemes for distressed farmers, there are reports that have suggested that the central government is looking at this policy with an eye on general elections due by May.

This is not entirely unheard of, given that the United Progressive Alliance (UPA) government implemented the Agricultural Debt Waiver and Debt Relief Scheme (ADWDRS) in 2008, which unconditionally relieved debts of nearly 40-60 million farmer households.

Previous Mint editorials have expressed almost ad nauseam that farm loan waivers are not the answer, even citing a 2009 paper, which showed that public sector banks typically lend more in election years, and are therefore subject to political capture.

There is also other particularly worrying evidence on the ineffectiveness of the ADWDRS itself. World Bank economist Martin Kanz finds in a recent paper that the loan waiver scheme did not have any positive impact on household savings, credit uptake from banks, or investments.

Economic theory suggests that waiving debts via such a scheme will lead to debt overhang (essentially stagnated investments due to any new income being used largely for paying back old debts). However, Kanz, in another study with co-author Xavier Gine, finds no evidence of loan waivers alleviating this phenomenon: increasingly, farmers shifted away from formal credit to risky informal credit and banks redirected credit to less risky avenues. Thus, the scheme resulted in a double whammy despite being well-intentioned and perhaps even well-targeted.

To better understand the shortcomings of unconditional farm loan waivers, it is important to consider it from the perspective of the potential beneficiary. A farmer who is eligible for loan waivers faces two problems well-documented in finance and economics. First, there is the risk of inducing strategic default due to moral hazard. This simply means that because the farmer knows that the loan will be waived in the future, she will strictly prefer to default on the loan rather than work towards repayment.

Another reason that could be at play here relates to the vicious cycle of debt that sometimes characterizes farm households in India. The problem of self-control, as suggested by Chicago behavioural economist Sendhil Mullainathan and colleagues, could exacerbate debt cycles for poor farmers in particular.

Indeed, as behavioural economics shows, there could be a range of factors spurring farmers to continue taking risky loans from the informal or formal sectors even when they know that these are harmful. For example, they could be biased towards present-day consumption or investment and, therefore, put off more productive investments in technology (e.g., farm equipment) in favour of paying off interest on other loans. They might also be falsely optimistic about their chances of paying off a loan without having to take another loan, which is exactly where expectations of a waiver in the future can have adverse effects.

How does policy then address this issue in a more sustainable and targeted manner? The simple answer is in line with what a recent report by economists suggests: don’t provide loan waivers.

But the context is also important; under certain conditions, farm loan waivers could boost productivity and help sustain improved savings for farmers.

One such condition could be monitoring of debt and ensuring appropriate governance mechanisms for new loans or targeted benefits. Although this may involve additional enforcement costs for the government, it will likely be far lower than the huge fiscal burden associated with debt relief schemes.

Another idea goes beyond agricultural credit and into the realm of broader agricultural policy. Such policy must consist of multiple avenues to ensure a farmer’s ability to deal with negative shocks to her income.

This could include encouraging adoption of appropriate crop insurance products that operate along pay-on-harvest lines, as found to be effective in reducing farmer vulnerability in Kenya. Clearly, there is no simple, overarching solution that will work, which could potentially explain the reluctance of governments to champion them, even if on a pilot basis.

Some have argued that better financial training and control over finances will deter households from going back to informal credit markets after having farm loans written off. Again, such policies have shown to be limited in their impact, and also sometimes difficult to implement in practice.

What could work instead is, as mentioned previously, a mix of policy interventions that are aimed at reducing farmer vulnerability and helping them save more for tomorrow so that they can invest in improving their agricultural productivity.

Finally, given that such a policy recommendation is not exactly something you can beat your government’s chest about, it does prompt a wider discussion on the political economy of dismissing farm loans. It is clear that with bigger problems of trading off sound economics with effective politics, we are yet to find a stable equilibrium.

Anirudh Tagat is research author at the department of economics at Monk Prayogshala, Mumbai

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