Your Friendly Neighbourhood Loan Waiver Moral Hazard is Here.

4 comments Written on July 7th, 2014 by
Categories: Loans

It’s incredible what kind of idiocy passes for politics in the country. In 2008-09, the UPA government threw a huge sop to farmers, telling them their unpaid loans would be forgiven. The government paid a massive 52,000 cr. reimbursing banks.

But the problem was of moral hazard.

The debt waiver waived off all outstanding principal and interest for farmers with less than 5 acres. For more, 25% of all outstanding was waived.

In the process of this debt waiver, farmers began to realize one thing: it’s not useful to pay back loans. The waiver applied only to outstanding debt which remained unpaid. So, if you paid back your loan religiously, you were the idiot, because your neighbour who did not repay got to not pay back anything at all.

Immediately after the waiver was announced, every farmer stopped paying back loans. Many of the farmers who had paid back parts of their loans were furious, and though the loan waiver helped them partially, they had realized that it’s silly to actually pay your loan back. Especially when there was the smell of a loan waiver.

Now, the Andhra Pradesh and Telangana governments decided to waive off agri-loans just after they were elected to power. They probably came to power on that promise.

And while the RBI doesn’t like any of it, the chairman of the State Bank of India, our largest lender, has already complained that people have stopped paying loans. After all, 2008 wasn’t so long ago, and it would be downright stupid for people to pay if the government waived off loans only for those who don’t.

Who pays for this?

The man in your mirror. And mine. We’ll pay either through higher taxes or through a central government backstop of the state governments.

Effectively these governments will borrow this money. The debt burden is large relative to the size of these economies. The state of Andhra Pradesh, for example, before it split, had Rs. 150,000 cr. outstanding as debt.

Telangana’s loan waiver package along will cost another 16,000 cr. - which the government will have to bear.

The rest of Andhra Pradesh, which is a state too, has a much larger loan bill, of upto Rs. 100,000 cr.

As you can imagine, this will nearly double the debt taken by these states, which have just been formed. Obviously to pay the higher interest cost, the states will have to raise taxes or borrow even more, and that’s a losing proposition in the longer term.

The Rest of India is Watching

And now, with the monsoon more than 40% in deficit, we might be staring at a huge drought. If the Telangana or AP loan waivers go through, the rest of India will see farmers suddenly decide to stop their payments as well, whether they can or not.

Because when you introduce moral hazard, this is exactly the kind of behaviour you incentivize. We lost our ethics so long back it’s pointless to tell people that this is just wrong. But hopefully, if they realize they’re going to pay for it…

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The man behind Capital Mind. Deepak is a co-founder at MarketVision, a financial knowledge company. Deepak also provides data research and consulting services, and now lives in Bangalore. Connect with him at deepakshenoy@gmail.com.

4 comments “Your Friendly Neighbourhood Loan Waiver Moral Hazard is Here.”

How can we have a law so that we can sue the govt for such things?

If I lose my job, I should also ask GoI to pay for my Home/Car Loan !

Govt corporate subsidies are better planned, kept as FD with the bank, credited to you once you pay back the whole amount. They should seriously implement the same rather than waiving off loans.

This letter appeared in the Hindu a week ago – http://www.thehindu.com/todays-paper/tp-national/tp-andhrapradesh/attention-cm/article6158945.ece

Asking KCR of Telangana for a subsidy to farmers who had dutifully paid back their loans. “A farmer’s appeal:
We are poor farmers of Asifabad mandal in Adilabad district who had availed a crop loan during the financial year 2013-14. By March 31,2014, we had remitted the entire amount in the bank, with interest, so that we could apply for another loan in the current season. But during the election campaign, the TRS promised a crop loan waiver of up to Rs.1 lakh taken by farmers for the aforesaid period. Upon enquiry in the bank, we were told that crop loan due would be waived. However, the fate of farmers like me who sincerely paid off the loan is unclear. It is injustice that poor farmers like me forgoes this benefit extended by the newly-formed Telangana government. I humbly request the Chief Minister to kindly arrange for a reimbursement of the crop loan amount already remitted to the bank.”