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Ballooning loan waivers unravel structural farm sector concerns

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Mr.Dhananjay Sinha

Head of Research, Economist & Strategist

01 Jul 2017

Even as the Farm sector appears to be reviving in 2017 from the bad patch of poor monsoon of the prior two years, the rising wave of farm loan waivers suggest a distressing scenario in the hinterland. This is despite government data revealing a robust real agriculture sector GVA growth of 6.6%. Isn’t that paradoxical? To some, it may appear to be a political maneuver by farmers or possibly a short-term hiccup.

The reality however, is that the current farm distress has steadily evolved since FY11 – a year which marked the end of the previous loan waiver programs and the peak of the robust agri sector growth phase of 2005-2011. Economics of the Indian farm sector have been weakening since then, and have worsened sharply over the past three years. And, the fact that demand for farm loan waivers resurfaced every 5-10 years is indicative of a structural malaise. Clearly, the aggressive publicity of crop Insurance scheme over the past two years has not helped much.

The problem is rooted in the fundamental mismatch that the farm sector suffers, which has translated into rising dependence on policy support over the years. One aspect of the problem is that domestic food consumption has not been rising in line with production. Rising supply response induced by earlier phase of rising food prices and encouraged by build-up of initiatives like Food Security Act 2013 created favourable conditions for the farm sector. The other aspect is the persistent rise in institutional credit growth, aided by blanket policy targets, without any assessment of crop-wise credit requirement, resulting in rising farm sector indebtedness. These policy measures also included price and demand interventions, procurement & buffer management and liberal credit standards. All these have led to enlarged fiscal commitment to ensure viability of the farm sector and consequently agri loan repayment capability.

The per capita cereal consumption in India has been declining structurally (~18% drop in the past two decades; source: NSS data). Therefore, assuming an average annual decline of 0.8%, the population growth at 1.4% annually implies a rough estimate demand growth of 0.6% pa. Production growth of 2.8% (10 year average) and 8.8% in FY17 therefore implies a structural excess supply situation. Proportion of consumption of items like vegetables, fruits, meat, ggs etc may have risen recently, but lack of infrastructural support has resulted in high volatility in prices and net realizations. Hence, while food subsidy (largely contributed by cereals) has risen sharply since 2008 to currently ~38% of annual household spending on bread & cereals, ironically its proportion in household food consumption has been declining consistently. 

Policy support has waned over the past 3-4 years, resulting in an adverse price scenario and farm terms of trade (ToT) declining by 6% during 2011-2016. Cost of cultivation rising faster than price realization from farm produce has caused contraction in net cash flows for farmers, thereby impairing their loan repayment capability. Evidence of declining policy support can be gauged from the following factors:

> Till 2016, increase in minimum support price (MSP) was modest at 3-4%.

> Lower intensity of cereal procurement ~29% of production, down from a peak of 37% in FY13, implying dwindling effectiveness of MSP in determining price realizations.

> While the allotment of foodgrains under PDS has declined by 33% to 54MT from the FY13 peak of 80MT, the offtake has declined at a lower intensity (-20%).This reflects higher market availability and lesser reliance of states on the central pool.

> Considerable drawdown of foodgrain buffer from the peak of 78MT in 2012 to a low of 44MT by mid-2016, indicating lower procurement and higher market availability resulting in pricing pressure.

> The persistent worsening in ToT during 2011-2017 is in contrast with the upbeat scenario of 2006-2011, when steep rise in price realizations saw ToT rising by 21.5% (4.2% CAGR). Price realizations during 2006-2011 had risen by 65% (13% CAGR), much higher than 53% (10.6% CAGR) rise in the cost of cultivation. This can be attributed to active policy interventions (to ensure higher support prices) and rising global commodity prices. The robust 25-30% growth in bank lending to the farm sector also amplified the upsurge in the agri and rural economy during 2006-2011.

> Decline in global real food prices also contributed to adverse pricing scenario for the Indian farm sector. IMF’s real food price index (deflated by manufacture price index) has declined ~30 since 2011 due to steeper decline in food prices. A sharper decline has been witnessed in cereals and vegetable oils. Shift in global consumption pattern and large availability of cereals eased prices globally. This follows a sustained decadal rise of ~72% since 2001.

> Currently, food inflation is negative while the input price inflation has been positive, indicating that ToT would have fallen further by 1.6% in FY17, thereby adding to the cumulative decline of 7.3% from FY11 peak. Post FY11, the intermediate consumption prices (input cost like wages, diesel prices etc) for the arm sector have risen sharply.

Negative shock induced by demonetization, especially on perishable items (fruits & vegetables, meat, egg, fish etc) accentuated the decline in ToT in FY17, the impact of which is still lingering.   Perishable items faced paucity of storage facility, resulting in price realizations plummeting below the cost of cultivation. With the perishables items contributing 75% of value of Indian food consumption (Foodgrains, Meat, Fish, Vegetables, Fruits etc), demonetization had a major impact on the farm sector economics. Foodgrains prices are way below MSP in several states, especially for highly remunerative products like pulses.

Therefore, notwithstanding the earlier promises of ensuring MSP 50% higher than the cost of cultivation and 2016 promise of doubling of farm income, the scenario has worsened in the past three years. Remember, the states to announce the farm loan waivers first were Andhra Pradesh and Telangana, which have collectively allocated Rs600bn under the loan redemption scheme since 2014.

Credit to the Farm sector has grown at a faster pace than other sectors. Notwithstanding the recent slowdown at 13% in FY17, banks’ agri lending was much higher than overall lending growth of 5%. Agriculture lending has increased at a compounded rate of 24% between 2003 and 2013 vis-à-vis 13% growth in nominal agri GDP. Consequently, bank credit-to-GDP ratio for the Farm sector has risen from 15.7% in 2003 to 38% in 2013 and further to 42% in FY17. Including other sources of institutional lending such as Co-operative Banks and Regional Rural Banks (RRBs), agri credit at an estimated Rs17tn in FY17 stood at 71% of nominal agri GDP.

The problem of farm loan impairment is rooted in a) elevated leveraging at 71% of Agri GDP and several states showing high & rising level of indebtedness of agri households, b) sharp deterioration in farm economics, c) declining productivity of credit reflected in sustained decline proportion (17.5% in FY16 vs 42% in FY99) of lending going into capital formation and d) greater exposure to farmers who do not have exposure to formal banking. Indian banking sector, especially PSBs are highly vulnerable, as their contribution to agri lending has risen to ~60%, nearly double the share they had in FY04. 

Decline in productivity of institutional lending reflects in the fact that lending growth averaged higher at 16% during FY2001-2014 while the nominal GDP growth was lower 11%. This phase is in contrast with an earlier period of FY1987-FY2000 when nominal GDP growth was much higher at 13% despite lower credit growth of 10%. The phase of aggressive lending that was seen in mid-1970s and lasted till late 1980’s also saw lending growth averaging at 17.5% and slower nominal GDP growth of 11%. This phase eventually culminated into loan waiver program in 1991. Clearly, there does not appear to be a clear positive correlation between aggressive agriculture sector lending and agri GDP growth.

Recent media reports indicate that six states that have implemented, announced or contemplating farm loan waiver are Uttar Pradesh (part of poll promise), Maharashtra, Karnataka, Punjab, Andhra Pradesh (2014-16, part of poll promise) and Telangana (2014-16, part of poll promise). Together they account for over Rs1.7tn of waiver or about 22% of estimated outstanding institutional lending (banks & other lenders) in these states in FY17. The intensity varies however, with Uttar Pradesh waiving off estimated 26% of outstanding loans, Maharashtra 22%, Andhra Pradesh 34%, Telangana 25%, Punjab 24% and Karnataka the lowest 7%. This will have a domino effect across other states and cause moral hazard problem for even farmers which have been servicing their loans. The clamour for farm loan waiver is also rising from other states such as Rajasthan, Gujarat, West Bengal, Haryana etc.

Based on our analysis since 2010, we believe that impairment problem of farm loans is structural and is likely to be as high as 18-20% of outstanding farm sector loans of Rs17tn or Rs3.0-3.5tn. This will a five-fold jump from Rs650bn loan waiver & restructuring package announced in 2007 and 18 times the Rs170bn restructuring package unveiled in 2005. Of this, nearly 2/3rd can be attributable to banks. Currently, Indian banks are reporting 7-8% NPA ratio, which is a considerable understatement in my view.

In the run-up to the 2019 general election and impending state elections in 8-9 agri dependent states between 2018 and 2019, it is likely that the governments will remain inclined to accepting demands for farm loan waiver. Also, as recent measures indicate, the Centre could adopt aggressive interventions like active procurement of foodgrains, farm loan waivers, controlling input prices such as fertilizers & seeds and subsidy on farm equipment, higher MSPs, export subsidy or import controls. Hikes in average MSP over the past 12-18 months have also been somewhat higher at 6-9% compared to 3-4% during 2013-2015.

Prevention of financial distress and ever ballooning farm loan waivers are symptomatic of persistent structural issues facing the agrarian economy. Hence, it calls for urgent measures to enhance its viability and financial sustenance. Importantly, blanket targets of institutional agri credit infusion without any consideration for end use, without assessment of crop specific credit needs, existing indebtedness or quality of collaterals are bound to create systemic financial stress and eventually impairment for banking system & a large fiscal burden. Likewise, while continuation of age old mechanism of policy interventions may create short-term respite, they do not address the structural problems plaguing the Indian farm sector for long.

Conversely, a long-term response will be to encourage formalization of the farm sector, incentivizing food processing, encouraging cold storage, warehousing & supply chain infrastructure, enabling collective farming, enhancement of irrigation infrastructure and ensuring adequate credit availability rather than blanket credit allocation targets. Decentralization of industries and a financially viable farm sector hold promise for a sustainable rural economic model. In my view, even if half of the existing annual resources of governments and banking system are allocated for these measures, we should be able to establish a more enduring rural economic model.