RBI governor takes a subtle dig at farm loan waivers, says it impacts credit discipline

In his monetary policy review meet on Thursday, RBI governor Urjit Patel may have taken a subtle dig at farmer loan waivers, the recent one being the Rs 36,359 crore relief announced by UP chief minister Yogi Adityanath for small and marginal farmers in the state.

"Farm loan waiver undermines honest credit culture, impacts credit discipline," Patel said in the meet, highlighting the worry over the structure of public finance and health of banks and the relationshhip formal lending institutions have with farmers.

"The general government deficit, which is high by international comparison, poses yet another risk for the path of inflation, which is likely to be exacerbated by farm loan waivers," the RBI said in its monetary policy.

In UP's case, the state government will finance the scheme, as reported, through bonds. But it is fiscally weak, with its deficit soaring to the highest in four years. Its finances rank among the worst in three large states.

Banks already have an exposure of Rs 86,000 crore-plus to the farm sector in UP and there are fears that this new loan waiver will encourage borrowers to default in future, a problem called moral hazard in economic theory. If borrowers suspect they can get away without repaying loans in future, they will borrow even more recklessly and ignore repayments.

"As such, while it may not add to the headline fiscal deficit (of UP) directly, the liability will remain and understate the headline fiscal deficit," Nomura said in a research report.

"The UP government has budgeted a fiscal deficit of Rs 415 billion (~2.9% of state GDP on our estimates) in FY18, but with Seventh Pay Commission hikes also pending the risks of this rising (both above and below the line) is to the upside. Additionally, the farm loan waiver scheme could put pressure on other states to follow suit," the report said.