THE GIST of Editorial for UPSC Exams : 10 JANUARY 2019 (The equivalence of farm loan waivers and corporate NPAs)

The equivalence of farm loan waivers and corporate NPAs

Mains Paper 4: Economy
Prelims level: NPA
Mains level: Indian Economy development

Context

•  A farm loan waiver is a sector-wide extinguishing of loans mandated by the government, usually before an election, with the exchequer compensating banks.
•  On the other hand, a corporate NPA represents a business failure, for reasons internal and external, and triggers a bankruptcy process to recover dues by financial creditors to the maximum extent possible either through resolution or through liquidation.
•  A bankruptcy process does not imply any liability of the government, unless very large in magnitude.
•  The government obligation can be more pressing if NPAs originate in public sector banks or are due from public sector corporations.
  Historical underpinnings of the bankruptcy procedure
•  The equivalence arises when conditions warrant that the state must indirectly bear the burden of corporate NPAs by infusing funds into banks, as had happened in the US following the 2008 financial crisis and as is happening now in India.
•  Equivalence can also be drawn when the problem of corporate NPAs repeats itself in the same sectors implying that, for some reason, banks keep lending to the same sectors even in the absence of structural improvements.
•  Persistent problems in power and infrastructure sectors and the fate of development finance institutions before some of them converted to universal banks immediately come to mind.
•  The evidence of this equivalence would be a slowdown in both agricultural and corporate lending occasioned by farm loan waivers and NPA crises, respectively—something we have been witnessing in India for the last few years.
•  Another ground for equivalence arises if the resources of the exchequer are used to buoy companies that would otherwise go into bankruptcy.
•  The assumption is that the motivation of keeping a company afloat interferes with the objective of choosing the most efficient vendor, and hence represents a distortionary cost.
•  As in the case of preferential access to inputs such as coal, and award of contracts without regard to expertise in areas such as defence.

Impact on economy

•  A key underpinning of bankruptcy procedures is the limited liability clause that protects the assets of promoters unless explicitly pledged.
•  Corporate bankruptcy, therefore, is a simultaneous process of cleansing bank balance sheets and a mechanism allowing optimal risk-taking by entrepreneurs.
•  Effective functioning of a bankruptcy law is expected to enable the generation of new cycles of credit, with credit flowing to better projects in similar or entirely new sectors.
•  On the other hand, a farm loan waiver impedes the flow of such credit as structural problems besetting agriculture are typically not addressed.
•  Couched in these terms, corporate bankruptcies and farm loan waivers appear to have nothing in common.

Bank recapitalizations vs. Farm loan waivers

•  It seems that the criticism of farm loan waivers reflects a view of the proper relation between the farm versus the non-farm sectors.
•  It is believed that food prices for consumers must be kept low through restrictions on farmers and subsidies to consumers.
•  The Organization for Economic Co-operation and Development (OECD) estimates that the average yearly revenue lost by Indian farmers between 2014 and 2016 on account of export restrictions, net of subsidies received, is ₹1.65 trillion.
•  Historical performance shows that the credit quality of large corporate borrowers is not superior to that of agriculture/priority sector lending.
•  In that context, interest rates charged by banks to large corporate borrowers have been kept artificially low and incommensurate with the risks involved.
•  Low prices of agricultural products can also be achieved by reducing the role of the middlemen but for various reasons, including the political muscle involved, this does not happen.

Way forward

•  This model of development is no longer tenable.
•  India can no longer rely only on exports and will have to look towards domestic demand to power its growth. And skewing income distribution away from 50% of the population will not help.
•  Cities are unable to manage the influx of refugees from agriculture.
•  The Swaminathan report of 2006 clearly states that India’s food security cannot be achieved through imports, thus emphasizing the imperative of a healthy agricultural sector.
•  From an ethical point of view, taking care of the big farmer who, unlike the corporate promoter, risks losing personal assets in the event of a default, is as important as taking care of the big businessman.
•  The problem of the spendthrift farmer and that of the flagrant corporate firm are two sides of the same coin.
•  The difference is that unlike corporate honchos, farmers aren’t fleeing the country.

Online Coaching for UPSC PRE Exam

General Studies Pre. Cum Mains Study Materials

Prelims Questions:

Q.1) Consider the following statements regarding Public Affairs Index:
1. Public Affairs Centre (PAC) releases the Public Affairs Index.
2. According to Public Affairs Index 2017, Kerala and Tamil Nadu –has secured first and second rankings respectively.

Correct code(s) is/are:
a) 1 only
b) 2 only
c) Both 1 and 2
d) Neither 1 nor 2

Answer: C

Mains Questions:
Q.1) If the recapitalization of banks is welcomed, why is a farm loan waiver not acceptable?