riteshkbajaj
New member
During the presentation of Union Budget for the year 2008-09,the finance minister Mr. P.Chidambram proposed Rs 600 billion as debt/loan waiver for farmers, the amount was later raised to Rs 720 billion. This came in wake of lot of suicides by farmers in the country.
The proposed loan waiver and debt relief package provides for complete write-off of all outstanding debt held on December 31, 2007 to scheduled commercial banks and co-operative societies, of small and marginal farmers, that is those holding less than 2 hectares of land. For all other farmers, there will be a one-time settlement for the outstanding debt, whereby 25 per cent will be written off if the farmer repays 75 per cent. This package broadly speaking has two important exclusions. Firstly, it excludes all the farmers on dry-land and poor quality land that hold more than 2 hectares of land even though they are among the worst affected from the agrarian crises and Secondly, it also excludes the majority of farmers who have taken debt from private sources, which in most cases is the prime source of lending in villages.
Without going into much detail of other negativities that many felt about this loan/debt waiver, the key issue according to me was “moral-hazard” which in a longer term can hurt the country more.
Q: “Will farmers who repaid their loan look stupid and learn a different lesson?”
Let’s take an example of Farmer ‘A’ and Farmer ‘B’ who both have equal and same type of land, took a loan of say Rs 100 from a Bank. If both would have not paid, the relief package would have applied to both of them and their loan would have been repaid by the Govt. But this is not the case as A had repaid his loan by selling a portion of his land, while B did not repay his loan.
Now take a closer look at A’s case. He is now thinking if he would have not repaid his loan he would have saved his portion of his land. But now he is thinking that next year he should take more loans next year and get back his land and probably the Govt. again will give a loan/debt relief package and he would also be better off.
As we see in the graph above. A took a loan of Rs 100 in 1st year and repaid it. When A’s loan taken is 0, his capacity to repay is constant but his willingness to Repay is maximum but as the loan taken increases, Willingness decreases. Hence when A takes a higher loan (150), his Willingness to Re-pay the loan decreases and he defaults by amount ‘a’ (100), instead of amount ‘b’.
So we see a precedent like this can create a problem of “moral-hazard”. Though in a short term it may yield result but in a long run it definitely will fail.
Q: “What should Govt. do?”
If the Govt. would not have given a debt/loan waiver in a worst case scenario B would have committed suicide. The Govt. also has moral duties towards the public and also it can sometimes improve market outcomes provided the policy is aimed for a long term and does not have any biases.
In this case if the loan waiver would have also included some incentives for people who have paid loans they would have not looked like a stupid. Also it should have included something that would have made people who have not repaid their loan more responsible so that they don’t default intentionally.
To conclude I would like to quote what N.Gregory Mankiw in his book “Economics: Principles and Applications” has said, “Govt. can improve on market outcomes at times does not mean that it always will. Public policy is made not by angels but by a political process that is far from perfect. Sometimes policies are designed simply to reward the politically powerful. Sometimes they are made by well-intentioned leaders who are not well informed.”
The proposed loan waiver and debt relief package provides for complete write-off of all outstanding debt held on December 31, 2007 to scheduled commercial banks and co-operative societies, of small and marginal farmers, that is those holding less than 2 hectares of land. For all other farmers, there will be a one-time settlement for the outstanding debt, whereby 25 per cent will be written off if the farmer repays 75 per cent. This package broadly speaking has two important exclusions. Firstly, it excludes all the farmers on dry-land and poor quality land that hold more than 2 hectares of land even though they are among the worst affected from the agrarian crises and Secondly, it also excludes the majority of farmers who have taken debt from private sources, which in most cases is the prime source of lending in villages.
Without going into much detail of other negativities that many felt about this loan/debt waiver, the key issue according to me was “moral-hazard” which in a longer term can hurt the country more.
Q: “Will farmers who repaid their loan look stupid and learn a different lesson?”
Let’s take an example of Farmer ‘A’ and Farmer ‘B’ who both have equal and same type of land, took a loan of say Rs 100 from a Bank. If both would have not paid, the relief package would have applied to both of them and their loan would have been repaid by the Govt. But this is not the case as A had repaid his loan by selling a portion of his land, while B did not repay his loan.
Now take a closer look at A’s case. He is now thinking if he would have not repaid his loan he would have saved his portion of his land. But now he is thinking that next year he should take more loans next year and get back his land and probably the Govt. again will give a loan/debt relief package and he would also be better off.
As we see in the graph above. A took a loan of Rs 100 in 1st year and repaid it. When A’s loan taken is 0, his capacity to repay is constant but his willingness to Repay is maximum but as the loan taken increases, Willingness decreases. Hence when A takes a higher loan (150), his Willingness to Re-pay the loan decreases and he defaults by amount ‘a’ (100), instead of amount ‘b’.
So we see a precedent like this can create a problem of “moral-hazard”. Though in a short term it may yield result but in a long run it definitely will fail.
Q: “What should Govt. do?”
If the Govt. would not have given a debt/loan waiver in a worst case scenario B would have committed suicide. The Govt. also has moral duties towards the public and also it can sometimes improve market outcomes provided the policy is aimed for a long term and does not have any biases.
In this case if the loan waiver would have also included some incentives for people who have paid loans they would have not looked like a stupid. Also it should have included something that would have made people who have not repaid their loan more responsible so that they don’t default intentionally.
To conclude I would like to quote what N.Gregory Mankiw in his book “Economics: Principles and Applications” has said, “Govt. can improve on market outcomes at times does not mean that it always will. Public policy is made not by angels but by a political process that is far from perfect. Sometimes policies are designed simply to reward the politically powerful. Sometimes they are made by well-intentioned leaders who are not well informed.”