The Indian Economy Blog

September 5, 2006

Just Heart Alone Won’t Suffice

Resolving the ‘agrarian crisis’ requires understanding the laws of economics

P Sainath’s years of experience covering India’s countryside lends a credibility to his voice. How unfortunate it is then that he should expend it on framing the issue in partisan, rich vs poor, urban vs rural terms. Here’s an excerpt from a recent interview he gave Tehelka

(The ‘agrarian crisis’) happened because through the reform years, we’ve been diverting resources, we’ve been robbing the poor to pay the rich. Now I cover guys who commit suicide because they’re not able to get less than 10% interest on Rs 8000 crop loan. I go back to my urban middle-class home in Mumbai where I get an invitation from my bank ‘buy a Mercedes Benz, no collateral at 4% interest’. So if you’re buying a Mercedes Benz – unproductive expenditure – you pay virtually no interest. If you are the food producers, you’re paying two to three times that interest. That’s the sheer injustice of it. [Tehelka, via Amit Varma]

In the interview he rails against the government (especially the previous one) for not doing enough, against journalists for being more interested in covering India Fashion Week and, quite unsurprisingly, at multinationals and genetically modified cotton for undermining the farmer.

It has been the The Acorn’s case that this crisis is caused by the government’s determined refusal to allow market forces to play in the agriculture sector. Its policies have created perverse incentives: leading to a scarcity in formal sources of credit that is the primary financial cause of farmer suicides. (See this post on Amar Akbar Anthony). The solution to India’s ‘agrarian crisis’, therefore, lies not in government largesse, but in its retreat. It lies in making rural and agricultural markets work.

Supporters of Sainath’s view may be quick to dismiss such proposals, coming as they do from people who have ‘not been there’. So here’s an article from someone who has (and still is) .

The discomfiting fact is that interest rates of informal lenders are difficult to control, whereas formal institutions which are under public scrutiny have to keep their interest rates low. Thus formal institutions tend to ration credit to small farmers since they are not able to meet their full costs. Transaction costs on small loans are necessarily higher than for large loans, when expressed as a percentage of the loan amount. The pricing should cover the cost of funds, the transaction costs and the risk costs (likelihood of bad debts). Most arguments in favour of lower interest rates for small farmers do not take this into account. As a result, banks find it unprofitable to lend to small farmers and effectively cut their losses by lending as little as they can get by without incurring regulatory wrath.

In India, though interest rates on small loans by RRBs and cooperative banks were deregulated in 1996, the amount of credit by these banks has not gone up significantly. This is because the regulatory cap was never removed for the largest channel of rural credit, the commercial banks, thus ensuring that RRBs and cooperatives could never significantly increase their interest rates. More recently, the government has been asking (though it has refrained from getting the RBI to direct) banks to reduce interest rates to farmers to 9%, on the grounds that interest rates on housing loans to the urban middle class were down to 7-8%. Though it is acceptable to compare these rates, what is not discussed is that the transaction cost of an urban housing loan is much lower because of high volumes per branch and much lower risk levels. Bad debts for housing loans are a fraction of one percent while those for agricultural loans are anywhere from 3-5%, even without the risk of politically motivated loan waivers, and with those included, the bad debt costs are much too high to be built into any reasonable interest rates.

Politicians, intellectuals and farmers all need to accept that small loans are more expensive and must be priced accordingly. Thus an answer to the credit needs of small farmers in India is to free up interest rates, not just in terms of regulation but in terms of acceptability. At the same time, the government should permit a whole spectrum of credit providers, formal and informal, to enter the field and compete with each other so that they can enhance the total credit flow and eventually bring down costs. No regulation can control supply and price simultaneously. So if more credit has to flow to farmers, the price (interest rate) must be deregulated. Initially it may go up, attract more players and then they will compete and bring down the rates. Ironically, this lesson from the housing and consumer finance market has been missed by our policy-makers. [Seminar]

11 Comments »

  1. [...] This post also appears on The Indian Economy Blog.  Home | Permalink |  [...]

    Pingback by The Acorn » Just heart alone won’t suffice — September 5, 2006 @ 1:48 pm

  2. “It has been the The Acorn’s case that this crisis is caused by the government’s determined refusal to allow market forces to play in the agriculture sector.”

    As is my custom, if I could just quibble a bit: I would say the crisis isn’t CAUSED by the government policies in question, but it is surely EXACERBATED by them.

    The issue surely goes much deeper than Sainath imagines, since even if you had a more efficient financial framework the urban rural interest differential would probably still exist. The problem is there is a risk differential.

    If the Indian farmers borrowed more money but did not raise productivity they would simply get into more debt. The interest rate differential is in part a reflection of a productivity differential. Productivity is rising in the urban areas, while it is stagnating or deteriorating in the rural ones.

    To improve rural productivity you need more economic value being produced with less people employed. This is the connundrum, and this is the real issue to which there is no easy short term solution.

    If the problem was simply the availability of funding, then people like Sainath could undoubtedly help a lot by practicing some sort of well-intentioned ‘carry trade’ and borrowing money on behalf of sponsored farmers, and then recovering the money from them.

    Much of the money borrowed in this way would probably be unrecoverable, and at worst would produce more suicides as even more people got into even more debt.

    The problem is that India is a country in economic transition and in the transition there are winners and losers. Everyone in India will be much better off – including the descendants of today’s farmers – when this transition has been made, and when the agricultural sector constitutes a proportionately smaller part of GDP, and when the proportion of the population who earn their living from agriculture is greatly reduced. The human dimension of the problem is of course much greater because of the extreme economic fragility of many of those involved, but the central issue is in principle not greatly different from the reductions in the mining workforce in Europe or in the car sector in the United States in the last quarter of the twentieth century.

    Of course, the day all these farmers start having substantially less children, then that day this problem will start to ease off in and of itself, since then the cheaper money which may become available from more efficient financial markets could then be used to get into more capital intensive agriculture to make up for the missing sons no longer able to work.

    Comment by Edward — September 5, 2006 @ 5:59 pm

  3. Sainath’s belief that when you buy a Benz, you are paying “virtually no interest” is naive. Benz is not into social work; they want to maximize their profits. They don’t give away neither cars, nor loans. Low cost financing or even “zero” cost financing is not zero or low. They recover the cost of finance through the price of their cars.

    There are other points one can raise just on the snippet quoted which one does not have the time nor the inclination to go into right here.

    Comment by Atanu Dey — September 5, 2006 @ 6:39 pm

  4. I think it’s a frustration, after seeing so many farmer deaths. When something so urgent a need is pressing on our present circumstance and that calls for an immediate remedial action, it is natural to be frustrated. In fact I’d say to not to take potshots at each and everyone would be committing a disservice. Something along the lines of what Franklin said: “Just as we should account for every idle word, so must we account for every idle silence,” applies here. Needling a bit here and there wouldn’t hurt.

    But I also understand that those of us ardent believers in the common sense of letting the market forces “play” are somewhat miffed by such an unorganized frustration, which is what it is. But, really, who are we kidding here. We only have to remind ourselves of what Buchanan’s public choice theory informs us, to contextualize what is happening with the farmers suicides.

    Theories, just as free market strategies, need time, to make their effect felt, don’t they? We know that the rate at which this agrarian crisis has been taking people’s lives – the very people who would otherwise be the agents in the same free market enterprise – has far exceeded the speed with which the free market strategies, if any, were able to help it. Can we deny that?

    That remark about Benz loan for 4%, I read it as just an illustration of the glaring contrast between his own choices and the choices for the farmers. Not much more need be made out of it.

    Here’s the bottomline: When a man or a woman is so passionate about bringing the problems to the fore – and credible, not just a talking head – the same person is usually the right person to parlay the solutions too. But where are they, in practice?

    In this present situation, the credibility loss is not Sainath’s but the government’s, for all obvious reasons this post highlighted.

    Regards,
    Crazyfinger

    Comment by Crazyfinger — September 6, 2006 @ 1:10 am

  5. I’d just like to know why buying a Mercedes Benz is considered ‘unproductive’. Somebody buy Sainath a high-school economics textbook

    Comment by Phoenix — September 6, 2006 @ 6:05 am

  6. “But I also understand that those of us ardent believers in the common sense of letting the market forces “play” are somewhat miffed”

    This just reminds me of one small point: not everything here is about ‘markets’. Only fanatics would suggest, I contend, that the simple(ton) uses of market forces will resolve India’s agricultural problem. What is involved, as I say, is a massive and convulsive transition out of agriculture. This has nowhere and never been done by the mere use of market forces. Look at British history in the 19th century, or the US in the 1930s (or read John Steinbeck), or Japanese rice farmers, or the European Union Common Agricultural Policy. It is obvious that market mechanisms have a decisive role to play in deciding how much of what is produced (and as we are seeing in the post, in breaking down bureaucratic-guaranteed market rents), but the transition itself, this needs a lot of planning and regulating, and really the conclusion I am coming to is that this is the biggest reform that India needs, in its mechanisms for achieving consensually grounded rational strategic plans. After that all the rest would be (nearly) plain sailing.

    It is obvious that India needs a large dose of de-regulation and free market reform, but it also needs a modern and mature public sphere to make all this work, let’s never forget that.

    I mean what the hell do people think goes off ‘on the Hill’ in Washington, what are all those ‘lobbies’ all about. As I said, nowhere and never.

    Comment by Edward — September 6, 2006 @ 4:12 pm

  7. Taking all this a little bit further, and off the top of my head, if you look at the agricultural transition from the perspective of modern economies you will notice something interesting.

    Industrialisation inevitably creates in its wake a ‘proletariat’. This ‘proletariat’ normally leans towards more collectivist solutions to problems (ie it is often strongly anti-market in connection with how to handle declining industries and normally favourable to increasing state regulation). Typically this favours parties of the left. But reforms are driven through (in the main) by parties of the right. In a democracy at the industrial stage the ‘reform’ party finds it hard to get a natural majority, unless….. unless it forms an alliance with rural interests. This is one of the reasons why you never really get a free market in agriculture, since there is an in-built tendency to provide generous support to rural interests. Obviously France would be the archetypal example of this process at work, but the position of the interior states in the US would not appear to be profoundly different.

    Of course this ‘most favoured segment’ policy only comes into being following the rationalisation of agriculture into larger scale profitable units, and following the displacement of a large part of the existing agricultural population off to play the role of the ‘proletariat’ which needs counter-balancing.

    In the end this is just another explanation of why I think the ‘pure markets’ view of what comes next in Indian agriculture is oversimplifying things a little.

    Comment by Edward — September 6, 2006 @ 4:28 pm

  8. “The solution to India’s ‘agrarian crisis’, therefore, lies not in government largesse, but in its retreat.”

    As long as politics is alive (not a bad thing) the retreat won’t happen. In the short term, the government can actually pay for insurance (and not force bank to write-off loans) and have insurance industry dictate terms to farmers as what they can plant to mitigate risk instead of uncontrolled year-after-year disaster.

    Over the long term, government can play role with better policies such as argricultral reform – allowing bigger industrial farms to lease land from farmers and allowing migratation to towns/cities (the push), thereby providing them with a steady stream of income; insurance reform – allowing foreign players with decades of argricultural insurance product expertise (if anything, it would force local gaints to think about new markets and innovate products); and labour reform so that vast factories, to make widgets – including those unproductive mercedes benzs, can be built that can pull unskilled/semiskilled labour away from unproductive farming year-after-year.

    But don’t expect sane ideas from the current govt.

    Comment by Chandra — September 6, 2006 @ 10:25 pm

  9. [...] On the agrarian crisis again. In a column titled What the heart does not feel, the eye cannot see P Sainath lashes out against the criticism directed against him here (and here):

    Then there are the ideologically insane. The members of the sect have no interest in either farmers or agriculture. Only in upholding their Gospel. For them, farmers are dying because they have not been reached by free market reforms. If more of them keep dying after they are reached, it’s because the “reforms have not gone far enough.” It hangs a halo of righteousness around wanton ignorance. [...]

    Pingback by The Acorn » Hearty monopoly — September 8, 2006 @ 4:30 pm

  10. Its so convenient. Too much government has caused the breakdown of rural credit which has led to the cotton farmer suicides. This is just so staggeringly false. There have been now, literally dozens of articles and some books which have spoken about the impact of government retreat from formal credit provision in the rural sector and the negative impact this has had on the rural sector according to many dimensions. The EPW has had several articles on this.. (I am not at my computer so I dont have the exact references), Madhura Swaminathan has a book about this, and Rohini Pande and Tim Besley have an article in the AER o QJE arguing that the era of social banking did result in reductions in poverty.

    I can accept views which do not coincide with my own if they are backed up with some evidence. This post simply ignores virtually all the work that people from all ends of the political spectrum have done. Its sad in more ways than one.

    Comment by Arjun — September 12, 2006 @ 9:51 pm

  11. If it is true that small loans are more expensive for the lenders as stated, can’t finanicial institutions innovate with ‘sliding scale’ interest rates that could encourage farmers (small borrowers) to team up as cooperatives? Institutions could foster communities of loan seekers based on their geographic location, common needs (a group of cotton farmers from a region) etc.

    Comment by Venkatesh Goteti — September 14, 2006 @ 7:38 pm

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