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Agricultural Credit in the Post-Reform Era

The negative policy on credit for agriculture and other priority sectors, which has been prevalent since the beginning of the post-reform era, has manifested itself in three broad areas: the enervation of the institutional architecture for rural credit, disincentivisation of credit flow to agriculture through the mechanical application of Basel norms and the squeeze on resources available for agricultural credit operations. This paper discusses these areas and also the experience of a couple of advanced economies. It suggests a set of reforms which will reverse the policy coarctation for agricultural credit. It argues that the successful promotion of the deepening of rural financial markets, which would ensure uninterrupted flow of credit to agriculture will require systematic rather than isolated efforts, with related actions being undertaken on several fronts.

Agricultural Credit in the Post-Reform Era A Target of Systematic Policy Coarctation

The negative policy on credit for agriculture and other priority sectors, which has been prevalent since the beginning of the post-reform era, has manifested itself in three broad areas: the enervation of the institutional architecture for rural credit, disincentivisation of credit flow to agriculture through the mechanical application of Basel norms and the squeeze on resources available for agricultural credit operations. This paper discusses these areas and also the experience of a couple of advanced economies. It suggests a set of reforms which will reverse the policy coarctation for agricultural credit. It argues that the successful promotion of the deepening of rural financial markets, which would ensure uninterrupted flow of credit to agriculture will require systematic rather than isolated efforts, with related actions being undertaken on several fronts.


I Introduction

he financial sector reforms after 1991 systematically undermined the institutional credit arrangements for agriculture. A clear and explicit reversal of the policy of social and developmental banking was the leitmotif of these reforms. However, the polity, especially since May 2004, has displayed some response to the concerns about the insufficient flow of credit to agriculture. The programme of doubling of agricultural credit in three years and provision of short-term credit to farmers at an interest rate of 7 per cent are the outcomes of these concerns. But these are basically isolated and reactive interventions aimed at improving the supply. These interventions are at best piecemeal steps within an overall policy vacuum as far as the rural financial system is concerned. The issues of policy and the institutional environment for the emergence of a robust rural financial system are yet to be touched. The discourse on the suitable architecture for rural financial institutions (RFIs) is conspicuous by its absence. The successful promotion of the deepening of rural financial markets, that would ensure an uninterrupted flow of credit to agriculture, will require systematic rather than isolated efforts, with related actions being undertaken on several fronts.

The Reserve Bank of India (RBI) and the government have emphasised the importance of credit to agriculture many times. But coming to the brass tacks, their actions, especially those of the RBI, in the past decade and a half have been a deterrent to the growth of agricultural credit. The depressing scenario of agricultural distress, the recurring instances of farmers’ suicides, the declining public capital formation in agriculture and the laggard growth rates in agriculture; all have their genesis in the continuum of decisions and actions taken since the early 1990s, with the onset of the financial sector liberalisation. The Committee on Financial System [GoI 1991] set out the broad philosophy of a negative policy for credit to agriculture and other priority sectors which was manifested in three broad areas: the enervation of institutional architecture for rural credit, disincentivisation of credit flow to agriculture through the mechanical application of Basel norms and the squeeze on resources available for agricultural credit operations. This paper discusses these three broad areas as also the experience of a couple of advanced economies and suggests a way forward through a set of policy reforms which are a sine qua non, if credit flow to agriculture has to be stepped up.

II Decaying Institutional Architecture

The financial sector liberalisation has led to a debilitation of institutional framework for agricultural credit. The rural branch network saw a tremendous growth after the nationalisation of banks in 1969 and the establishment of regional rural banks (RRBs) in 1975. This percentage of rural branches of commercial banks which was 17.6 per cent in 1969 steadily increased to 58.2 per cent in 1990. Thereafter, it is a story of progressive decline, as the RBI liberalised the policy for the closure of rural branches on grounds of unviability and lack of profitability. As Table 1 shows, the total number of rural branches which went up to 35,390 in 1993-94 declined to 33,017 in 1994-95 to 32,673 in 19992000 and further to 30,750 in 2005-06. Similarly, in percentage terms it declined from 58.2 in 1989-90 to 51.7 in 1994-95 and further to 44.48 in 2005-06.

In the multi-agency approach, apart from commercial banks, financial services are provided to the rural sector by the cooperative banking system and the RRBs. In the aftermath of reforms and adherence to the Basel standards of capital adequacy, income recognition and asset classification, the government of India provided financial support to the extent of Rs 22,000 crore to cleanse the balance sheets of public sector commercial banks and recapitalise them. It also provided Rs 2,130 crore to the RRBs for cleansing of balance sheets and recapitalisation. At later stages, government came to the rescue of financial institutions like Unit Trust of India (UTI), Industrial Finance Corporation of India (IFCI) and Industrial Development Bank of India (IDBI) also. The cooperative banking system with state cooperative banks (SCBs), district central cooperative banks (DCCBs), primary agricultural cooperative credit societies (PACS), state cooperative agriculture and rural development banks (SCARDBs) and primary cooperative agriculture and rural development banks (PCARDBs) is a major purveyor of financial services to the rural sector. However, the central government abdicated its responsibility to this system ostensibly on the ground that the ownership of these institutions is vested with state governments and they have to take the responsibility for their financial restructuring. It was only after much persuasion that the government appointed the Capoor Committee to study the functioning of cooperative credit system and suggest measures for its strengthening. The measures suggested included the reduction of government control, strengthening of base level institutions, rehabilitation of potential units and adoption of Model Cooperative Societies Act [GoI 2000]. The working out of the financial package on the basis of the Capoor Committee recommendations was entrusted to the Vikhe-Patil Committee which made recommendations regarding the revitalisation assistance, the pattern of its sharing and the method of funding [GoI 2002a]. But neither the reform package nor the financial package was able to see the light of the day. The UPA government that took office in 2004 chose to add one more committee to the list and constituted the Vaidyanathan Committee to look into reforms in the cooperative sector. This committee submitted its report on the short-term structure, which was accepted by the government. The recommendations of this task force covered the financial package to wipe out accumulated losses and meet minimum capital requirements and legal and institutional reforms [GoI 2005]. But implementation of the report at the ground level in the form of flow of funds to cooperative credit institutions is yet to take off. The Vaidyanathan Committee’s report on long-term cooperative credit structure is yet to be accepted by the government. The loss as a result of a decade of inaction had been costly for the cooperative banking sector, debilitating a large part of the system as seen from Table 2.

The outcome of this systematic atrophy was that the cooperatives which had a share of 49.1 per cent of total credit to agriculture in 1990-91, witnessed the decline of that to 30.9 per cent in 2004-05.

In contrast, the RRBs benefited from the recapitalisation and cleansing of balance sheets which was accompanied by the development action plans (DAPs) operationalised with technical inputs from the national bank for agriculture and rural development (NABARD). The DAP exercise was utilised by RRBs to recast their systems and procedures, lending and deposit taking programmes, strategies of recovery and human resource management practices to emerge viable without neglecting the outreach aspects of their credit programmes [Satish 2004]. The organisational development initiative (ODI) which was undertaken in these institutions also assisted the turnaround process. This process improved the organisational climate and staff morale. It could stimulate a creative problem-solving attitude among RRB staff and explore new business opportunities [Basu and Das 2000]. By the end of the 1990s, these institutions were in a stage of take off, to expand and take on a greater role in rural credit delivery, especially in the areas where the cooperatives had become moribund. But the RRBs needed structural and policy level changes, including freeing themselves from the apron strings of their sponsor banks, which were stymieing their expansion, fearing competition. The Chalapathi Rao Committee appointed by the government came out with far-reaching recommendations for reforming the RRB system, which included changes in capital structure and ownership pattern, governance structure, regulatory and supervisory systems and operating structure [GoI 2002b]. Unfortunately, not unlike many committee reports earlier, this report also landed in a cold storage. With no recruitment and branch expansion the RRBs present a picture of stagnation as seen from Table 3. This stagnation crippled these banks, rendering them incapable of fulfilling their original mandate.

On the other hand, this set-up is being tampered with in an ad hoc manner with amalgamations at state level, sponsorbankwise. This process of amalgamation is being carried out without a road map and has negativated the mandate for their creation. Thus an institutional set-up which showed a promise of emerging as an alternative to the cooperative system was

Table 1: Number and Percentage of Rural Branches

Year Number of Rural Branches Percentages to Total

1989-90 34,867 58.2 1990-91 35,134 56.9 1991-92 35,254 56.8 1992-93 35,360 56.3 1993-94 35,396 55.9 1994-95 33,017 51.7 1995-96 32,981 51.2 1996-97 32,909 50.5 1997-98 32,854 49.9 1998-99 32,840 49.3 1999-2000 32,673 48.7 2000-01 32,640 48.3 2001-02 32,443 47.8 2002-03 32,303 48.55 2003-04 32,121 47.80 2004-05 32,082 46.93 2005-06 30,750 44.48

Source: Basic Statistical Returns, RBI, various years.

Table 2: Health of Rural Cooperative Credit System

(as on March 31, 2005)

Institution No of No of Loss-Total Units making Units Accumulated Losses (Rs crore)

State Cooperative

Banks (SCBs) 31* 6 267.91 Dist Central Cooperative

Banks (DCCBs) 367* 79 4,793.99 Primary Agricultural

Cooperative Credit Societies

(PACS) 1,08,779 40,388 6,862.43 State Cooperative Agriculture

and Rural Development

Banks (SCARDBs) 20 9 1,098.43 Primary Cooperative Agriculture

and Rural Development Banks

(PCARDB) 727 472 2,474.97

Note: * Six SCBs and 136 DCCBs are not complying with the minimum capital requirements as specified under Section 11 of Banking Regulation Act, 1949 (as applicable to cooperative societies).

Source: Cooperative Credit Structure: An Overview-2004-05, NABARD.

allowed to stagnate by leaving their managerial control to the sponsor banks, which had a poor vision of the contours of the rural finance system of the country and had no use for these institutions other than as sources of cheap funds and stations for their unwanted personnel.

III Application of Basel Norms to Agricultural Credit

The first RBI circular to commercial banks in 1992-93 on prudential norms of income recognition, asset classification and provisioning [RBI 1992a] was made applicable uniformly to all sectors, including agriculture, even without a modicum of consultation with the apex bank for agricultural finance. By strictly adhering to these instructions not a single rupee would have been lent to agriculture. The RBI then realised its faux pas and introduced the concept of crop seasons in a clarificatory circular that partially mitigated the damage [RBI 1992b]. In its rationale for prudential norms, the RBI states.

In line with the international practices and as per the recommendations made by the Committee on the Financial System, the Reserve Bank of India has introduced in a phased manner prudential norms for income recognition, asset classification and provisioning for the advances portfolio of banks so as to move towards greater consistency and transparency...The policy of income recognition should be objective and based on record of recovery rather than any subjective consideration. Likewise, the classification of assets of banks has to be done on the consistent application of the norms. Also, the provisioning should be made on the basis of classification of assets based on the period for which the asset has remained non-performing and the availability of security and the realisable value thereof [RBI 2001].

Banks were required to classify the non-performing assets (NPAs) into further categories based on the period for which the asset has remained non-performing and the realisibility of the dues, and on the basis of these classifications, make provisions as prescribed by RBI. And there was also an indirect hint from the central bank that banks were open to price agriculture and other priority sector loans at higher levels, “In acquiring assets banks should use pricing mechanism in conjunction with product/ geography/industry/tenor limits. For example, if a bank believes that loans to a certain sector are unattractive from a portfolio perspective, it can raise the prices of these loans to a level that will act as a disincentive to borrowers” [RBI 2004a].

The net impact of these measures on priority sectors was twofold: firstly the size of lendable resources of banks shrank to the extent of funds earmarked for meeting capital adequacy and provisioning requirements; secondly, the squeeze had to be applied to sectors perceived as of high risk. In 1994-95 the percentage of NPAs to total advances was 19.45, whereas it was 31.08 per cent in respect of priority sector advances (of which agricultural advances were a subset) for public sector banks. One can hardly fault the banks that taking these aspects together they slowed down on credit to priority sectors, especially to agriculture. After all they were adhering to the diktats of the central bank in true spirit! And further, a risk premium had to be loaded on to the lending rates of such high-risk sectors. A squeeze on credit to agriculture and a relatively high-lending rate were sought to be justified on the basis of this misconceived application of Basel norms to Indian agricultural credit.

NPA Norms and Agricultural Credit

As per the present NPA norms in respect of advances granted by commercial banks for agricultural purposes, where interest and/or instalment of principal remains unpaid after it has become overdue for two harvest seasons, but for a period not exceeding two half-years, such an advance should be treated as NPA. These norms are applicable to direct agricultural advances only. Loans to allied agricultural activities like dairying, fisheries, poultry, etc, the identification of NPAs would be done on the same basis as non-agricultural advances. Such advances attract the 90-days delinquency norm. As far as cooperative banks are concerned, it is stipulated that if interest is not paid during the last two seasons of harvest (covering two half years) after principal has become overdue, such advances should be treated as NPA.

Agriculture faces uncertainties caused by fluctuations in rainfall, floods, droughts and other natural calamities. Such uncertainties are particularly severe in the rain-fed areas. Added to these are pest attacks some crops like cotton are prone to. Then there is the recurring issue of non-remunerative prices for agricultural produce. The compounded effect of these phenomena results in lower incomes and poorer capacity to repay. As farmers use agricultural loans to generate their livelihood, they would normally not behave in a manner which would permanently jeopardise their credit support. Therefore, even if an agricultural loan were not repaid on time due to vagaries of climate or markets, it would be eventually repaid out of the income of subsequent seasons, if the borrower could sustain himself during the period and his overall debt burden did not financially ruin him. Thus income and cash flows smoothen out over a cycle and the dues get cleared over a period, if the adverse climatic and market conditions do not persist. This cyclical nature of agriculture calls for different treatment of reckoning farm cash flows and identifying NPAs. The present norm of non-recovery of interest/ principal up to two crop seasons or covering two half years after the due dates does not fully mirror differing crop maturity periods, some of which may extend up to 18 months. There are regional disparities in crop duration and the current prescription of two half years is not appropriate for longer duration crops. Further,

Table 3: RRBs: Position of Branches and Staff Strength

Year Number of Branches Staff Strength
1990-91 14,527 67,161
1991-92 14,539 69,379
1992-93 14,543 70,170
1993-94 14,542 70,604
1994-95 14,509 70,848
1995-96 14,497 70,975
1996-97 14,461 70,785
1997-98 14,459 70,487
1998-99 14,499 70,484
1999-2000 14,301 70,294
2000-01 14,313 70,141
2001-02 14,390 69,876
2002-03 14,433 69,547
2003-04 14,446 69,249
2004-05 14,484 68,912
2005-06 14,494 68,629

Source: Statistics on Regional Rural Banks, published by NABARD, various years.

both crop and term loans are repaid out of farm income. If crops fail due to natural calamities, recovery of all loans is adversely affected; as such term loans have to be treated on par with application of NPA norms. Advances to allied activities are treated on par with non-farm activities for the purpose of asset classification, without any linkage to the crop situation. In reality, allied activities are closely linked to agriculture and are subsidiary activities taken up to augment the family income. Income from them is also not evenly spread throughout the year and the uneven spread of cash generation from them causes temporary distortions in cash flows leading to possible delays in repayment. Subsidiary incomes may not be adequate to repay the bank loan and interest besides sustaining the family when the principal farm activity is adversely affected. Farmers who take agricultural term loans also borrow for crop production. But banks are not allowed to distinguish between crop and term loan accounts to ensure that credit is available for production, as outstanding amounts of all loans accounts of a borrower are classified as NPA, if there is a default in any one of them.

That the RBI is single-minded in supplanting the so-called international best practices on Indian financial systems regardless of the deleterious effects is further confirmed by its recent circular to term lending and refinancing institutions on provisioning and related norms for government guaranteed exposures [RBI 2006a]. The RBI is aware that a large part of government-guaranteed credit is to land development banks which purvey an investment credit to agriculture and also to the weaker state cooperative banks from the refinance window of NABARD. With one stroke the RBI has made a mockery of sovereign guarantees and brought such loans on par with other credits. This action which increases the provisioning requirements at the level of NABARD will have the consequence of a sharp increase in the cost of credit to the farm sector, specifically for investment credit.

Vyas Committee’s Recommendationson NPA Norms

The need for modifying these norms for agricultural credit has been stressed even by RBI’s Vyas Committee:

The committee recommends that while the current norm of default for two crop seasons could be retained for classification of loans as NPA, the added stipulation of two half years could be removed. Crop season for this purpose would mean the period required for the concerned crops to mature for harvesting. The technical committee appointed for fixation of scales of finance could also determine durations of seasons for different crops. Two crop seasons after the due date should refer to only those two consecutive crop seasons in which the farmer normally undertakes crop production. For long duration crops, a loan may be treated as nonperforming, if interest or principal remains unpaid for one crop season after becoming due. Further, relaxations suggested in respect of crop loans may also be mutatis mutandis made applicable to agricultural term loans. The committee also suggests that the earlier norm of 180 days default for classifying a loan as NPA may be restored for loans for activities allied to agriculture [RBI 2004b].

But the central bank is unmoved. It smugly declares, “Four of the committee’s recommendations were not accepted by the Reserve Bank. These include: (i) retaining the earlier norm of 180 days default for classifying a loan as NPA for loans to agriculture and allied activities, (ii) considering only the account with default for NPA classification and not the outstandings, when a farmer has availed both production and investment loans” [RBI 2006b]. The obsession of RBI with the mechanistic implementation of Basel norms, particularly capital adequacy and provisioning norms, without taking into account India-specific development imperatives has led to a false perception of commercial banks of risks in agriculture and lending to agriculture, resulting in slowdown in the credit flow to the sector.

IV Resources for Agricultural Credit

Agricultural credit requires a second tier refinance arrangement which makes available financial resources which otherwise cannot be sourced from the market. This refinance support is especially crucial for cooperative banks which do not have an access to retail deposits in a manner similar to the commercial banks. Refinance also enables the banks to price their agricultural credit competitively. The Food and Agricultural Organisation (FAO) in its series ‘Agricultural Finance Revisited’ states that one of the roles that governments in developing countries have to play is with regard to providing rural finance intermediaries access to refinancing facilities, in particular, to be used for term lending, through second tier or apex (wholesale) financial institutions [FAO 1998]. In India, till the formation of the NABARD in 1982, this wholesale refinance window was located within the central banking system of the country – the RBI.

The Initial Phase

In the initial years of its formation, the stand adopted by the RBI was the traditional central banker’s approach to the question of refinance, i e, as the central bank of the country, it was a bankers’ bank and that consequently it would provide credit support only as a lender of the last resort. The stand of the Bank is made clear in the statutory report submitted to the government of India in 1937 which says, “The Bank thus holds the cash reserves or the fluid resources against the deposits of all the important banks…..these reserves form by far the largest portion of our working capital. This being the main origin of the resources of the Reserve Bank it will be easy to understand why it has to be the Bankers’ Bank in emergency and not their ordinary financing agency” [RBI 1985].

The change in the attitude occurred only after the acceptance of the recommendations of the Informal Conference (of 1951). The then governor Benegal Rama Rau took a view that the special statutory responsibility of the Reserve Bank in relation to agricultural credit in fact laid on the bank an obligation to provide assistance to the cooperative banking system, which was then the sole institutional agency providing agricultural credit, in the normal operations of these institutions, at least in regard to shortterm credit. The view that as a central bank, the Reserve Bank was merely a lender of the last resort, was considered as irrelevant insofar as its responsibility in the matter of provision of agricultural credit was concerned. It may be seen that by shedding the orthodox approach of a central bank and by involving itself directly in the areas concerning rural credit, the Reserve Bank earned a unique place for itself among the central banks. This approach brought it closer to cooperative credit institutions and through them to the rural people and thus took the Reserve Bank nearer to “what the central bank of this country ought to be” as visualised by the All-India Rural Credit Survey Committee [RBI 1985].

Advent of NABARD

As an exercise in decentralisation of RBI’s functions, NABARD was established, on the recommendations of the Committee to Review Arrangements for Institutional Credit for Agriculture and Rural Development (CRAFICARD), as a refinancing agency for the entire rural credit system. The CRAFICARD had made a specific mention about the need for continued access for this institution to the resources of the central bank [RBI 1981] Consequently, NABARD had been sourcing resources for longterm as well as short-term agricultural credit from RBI. The national rural credit (long-term operations) (NRC(LTO)) fund was established in NABARD at its formation in 1982, to which entire resources under national agricultural credit (long-term operations) fund amounting to Rs 1,025 crore were transferred. Further, the Reserve Bank was extending the general line of credit (GLC) under Section 17(4E) of RBI Act for providing refinance to cooperatives and also to regional rural banks for their shortterm credit extended to agriculture.

Aftermath of Reforms

However, since the advent of the financial sector reforms in 1990s, the Reserve Bank seems to be more comfortable to retrogress to 1930s and adopt the orthodox approach of a central monetary authority. The RBI stopped its contribution to the NRC(LTO) fund in the beginning of the financial year 1992-93 and from then on it had been transferring its entire profits to the government of India. From that year onwards the only contribution to NRC(LTO) fund has been out of the surpluses of NABARD itself. This severely constrained the growth of refinance resources available for long-term lending to agriculture. NABARD in its annual report for 1992-93 stated,

As enunciated in the central budget for the year 1992-93, the entire surplus profits of RBI were required to be passed on to GoI. As such RBI did not contribute to NRC(LTO) fund during the year...Considering the need for a substantial step-up in the private capital formation in agriculture during the Eighth Plan period to put it on a higher growth path, the flow of credit to agriculture and rural development from institutional sources have to be suitably expanded...In case the resources of NABARD are not suitably augmented, it may not be possible for it to meet the refinance commitment...Raising resources at market rates and providing refinance would not be a viable proposition for NABARD. There is, therefore, need for continued support to its resources through contribution from RBI to its NRC(LTO) fund [NABARD 1993].

As is seen from Table 4, after stopping its contribution to NRC(LTO) fund completely in 1992-93, the RBI realised that by doing so it was violating Section 46 (A) of RBI Act, 1934 and Section 42 (1) of NABARD Act, 1981 which make it mandatory for RBI to contribute to this fund. So the via media of adhering to the letter of the acts while flouting the basic spirit behind them was discovered by contributing a token amount of Rs 1 crore every year.

Monetarist Stance on Short-term Credit

In case of short-term refinance, the GLC limit which reached a level of Rs 6,600 crore in 2000-01 has been gradually tapering off and for crop year 2005-06 it has come down to an all time low of Rs 3,000 crore and ceased completely from January 31, 2007. The Reserve Bank has maintained before standing committee on finance that in order to maintain the integrity of the monetary and financial system, as also to enhance the transparency, the bank has been transferring the entire surplus after appropriation to statutory reserves to the government. Consequently, lines of credit from the bank to financial institutions are discouraged. It has further stated that, ideally as per the wellestablished central banking norms, the bank should create additional money for on-lending for long-term purposes only in exceptional cases and, if unavoidable, as credit to government of India, which in turn can reallocate the created money among various national purposes.

To all requests for enhancement, earlier and continuation now, of the GLC, the RBI’s stand is that since GLC is created money, it is by nature inflationary, and therefore, has to be discouraged. This stand can be examined from two facets. Even if it is accepted as inflationary, its share of M3 is too low to be of any influenceable value. With M3 at a level of Rs 30,18,622 crore (as on December 22, 2006) the GLC of even the highest level reached of Rs 6,600 crore would not exceed 0.21 per cent, i e, less than one-fourth of 1 per cent of M3. On the other facet of inflationary nature of created money, enough theoretical and empirical work has been done to disprove the traditional monetarist view. It is not the nature or source of money which is a cause for inflation but nature of deployment of such money. The GLC through which the short-term refinance is extended to cooperatives and the RRBs is ultimately resulting in crop production, that too mainly foodgrains, oilseeds and pulses. These are basically in the nature of wage goods, which are inflation-dampening. The crop

Table 4: Contribution of RBI and NABARD to NRC(LTO) Fund

(Rs crore)

Year Contribution of RBI Contribution of NABARD

1982-83 180 47 1983-84 225 100 1984-85 275 140 1985-86 300 190 1986-87 350 250 1987-88 300 285 1988-89 330 235 1989-90 330 350 1990-91 375 400 1991-92 400 515 1992-93 0 525 1993-94 1 555 1994-95 1 250 1995-96 1 250 1996-97 1 450 1997-98 1 550 1998-99 1 832 1999-2000 1 1020 2000-01 1 1150 2001-02 1 530 2002-03 1 221 2003-04 1 124 2004-05 1 81 2005-06 1 30

Source: Annual Reports of NABARD, various years.

production in a country where 66 per cent of the farmer households are small and marginal farmers with landholdings of less than 1 ha cannot be termed inflationary.

In a developing economy like India, it should be the mediumterm objective of the monetary and credit policies to seek to change the risk profile of the agriculture sector itself and the credit policy should become an important ingredient of the macroeconomic management package. Credit, and by consequence refinance, both short-term and long-term, should be viewed in this context as a growth enhancement and risk-reducing instrument. However, the whole approach to the assessment of risks in the agricultural sector, and consequently, to shaping agricultural credit policies is being viewed in a narrow orthodox monetarist way. The monetarist approach to agriculture and agricultural credit clearly reflects a lack of appreciation of the relevance of this sector to an overall development of the economy [Mujumdar 2005].

Further Squeeze on Resources for Agriculture

The issue of provision of resources for long-term credit flow to agriculture, which received a severe set back in 1992-93 with the government’s decision to appropriate entire surplus of RBI and not leave any amounts for building up of NRC(LTO) fund in NABARD, got further compounded in 2001-02 with the income tax imposed on NABARD by the government of India. The ostensible reason was that NABARD was a commercial organisation and should be paying income tax to the government. In his budget speech the then finance minister stated, “The income of NABARD, NHB and SIDBI was exempted from tax in order to provide fiscal support in the initial years of their functioning. Now these institutions have come of age and are working on commercial lines. I, therefore, propose to withdraw the tax exemption available to these institutions” [GoI 2001]. To classify a refinancing institution, which has no recourse to cheap retail resources and has to borrow at market rates and extend refinance at sub-market interest rates, as a commercial organisation is certainly beyond the realm of simple logic. Imposition of income tax deprived NABARD of the ability to plough back resources to agriculture sector.

A refinancing institution cannot depend solely on borrowed funds and has to have access to the resources of the central bank or the treasury. But in case of NABARD, it has been depending solely on borrowings since the door has been shut on other funding arrangements. Market borrowings which formed just

11.71 per cent of its loan portfolio at its inception have now risen to 63.66 per cent (excluding GLC from RBI). Table 7 indicates as to how the outstanding loan portfolio of NABARD is already

2.75 times of its own funds.

Further, NABARD had been shut off from various sheltered borrowing avenues which were available to it earlier, which enabled it to raise low cost resources. The statutory liquidity ratio (SLR) bonds were discontinued in 1999 and tax-free bonds in 2003. In 2006-07, even the instruments of capital gains bonds and priority sector bonds were withdrawn from NABARD. Surprisingly, NABARD seems to be only an institution for imposition of fiscal discipline. Municipalities have been allowed to issue tax-free bonds and Rural Electrification Corporation (REC) and National Highways Authority of India (NHAI) are still allowed to float capital gains bonds. The Small Industries Development Bank of India (SIDBI) is allowed to accept subscriptions to small enterprises development fund in lieu of priority sector shortfall by foreign banks and recently government has extended sovereign guarantee to India Infrastructure Finance Company (IIFCL) to raise Rs 5,000 crore. NABARD has not been allowed even the facility to float infrastructure bonds, which had been allowed to other public sector entities like REC, Power Grid Corporation of India (PGCI), Power Finance Corporation (PFC), NHAI, etc. This is only a pointer to the fact that though at the highest levels of the government there is abundant rhetoric on concern about agriculture and investment flow to it. In concrete terms, there is a deliberate squeeze on the resource flow to the sector. In short, agriculture and its apex institution are true Cinderellas outside the radars of the policymakers.

V Support for Agricultural Credit in Advanced Economies

In contrast to the situation in India, in most of the advanced economies, there exists a robust mechanism to fund agricultural credit with the full backing of the treasuries and central banks. The farm credit system (FCS) is America’s first governmentsponsored enterprise. It was created in 1916, when Congress chartered 12 regional farm credit banks. Congress wanted to increase the ability of farmers to obtain credit to finance the

Table 5: General Line of Credit Extended by RBI to NABARD

Year GLC Limit (Rs Crore)

1982-83 1,200 1983-84 1,300 1984-85 1,300 1985-86 1,300 1986-87 1,400 1987-88 1,950 1988-89 2,700 1989-90 3,350 1990-91 3,350 1991-92 3,350 1992-93 3,750 1993-94 4,350 1994-95 4,850 1995-96 5,294 1996-97 5,272 1997-98 5,700 1998-99 5,800 1999-2000 6,100 2000-01 6,600 2001-02 6,500 2002-03 6,500 2003-04 6,500 2004-05 5,200 2005-06 3,000

Source: Annual Reports of NABARD, various years.

Table 6: Income Tax Paid by NABARD

Year Tax Paid (Rs Crore)

2001-02 405.01 2002-03 411.37 2003-04 391.58 2004-05 367.36 2005-06 360.00

Source: Annual Reports of NABARD, various years.

purchase of farms and ranches. The federal land bank system was also established, comprising 12 federal land banks which enabled the farmers to obtain long-term first mortgage loans to purchase capital assets used in agriculture and allied activities. The production credit system was also a part of the FCS through which farmers obtained short-term and intermediate loans for their farming operations [Lee, Boehlje, Nelson and Murray 1980].

Today after reorganisation and mergers there are four regional farm credit banks (FCBs) and one agricultural credit bank (ACB) under FCS. The FCBs provide loan funds to 81 agricultural credit associations (ACAs) and nine federal land credit associations (FLCAs). The ACAs make short-term, intermediate and longterm loans whereas the FLCAs make only long-term loans. The ACB which has the authority of an FCB provides funds to five ACAs. The ACB also makes loans to agricultural, aquatic and public utility cooperatives and is authorised to finance the US agricultural exports and provide international banking services for farmer-owned cooperatives. The FCS has outstanding loans of US $103 billions to more than half a million borrowers which include farmers, ranchers, rural house-owners, agricultural cooperatives, rural utility systems and agri-businesses. Except ACB all lending institutions under FCS are exempt from payment of federal and state corporate income taxes. However, the ACB gets tax breaks from states and is taxed only after patronage refunds, and as such its tax liability usually gets reduced by nearly 85 per cent every year. The FCS gets its funding from the federal farm credit banks funding corporation. This corporation raises funds through bonds which are directly backed by US treasury and have the same status as treasury bonds. In times of need the federal government never hesitated to create new funding mechanisms as in 1987 when the farm credit system financial assistance corporation was set up. In addition, the federal agricultural mortgage corporation also known as farmer mac provides a secondary market for agricultural real estate and rural housing mortgages [FCA 2005].

In Japan, the Agriculture, Forestry and Fisheries Finance Corporation (AFC) was established in 1953 with capital from the Japanese government. It extends long-term low interest loans for agriculture and allied sectors. The policy of the Japanese government is that agriculture, forestry and fisheries have such characteristics as uncertain harvests affected by climate, wide price fluctuation of outputs, long gestation periods, low return on investment and poor markets for possible collateral. These characteristics make it difficult for private sector financial institutions to provide financial services to these sectors necessitating AFC’s heavy contribution to them. The government also launched the agriculture modernisation loan programme in 1961 utilising the funds of JA Bank for medium to long-term agriculture investment by subsidising interest payments. JA Bank is basically a financial group comprising primary agricultural cooperatives, prefectural credit federations of agricultural cooperatives (PCFACs) popularly known as Shinnoren and the central bank of agricultural cooperatives (Norinchukin Bank). JA Bank depends heavily on interest subsidies from prefectures. Commercial banks have a minuscule share in agricultural credit in Japan. Of the outstanding agricultural credit of 21,482 billion yen (as on March 31, 2004) the share of JA Bank group was

87.5 per cent, that of AFC was 8.3 per cent and commercial banks accounted for only 4.2 per cent. The AFC receives funding from fiscal investment and loan programme (FILP) and also directly from the fiscal fund of the central government. The funds collected through postal savings and public pension reserve are automatically entrusted to FILP based on the credit extended by the government of Japan. The agricultural improvement loans are interest free loans extended by prefecture governments through AFC and PCFACs. Ensuring the economic stability of the farming community and the agricultural economy on which they are dependent is one of the core philosophies of the Japanese government. In tune with this philosophy, it has designed the agricultural finance systems with a strong funding support from the central treasury as well as prefecture treasuries [AFC 2005].

VI Summary and Conclusions

In totality, over the last decade and a half, what has been observed from the above analysis is a reversal of the public policy objectives of extending the reach of agricultural credit, providing affordable and timely credit to rural households (specifically the economically vulnerable households) and overcoming historical problems of imperfect and fragmented rural credit markets. The effects of this policy reversal are corroborated by NSSO’s survey. The survey reveals that the share of institutional credit agencies in the outstanding amount of cash dues of the rural households declined by about 7 percentage points between 1991 and 2002 and was 57 per cent in 2002. This is in sharp contrast to the earlier periods wherein there were gradual increases in each decennium. This share increased from 29 per cent in 1971 to 61 per cent in 1981. Though the pace of increase

Table 7: Own Funds and Loan Portfolio of NABARD

(As on December 31, 2006) (Rs crore)

Own funds 24,243.69 Outstanding investment credit portfolio 33,565.33 Outstanding production credit portfolio 15,693.74 Outstanding rural infrastructure credit portfolio 17,568.69

Source: NABARD.

Table 8: Trends in Lending to Agriculture and SmallBorrowal Accounts

Year Share of Agriculture Rural Credit-No of Small Borrowal as a Proportion Deposit Ratio Accounts below of Total Bank (in Per Cent) Rs 25,000 Credit (in Per Cent) (in millions)

1990-91 15.00 60.00 58.78 1991-92 15.10 57.90 62.54 1992-93 13.60 55.30 58.52 1993-94 13.00 50.00 55.81 1994-95 11.90 48.60 53.91 1995-96 11.40 47.30 51.90 1996-97 11.40 44.10 47.32 1997-98 11.40 43.40 46.83 1998-99 11.00 41.00 42.74 1999-00 9.90 40.40 39.27 2000-01 9.60 39.00 37.25 2001-02 9.80 41.80 37.32 2002-03 10.00 42.42 36.87 2003-04 10.90 43.69 36.76 2004-05 10.79 49.87 38.73

Source: Basic Statistical Returns, RBI and Special Statistics, EPW Research Foundation, various years.

decelerated, still there was a 3 percentage points increase to 64 per cent in 1991. On the other hand, the share of institutional agencies in the amount of debt for urban households increased progressively from 60 per cent in 1981 to 72 per cent in 1991 and 75 per cent in 2002 [NSSO 2005]. The negative impact of the post-1991 policies can be further observed from Table 8. Credit to agriculture as a proportion of total bank credit of commercial banks decreased from 15 per cent in 1990-91 to 9.9 per cent in 1999-2000 and further to 9.6 per cent during 200001, with a fractional recovery to 10.9 per cent in 2003-04. The number of small borrowal accounts below Rs 25,000 which can be treated as a proxy for extensiveness of credit flow to priority sectors shrank from 58.78 millions in 1991-92 to 39.27 millions in 1999-2000 and further to 36.76 millions in 2003-04. The rural credit-deposit (CD) ratio which was 60 per cent in 1990-91 fell to 39 per cent in 2000-01, though it recovered to 49.87 per cent in 2004-05.

The incremental CD ratio which averaged 60.4 per cent during 1981-91 drastically reduced to 34.5 per cent during 1991-2001. The effects are further reflected in the declining trend in the capital formation in Indian agriculture, since early 1990s. The level of capital investments in agriculture that was at 1.88 per cent of GDP in 1992-93, declined to 1.27 per cent in 2002-03. And consequently, the growth rates in agriculture which averaged

3.2 per cent per annum for the pre-reform period of 1982-90 declined to 3.2 per cent in the post-reform period of 1992-2000. In the second phase of reforms, it was particularly low at 1.5 per cent in the 1997-2000 period [Parikh and Radhakrishna 2002]. For the subsequent period the growth rates were dismal at 0.3 per cent, (-) 0.4 per cent, (-) 6.9 per cent and 0.7 per cent for the years 1999-2000, 2000-01, 2002-03 and 2004-05, respectively [GoI 2006].

It appears that the RBI and government view that the development of financial markets is sufficient to take care of credit needs of agriculture and rural sector. But financial markets fail the poor – whether farmers or micro-entrepreneurs – due to the following reasons:

  • (1) No lender is willing or permitted to pass on the extra costs associated with lending to customers.
  • (2) No insurer is willing to compensate for borrowers’ and lenders’ risk aversion by offering insurance against non-payment due to natural calamities.
  • (3) Potential borrowers are unwilling to borrow because of risk aversion, even if the expected value of their profits outweighs the expected costs of their investments.
  • (4) Social and private values of costs and benefits diverge because of externalities [Hume and Mosley 1996].
  • The fact that credit markets fail the poor underscores the importance of interventions in rural financial markets. The review of macroeconomic and financial sector policy framework has shown that the state plays an important role in enabling an environment in which financial institutions can prosper, thus increasing financial deepening and access to financial services. Because of the imperfections in intertemporal markets,institutional innovation and formation cannot emerge through market forces alone. A liberalised formal financial market may be a necessary condition for the creation of a spontaneous supply of financial services to the target group, but in itself it is not sufficient to achieve this effect. Consequently, there is a need for intervention and technical assistance, even if financial repression has been abolished [Krahnen and Schmidt 1994].

    The Way Forward

    The way forward to reverse the policy coarctation for agricultural credit and provide an enabling environment for ensuring the flow of credit and other financial services to agriculture and allied sectors should broadly encompass the following:

  • (i) The dismal performance of commercial banks in purveying agricultural credit is due, in part, to the insufficient supervisory oversight on part of the RBI over the rural business of these banks. This, in turn, stems from the lack of domain knowledge about agriculture and agricultural credit within RBI after the formation of NABARD. This position would be rectified only by handing over the entire supervisory responsibilities of rural branch network of commercial banks to NABARD, which would be able to ensure a better and systematic monitoring and supervision of flow of credit and other financial services to agriculture on account of its deep understanding and knowledge of the sector and strong field level presence.
  • (ii) For the revitalisation of the cooperative banking sector, central government, state governments and NABARD should work for the speedy grounding of the reform package envisaged under the Vaidyanathan Committee report on short-term cooperative credit structure. Government should also expedite the decision on acceptance of the Vaidyanathan Committee report on long-term cooperatives.
  • (iii) The time has come for the RRBs to come upon their own and play a greater role in agricultural credit under the overall guidance and advice of NABARD. To ensure this, the umbilical cord to their sponsor banks has to be severed. In principle no business should be owned (or managed) by its competitor; if it happens so, the result is either cannibalisation or stunted growth. The RRBs have to emerge as independent institutions and expand their operations and step-in into areas where cooperatives have weakened.

  • (iv) The RBI should realise that the Bank for International Settlements (BIS) at Basel cannot be credited with sound knowledge of intricacies of lending to agriculture in developing countries, and undertake a comprehensive reform of Basel norms for agricultural credit. It has to innovate measures for “suitable country-specific adaptations” in applying these norms to Indian situation. The RBI does not tire of mentioning about adherence to international best practices in prudential norms. However, in practice, these international best practices basically mean American and European best practices whose economies and agriculture are far different from that of India. No advanced economy has an agricultural sector with a GDP contribution and share of employment of the levels as in India. The RBI has to address the root cause of the problem of deceleration in credit flow to agriculture: the disincentivisation of agricultural credit to the banking sector by a mechanical application of Basel norms.
  • (v) Refinancing is a central banking function and the RBI has to continue to exercise that role through NABARD by resuming the GLC. The Vyas Committee said that in view of Reserve Bank’s decision to phase out GLC there is need to provide a contingent line of credit at a reasonable rate of interest so that NABARD can draw funds for providing short-term refinance
  • to cooperatives and RRBs [RBI 2004b]. If RBI is not agreeable to the same, government should direct RBI to place half of the funds impounded with it under CRR with NABARD to enable it to dispense refinance for short-term agricultural credit.

    (vi) In the interest of capital formation in Indian agriculture, there is an immediate need to strengthen the arrangements for resources for refinancing investment credit to agriculture. For this purpose, the transfer of funds out of RBI’s surplus to NRC(LTO) fund in NABARD has to be restored whether it is directly through the monetary route or indirectly through the fiscal route. While the Agricultural Credit Review Committee [RBI 1989] had recommended the continued and increased contribution from RBI’s profits to the LTO fund, the recent Vyas Committee endorsed it. The committee recommended a judicious mix of market borrowings supplemented by central government funding out of profits transferred to it by RBI to further expand NABARD’s scale of operations [RBI 2004b] government on its part should restore income tax exemption for NABARD, so that it can plough back larger volumes into agricultural credit.

    (vii) Government and RBI should restore NABARD’s ability to mop up low cost resources by resuming instruments like SLR bonds, tax-free bonds, priority sector bonds, capital gains bonds, etc.

    When agricultural credit is handled with utmost importance and seriousness by governments, treasuries and central banks in countries where agriculture contributes to just 1-2 per cent of GDP and less than 2 per cent of the workforce is employed in agriculture, it should certainly deserve far greater attention than it now receives in India where 22.6 per cent of the GDP still emanates from agriculture and 60 per cent of the workforce is still employed in that sector. The suggestions above are the minimum steps to ensure a level playing field for this sector in the credit arena. In the absence of such measures, all the scholarly reports of the plethora of committees, expert groups and working groups such as those on rural credit, flow of credit to agriculture, investment credit in agriculture, CD ratio, financial inclusion, agricultural indebtedness, measures to assist distressed farmers, etc, would result in no more than adorning the bookshelves on the 6th floor of a certain high rise building on the Mint Street. Further, if the thoroughly insensitive attitude of the central bank and the ambivalent stance of the central government towards agricultural credit continue as at present, the 4 per cent plus growth rate in agriculture being aimed at during the Eleventh Five-Year Plan period would be no more than a mirage.



    [The views expressed are those of the author and not of the institution he works for.]


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