Economics India

Thursday, March 23, 2006

Interest Rate Subsidies on Farm Loans Could Get Out of Hands Soon!

In their meeting with Finance Minister Mr. P. Chidambaram on March 23, public-sector bank chairmen propose to ask for government subvention equal to 2.5 to 3 percentage points on agricultural short-term loans, to be able to lend at the government-directed interest rate of 7%, if they must cover their banks' transaction costs, and leave them with a reasonable spread. .

The government directive to lend short-term agricultural loans at 7 per cent per annum is applicable only to public sector banks and cooperative banks and not to private banks. Further NABARD refinance packages at subsidized interest rates will be available only to regional rural banks and cooperative banks and not to public sector banks.

If the public sector banks do not receive the needed budgetary subventions, they will inevitably be constrained to cross- subsidize agricultural loans by increasing interest rates for loans to other sectors. Some banks have already announced to do so with a possible increase of 1% p.a. in interest rates on loans to all other sectors.

If past experience is any guide, the government may nominally (on paper) allocate money for subventions to public sector banks and NABARD but in practice there may not be available necessary cash (liquidity) to release these allocations to banks.

If public sector banks are constrained to cross- subsidize short-term agricultural loans, the only alternative for them will be just to reduce their lending for agriculture – which means farmers are denied access to credit. What farmers want is access to adequate credit and not necessarily cheap credit.

What a mess? Instead of making the country's rural financial system market-oriented, competitive and efficient to be able to undertake viable financial intermediation on their own, the government has one more time chosen a subsidy instrument that will hurt all including the government, banks, farmers and borrowers in non-agricultural sectors.

Interest rate distortions do not help the economy, the savers, the borrowers and the financial intermediaries. Should we urge the government to reverse this wrong policy?


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