COVID-19: Augmenting farmer access to long-term credit

Failing to protect farmers amid the novel coronavirus disease (COVID-19) pandemic can worsen India’s agrarian distress.

By Tanya Kak
Published: Monday 06 July 2020

The current novel coronavirus disease (COVID-19) pandemic has severely disrupted agricultural supply chains and pushed over half of our population, which relies on agriculture for their livelihood, into further uncertainty.

Several farmers have struggled to sell their produce from the rabi season and raise capital to prepare for the sowing season this month, adding to the existing debt crisis.

Failing to protect them during this critical juncture could worsen India’s agrarian distress. How, then, do we support our farmers with access to finance to ensure both their livelihoods and our food security?

In order to offer relief to the sector, Union Finance Minister Nirmala Sitharaman extended Rs 20 lakh crore credit at a concessional interest rate to farmers. A Rs 30,000 crore emergency working capital fund for crop loans disbursed through rural cooperative banks and regional rural banks was also approved.

The implementation of these measures assumes an effective architecture in place to provide access to institutional credit to farmers who need it the most.

With at most 40 per cent of our small and marginal farmers being able to access sources of formal credit, this moment affords an opportunity to work towards a long-overdue agenda: Short-term agricultural credit reforms and building on these measures as a part of the long-term recovery strategy.

Institutional credit

The share of institutional credit in agriculture increased to 72 per cent in 2015 from 63 per cent in 1981, according to the National Bank for Agriculture and Rural Development’s All India Financial Inclusion Survey.

While this is encouraging, most of our small and marginal farmers still depend on informal sources of credit such as relatives and moneylenders, as well as on non-banking financial institutions like microfinance institutions. This is problematic for many reasons. A review of six randomised evaluations from India and other developing countries on the impact of expanded access to micro-credit found little suggestive evidence for its transformational effect on reducing poverty or improving living standards.

Some reasons for its low take-up include the terms being unsuitable for rural and agricultural contexts, as microfinance interest rates can be exceptionally high.

Microfinance loans also have strict and regular repayment schedules, which can be difficult for farmers to adhere to.

India’s agricultural sector needs to experiment with innovative solutions to expand the reach of institutional credit.

One such solution is the Union government’s interest subvention scheme (ISS), which offers short-term loans to farmers at subsidised rates.

The trend of farmers borrowing more for short-term production expenditure compared to long-term capital investment in productive agricultural technologies heightened partially due to ISS incentives, according to an internal working group of the Reserve Bank of India.

This is problematic as long-term investment is needed for the sector’s sustainability. An added complication is that tenant farmers in several states are unable to access institutional credit.

This is because they are not considered cultivators of their land under the state’s legal system and have no collateral to offer to banks.

Introducing asset-collateralised loans

These constraints point towards the need for policy innovations that offer farmers a viable, immediate path to accessing institutional credit.

Part of the solution may be found in expanding farmers’ access to asset-collateralised loans, where instead of a guarantor or a separate collateral, the new asset being bought can act as the loan collateral.

While this loan structure is commonplace in developed countries, it is yet to become widely available to farmers in India.

To test the impact of introducing asset-collateralised loans in a developing country context, researchers affiliated with the Abdul Latif Jameel Poverty Action Lab (J-PAL) conducted a randomised evaluation in Kenya. Four randomly selected groups of smallholder dairy farmers were offered loans of varying structures.

The terms for all groups specified the funds could only be used for the purchase of a rainwater harvesting tank.

Each of the four groups, however, was offered a different loan structure. One group of borrowers was offered the local standard loan, which required a significant cash deposit and loan guarantors to secure the remaining balance.

Other groups were offered loans that required a minimal cash deposit from the borrower or a guarantor — of either 4 per cent or 25 per cent of the asset value — and the asset itself pledged as collateral.

The results showed that asset collateralisation significantly increased take-up of the loan. Under the most flexible terms, 44 percent of farmers who received the asset collateralised loan offer decided to take it up.

While there were some delays in repayment, there were no loan defaulters among the 718 farmers who took an asset collateralised loan that required a 25 per cent cash deposit.

Of the 431 asset collateralised loans taken up requiring a 4 per cent deposit, three borrowers defaulted, but in each case the lender was able to repossess the tank and recover the entire value of the asset.

These results suggest that asset collateralised loans can be a useful tool to expand access to credit for farmers, and potentially encourage investment in new agricultural technology, at little cost to lenders.

Introducing asset-collateralised loans in the Indian context could be beneficial. To facilitate long-term investment, the government introduced Negotiable Warehouse Receipts. This enabled farmers to store their produce in accredited warehouses and use the issued receipt as proof of collateral to borrow from banks.

Challenges with this system include poor warehouse infrastructure, inadequate cold storage facilities for perishable crops and warehouses overestimating the value of stored crops.

While the storage loan system is important for farmers, asset-collateralised loans could augment the current system for long-term borrowing by providing more security of collateral.

Additionally, asset-collateralised loans would not require heavy infrastructure costs and would enable credit to flow more freely throughout the cropping cycle as opposed to only during the post-harvest period.

The story of a rising India would be incomplete without securing the livelihood of our farmers and making the sector self-reliant.

Improving access to long-term institutional credit is essential to that story and to the promise of financial inclusion and dignity for our farmers.

Views expressed are the author's own and don't necessarily reflect those of Down To Earth.

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