The Budget 2016-17 witnessed an increase of ₹2,000 crore in the allocation towards interest subsidy for short-term credit (i.e. crop loan) to farmers, compared with the revised estimate for 2015-16, thereby making a total provision of ₹15,000 crore towards interest subsidy.

In fact, of the total allocation of ₹35,984 crore for agriculture, cooperation and farmers’ welfare (ACFW), interest subsidy for short term credit to farmers alone constituted more than 40 per cent.

The subvention scheme was first introduced in 2006-07 to enable lending institutions to advance credit to agriculture at a lower rate of interest.

The Finance Minister in his Budget speech in 2006-07 announced that farmers would receive short-term credit at 7 per cent for crop loans up to ₹3 lakhs, by providing an interest subvention of 2 per cent to banks.

An additional subvention of 1 per cent was introduced this was increased to 3 per cent in 2011-12, making the total subvention 5 per cent. Therefore, farmers who pay their dues on time receive a subvention of 5 per cent and are charged an effective interest rate of 4 per cent.

Short-term credit impact The scheme hopes to spur short-term credit — or crop loans under direct finance to farmer. It enables the cultivators to procure inputs such as fertiliser and seeds needed for agricultural operations, or meet working capital requirements. But the financial liabilities under the scheme have been increasing rapidly over time.

The expenditure from the Union Budget towards credit subsidy has increased more than seven fold i.e. from ₹1,700 crore in 2007-08 to ₹13,000 crore in 2015-16. However, with resource allocation for the scheme having fallen over the last few budgets, it resulted in mounting backlog of unsettled claims.

The cumulative backlog stood at almost ₹35,000 crore by FY15. The allocation for the current year on the programme, which seems to be a huge increase, in fact is too little to meet the overall requirement.

The scale of expenditure on credit subsidies also raises an obvious question: that to what extent does the credit subsidy (interest subvention) reduce the cost of working capital for the farmer?

An analysis of interest on working capital as a percentage of the cost of cultivation of last five years in the case of some major crops — paddy, wheat, maize and cotton — shows that interest on working capital constitutes between 1-2 per cent of the cost of cultivation.

Similarly, it is difficult to establish a link between interest subvention and expansion of short-term credit.

In fact, with the introduction of interest subvention, the rate of growth of short-term credit has declined. For example, short-term credit grew at the rate of 24 per cent per annum between 2001-02 and 2005-06 i.e. in the five years before its introduction in 2006-07; it fell to 21 percent per annum in the five years after the introduction of interest subvention scheme.

There is a high probability of funds being misused, given the arbitrage opportunity in granting loans at highly concessional rates.

On the other hand, as the scheme targets only short-term credit, it discriminates against the long-term credit — meant for investment in fixed assets such as irrigation pumps, tractors, agricultural machinery and so on. This would promote capital formation and productive capacity in agriculture.

Capital formation down Despite the manifold increase in the volume of direct finance to agriculture in the 2000s — 17.8 per cent per annum as compared with 8.5 per cent per annum in the 1990s — there has been a fall in the share of long-term credit in total direct finance to agriculture. The share declined from 66.5 per cent in 1991-92 to 37.9 per cent in 2011-12; therefore, an increasingly smaller portion of agriculture credit was used for capital formation in the 2000s.

With capital formation in agriculture in recent decades acquiring a largely private character — it accounted for around 85 per cent of total capital formation in the sector in 2011-12 — the recent sluggish performance of long-term credit may turn out to be costly for agricultural growth in the years to come.

There is a strong association between long-term (direct) agricultural credit and private sector gross capital formation in agriculture — the correlation coefficient comes out to be 0.84 between the period 2000-01 and 2013-14.

Though banks have been able to achieve the overall agricultural credit target set by the government, they have fallen short of achieving the target set under investment credit. For instance, in 2007-08, banks could achieve around 86 per cent of investment credit targets, which declined sharply to 58 per cent in 2012-13.

Although the percentage of achievement has increased to 69 per cent in 2013-14, it was on account of reduction in target limit.

In sum, interest subvention on long-term credit will incentivise long-term capital formation.

The writer teaches economics at National Institute of Bank Management in Pune. The views are personal

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