Dr. Mor's Priority Sector Paper Cont.

This morning I posted a few comments on Nachiket Mor's recent paper on priority sector norms. A few hours later, Dr. Manohar Sharma of the International Food Policy Research Institute posted some a much more astute analysis of the same paper in the comments section of that post. Out of fear that Dr. Sharma's excellent insights will go unread, I am reposting them here.

The paper makes an important point, namely that for marginal farmers and landless labourers, human labour is a key production input, and “consumption” loans that finance the upkeep this productive input are conceptually no different than production” loans that finance farm machinery or fertilizers. For this reason, they ought to, as Dr. Nachiket Mor suggests, qualify as Direct Finance to Agriculture (DFA) under Reserve Bank of India’s (RBI) priority sector lending directive.

Notwithstanding the above, I have one central comment on the paper: it is not quite clear to me how merely re-classifying consumption loans as DFA, by itself, provides greater incentives for commercial banks to increase net lending to the agricultural sector in general or to marginal farmers/landless labourers in particular.

I raise this point for two reasons: First, I note that under current RBI regulation, interest rate on loans under Rs 200,000 are capped at the bank’s prime lending rate. Individual loans to marginal farmers/landless labourers are thus most likely to be amounts small enough to be subject to this regulatory interest rate cap. Also, per unit transactions cost for lenders is likely to be relatively high for such loan sizes. Hence it is not all that clear whether banks will sufficiently recoup costs incurred in lending small amounts to marginal farmers and landless labourers. The case that Dr. Mor makes would be considerably strengthened if the paper further fleshed out reasons why commercial banks -- currently unwilling to fulfil their DFA obligations even by lending to large farmers in amounts not subject interest rate caps -- will suddenly turn around to service much smaller consumption loans to marginal farmers simply because they are now counted as DFA. Second, commercial banks (like ICICI) are already using a variety of innovative financial instruments to partner with MFIs that provide general-purpose loans to poor rural households either directly or through Self Help Groups (SHGs). I am sure that Dr. Mor himself played a critical role in
some of these innovations. From the point of view of commercial banks, these arrangements are rather nice: the loans qualify as priority sector lending and reach relatively poor households, but at the same time avoid interest rate caps and also shift a significant chunk of administrative costs to the MFIs. So, this leads me to my second question: how will merely redefining this financial portfolio as DFA lead to its net enlargement? Would it not, by simple arithmetic, result in equivalent reduction loans classified as non-DFA credit?

Thus, in both cases, I would suggest that the paper address the additionally factor a little more clearly.