Y V Reddy: Rural credit - status and agenda
Speech by Dr Y V Reddy, Governor of the Reserve Bank of India, at the Administrative Staff College
of India, Hyderabad, 16 November 2004.
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Distinguished participants and guests,
It is privilege to be associated with the International Seminar in Honour of Professor CH. Hanumantha
Rao. His valuable contributions as a member of the Board of Directors of RBI, my professional
association with him for about three decades being a fellow Osmanian, and above all, my personal
regard for him, make the participation in the inaugural session today a source of pride and pleasure for
me.
There is a wide-range of subjects being considered by a galaxy of eminent scholars and
policy-makers, but I will confine my comments in the inaugural address to rural credit. The subject has
always been at the core of RBI's activities. Telugus' seem to have been playing a special role in the
design and implementation of rural credit policies in India. The monumental work of All-India Rural
Credit Survey of 1951-52 was the contribution of a Committee in which half the membership was
Telugus. Rural Electrification Corporation and NABARD have been led by Telugus and had Telugus
as Chairmen, for a large part. I cannot recall any economist who could equal Professor CH.
Hanumantha Rao in research, publication and policy involvement in the field of rural credit. In the
context of economic reforms, Professor Rao has published two papers which constitute a treasure
trove for all those interested in rural credit. The first titled 'Policy Issues Relating to Irrigation and Rural
Credit in India' (1993) makes a comprehensive analysis of problems, prospects and tasks. The
second, titled "Reform Agenda for Agriculture" (2003) proposes specific credit reforms in the light of
experience gained and makes a strong pitch for "a major change in the mindset." But being Telugus,
we are individualistic and tend to differ - sometimes politely. Let me illustrate: Shri M. Narasimham
Garu, the Bhishma-Pitamaha of the Financial Sector Reforms in India (1991) recommended redefining
of and reduction in priority-sector lending, describing some of it as "behest lending". Professor Rao
promptly disagreed (1993) with him on redefining priority sector lending though there was agreement
between the two on phasing out of concessional rates of interest. Before proceeding further, it is
appropriate to co-opt Shri Montek Singh Ahluwalia as a Telugu or an Andhraite since he lived in
Hyderabad and had his schooling - perhaps the secret of the solid foundation for scholarship.
There are several concerns in relation to rural credit which are generally expressed in terms of
inadequacy, constraints on timely availability, high cost, neglect of small and marginal farmers, low
credit-deposit ratios in several States and continued presence of informal markets. It is held that while
the commercial banks are more focused in improving efficiency and profitability, they have tended to
give comparatively less priority to rural credit. Regional Rural Banks (RRBs) and Co-operatives appear
to face serious problems of governance as well as operational efficiency. It is argued that most part of
the Co-operative Credit structure is multi-layered, under capitalized, over-staffed and under-skilled,
often with mounting non-performing assets while in a few cases resulting in erosion of public deposits
as well. Many of the RRBs also appear to share most of these problems, though there are some
vibrant and viable institutions in this category. These problems relating to rural credit have been well
documented and several policy-approaches were made to remedy the situation. However, there is
some element of dissatisfaction that overall situation in regard to rural credit is not improving to the
desired level inspite of such a series of actions. It is a matter of concern that cognizable success is
eluding the policy-makers, at a time when increasing commercialization warrants a big thrust in
institutional credit to agriculture. There is thus a discernible widespread intellectual recognition that
while immediate measures are undertaken to increase the flow of credit to agriculture, there is a need
to review the policy of rural credit in a comprehensive and thorough manner.
The current strategy adopted by RBI to increase the flow of credit may be summarized as follows.
First, the coverage of rural credit is extended to include facilities such as storage as well as credit
through NBFCs. Second, procedural and transactional bottlenecks are sought to be removed,
including elimination of Service Area Approach, reducing margins, redefining overdues to coincide with
crop-cycles, new debt restructuring policies, one-time settlement and relief measures for farmers
indebted to non-institutional lenders. Third, Kisan Card Scheme is being improved and widened in its
coverage while some banks are popularizing General Credit Cards (GCCs) which is in the nature of
clean overdraft for multipurpose use, including consumption. Fourth, public and private sector banks
are being encouraged to enhance credit-delivery while strengthening disincentives for shortfall in
priority sector lending. Fifth, the banks are urged to price the credit to farmers based on actual
assessment of individual risk rather than on a flat rate depending on category of borrower or end-use
while ensuring that interest-rates charged are justifiable as well as reasonable. In brief, the thrust is on
enhancing credit-delivery in a regime of reasonable credit-prices within the existing legal and
institutional constraints and to this limited extent there has been " a major change in the mindset", that
Professor Rao desired.
In this background, the agenda for future consists of five parts. First, there is a need for legal and
institutional changes relating to governance, regulation and functioning of rural cooperative structure
and Regional Rural Banks who have to be critical instruments for rural credit in future. In this regard, it
is useful to note the nature of competition and accountability to shareholders governing the functioning
of commercial banks which would make their foray into rural credit predominantly subject to
commercial considerations. The changes warranted in cooperatives as well as RRBs involve deep
commitment of state-governments and have significant bearing on political economy. Thus, the current
thrust to improve credit-delivery may soon face limits unless the legal and institutional changes are
agreed upon and acted upon in good faith in a timely fashion. It is the fervent hope of RBI that a
consensus will develop soon on these fundamental changes that are essential for achieving the broad
policy objectives.
Second, there are overhang problems of non-performing loans and erosion of deposits in both
cooperatives and RRBs. There is some assessment of magnitudes of losses and capital needs in
RRBs while in the case of cooperatives the data are not yet firm. It may not be appropriate to continue
to permit institutions that are not solvent to seek and accept public deposits and hence RBI favours
early restructuring and recapitalisation. There is an inevitable fiscal impact of any scheme of
recapitalisation which has to be transparent and has to bear all the costs of overhang issues as well as
capital adequacy to assure continued solvency and safety of public deposits in future. Such a one-time
fiscal support is justifiable, urgent and essential for several reasons, including that "There Is No
Alternative" and delayed response could end up being more expensive. The current acceleration in
credit-delivery can be sustained in the medium term, if such fiscal support from States and Centre is
firmly put in place soon to revive or reorganize rural cooperative structure and RRBs.
Third, there is a need to foster credit culture to make enhanced rural credit a lasting phenomenon. A
benign credit-culture is one which encourages appropriate credit price, credit-delivery under
transparent conditions of lenders' as well as borrowers' liabilities and incentives for repayment rather
than default. Measures that counter such a benign credit culture are often well-intended, but as the
experience so far has shown they tend to be seriously counter productive. There is a need for a
consensus in this regard, so that, rural credit system in India is compatible with our goals of higher
growth and better equity. In this regard, it is necessary to recognise that expansion of credit in some of
the States which have low credit-deposit ratio depends on conducive credit culture capturing factors
relating to governance and commercial viability.
Fourth, on the critical issue of risk-mitigation, it is held that experiments with crop or credit-insurance in
India have not been very satisfactory so far. In fact, many farmers argue that where compulsory
insurance is resorted to, it increases the burden of borrowing from institutional sources and once the
transaction costs are added, the overall costs exceed the Prime Lending Rates significantly. There are
several risks that a farmer faces, and of these future price and monsoon conditions are most severe
and almost entirely beyond the control of the farmer. While Minimum Support Price is a mechanism
that has served us well, its cost-effectiveness is subject to debate and in any case the coverage is
limited to cereals like rice and wheat and in some areas cotton. The farmer faces the risks of monsoon
conditions and usually the adverse climatic conditions are widespread in a geographical area, with the
result severe limits are set on private-insurance. Prof. CH. Hanumantha Rao flagged the issue of
strategy to reduce risks as one of the four major areas of long-term planning (in 1993) but they
covered only water conservation, venture capital and insurance promotion, where viable. Perhaps, it is
necessary to recognize that if some elements of insurance are abinitio not viable, extending credit
becomes more risky and hence constrained.
Finally, in the light of the above, there is merit in considering a comprehensive public policy on
riskmanagement in Agriculture, as not only a means of relief for distressed farmers but as an ingredient
for more efficient commercialized agriculture. The components of such a policy have to be worked out
in detail, but illustratively, the public-policy could consider some of the elements described here. First,
establishing a well articulated, objective and independent assessment of impact of adverse monsoon
conditions and appropriate relief to farmers on an assured basis. Second, facilitating farmers to assure
themselves of a price for all their products before harvesting, or even sowing the seed, through a well
regulated network of Forward, Futures and Options markets. Third, establishing and implementing
liability of suppliers for any shortfall in quality or assured supply in vital inputs such as seeds,
pesticides, power and water. Fourth, gradually eliminating and replacing price-subsidies with outlays
on risk mitigation for farmers in the broadest sense and Fifth, positioning flexibility in extending rural
credit within a broad framework of such a comprehensive public policy on risk-management in
Agriculture.
Let me conclude by thanking Dr. S.K. Rao and Dr. MahendraDev for inviting me to join this intellectual
feast. I have great pleasure in inaugurating the seminar and look forward to hearing the luminaries like
Dr. Arjun Sengupta, Dr. Yogender Alagh and Dr. R. Radhakrishna.
Thank you.