The Indian government has recently decided to cancel the entire debt of small farmers that will cost it around $15 billion (IRs 600 billion). The farm loan relief is to be offered to all farmers with less than two hectares of land. It is an ambitious program and if it works as planned, then it will provide a huge relief to the debt-crunched poor farmers in rural India, which will help stimulate the rural economy. It is going to be a long shot. It will help farmers free from grips of the feudal societies, reduce suicides rates, and most importantly stimulate rural economy and reduction in poverty. The newest budget has made a great leap forward in social welfare spending, with 20% increase in education and 15% increase in health expenditures. Along with the loan waiver for the selected group, the government has also decided to give a 25% rebate for all farm loans regardless of farm size or loan distress.
With growth rates at 8.7% and rising inflation, critics have labeled the new ambitious welfare program a "populist pre-election budget" and have speculated that it will put upward pressure in price level. Though this new move from the government has received some applause (including from me!), some economists are worried about rising fiscal deficit and inflation, competitiveness in the banking sector, and rising inflation. However, this program is supposed to be more effective than previous ones because rebates are to be distributed directly to the targeted groups. Unlike in the past when banks were used as intermediaries to achieve such socio-political goals, this time the exchequer would directly distribute rebates to the genuinely distressed ones.
Critics have argued that it will hamper competitiveness in the banking sector and temper incentives in the market. If you are a farmer and you think that the government is going to give debt relief after some years, then naturally you will be less interested in paying off loans. A distressing form of moral hazard? Meanwhile, if banks know that their loans to farmers are going to be written off in some years, then the quality of the credit market would go downhill. More here, and here
This line of argument is completely valid but one has to consider historical factors and the ability of the farmers before arguing against these new reformative measures by the state. If you look at more than 800 million poor farmers from the rural areas, it is not difficult to realize that they have not been touched by rising economic growth Indian has achieved for the past two decades. The enormous revenue generation in recent years has to be redistributed efficiently so that the poor people do not feel left out. And, given the status quo, the poor farmers would in no way be able to pay off bank loans and loans from landlords (remember the age-old Adhi system, or sharecropping, in rural India). Without debt cancellation, the poor farmers would pass on debt (principal plus exorbitant interest) to their children, thus making debt servicing a generation phenomena. When will they get rid of this vicious cycle? Neither they can do it on their own nor the market would come up with a solution. The government has to step in to break the cycle and relive the farmers from long overdue debts that is holding their progress and keeping them and their families in poverty for years.
Though I believe that market is the best solution in the long run, in cases like this the state has to take a lead role to make sure that the real market forces work as they should in a level playing field. Without correcting the centuries old feudal system, including generation-passing debt structure in rural areas, it is hard to imagine that markets would find a solution to this issue. Markets did not work until now, and if the government plans to intervene then we should support it. I think it will have similar effect, though in varying proportion, as that of a stimulus package in the US. The rural economy needs to be freed from clutches of feudal regressive market structure, corrected immediately, and stimulated to help people fight poverty. There might be some problems and frauds cases of eligibility, but I don't think this move will seriously dampen market incentives. It is a corrective measure and this one is to be done in such a way that implementation bypasses the corrupt state administration.
We can find similar kind of problems in other South Asian nations, including Nepal. Recently, the Nepali government had decided to reserve jobs for marginalized groups in all state ranks. Considering the historical, cultural, and caste-based discriminated job market, I think it is a good move. Still wonder why? Read this article.