The government of Punjab has started a programme for disbursing interest-free loans of Rs25,000 to 40,000 per acre to farmers for the financial year 2017-18.

The Rs17 billion cost of interest on these loans is to be borne by the provincial government while the loans will be disbursed to registered farmers having agricultural land of less than 12.5 acres.

The amount will be disbursed through a smartphone-based mobile payment mechanism and loans will be provided for maximum five acres per farmer. Though a good plan on paper, the actual results of such a financial support plan may not meet the intended targets.

The government should invest funds in facilitating them through the provision of the latest agricultural technology

There is cross-country empirical evidence available on the failure of such microfinance-based loan schemes which are designed without considering the local social, cultural and economic landscape.

A recent example is the social unrest by farmers in many Indian states demanding loan write-offs as they are unable to payback their loans due to the low market prices of their produce.

There are several social and economic reasons for under-utilisation or misallocation of such loans by the farmers.

The rural economy operates on a credit system and once cash is available (through loans for example), the social and cultural rituals and customs (i.e. arranging dowry for daughters) are given first priority.

The lives of persons living in rural areas are subject to the local customs and traditions which require unnecessary spending on various cultural and social needs thereby misdirecting the flow of funds from their optimal use.

Another reason for the non-performance of agricultural loans is the assumption, on the part of policy markers, of a production gap owing to the non-provision of credit.

In the absence of such government loan schemes, the rural economy keeps moving and the gap between crop production, before and after the provision of credit, remains almost unchanged.

This is due to the fact that farmers in rural areas are engaged in agricultural practices through a tribal system where the extended family clan provides support for sowing and harvesting the crops.

Similarly, local shopkeepers provide the necessary fertilisers and pesticides to farmers on easy credit as they are familiar with each other.

The low productivity of small farmers may also hinder the workability of agricultural loans. Small landholders are unable to afford the latest agricultural equipment for higher production per acre.

The provision of small loans to farmers is not enough to enable them to buy tractors, irrigation technology or other useful equipment.

The actual increase in production comes though the application of the latest technology in the agricultural sector which a small farmer is unable to buy.

The usability of loans to farmers is also affected by the recovery rate on such programmes.

The case of non-performing loans and bad debts of Zarai Taraqiati Bank Limited (ZTBL) to farmers is evident of the fact that the recovery rate of such loans is very low, resulting in massive losses to financial institutions.

Similarly, commercial banks operating in rural districts know very well the lower recovery rate of loans made to farmers.

Such loans are sought on the pretext of agricultural requirements by farmers but spent on other needs resulting in delayed repayments and higher interest costs.

The solution lies in improving market conditions for increasing the farmer income through higher market prices of crops and provision of latest agricultural technology to farmers.

The higher per acre output in advanced countries is not owing to the provision of credit to farmers by the government but rather ensuring the accessibility of latest technological equipment, modern agricultural practices, high-yielding seeds and high-impact fertiliser varieties to farmers.

Similarly, the installation of wheat, rice, cotton and sugarcane processing units through public private partnerships in rural areas may fetch higher prices for the raw produce of the farmers.

Therefore, instead of burdening farmers with non-productive loans where the recovery rate is low, the government should invest such funds in facilitating them through the provision of the latest agricultural technology.

Published in Dawn, The Business and Finance Weekly, July 24th, 2017