Managing capital formation in agriculture

By: | Published: September 14, 2015 12:22 AM

Banks have to follow systematic procedures in identifying the requisite borrower and engaging him in proper capacity building.

Agricultural credit provided directly to farmers, called direct finance to farmer for agriculture, is either short-term or long-term. While short-term credit enables cultivators to procure inputs such as fertiliser and seeds needed for agricultural operations, long-term credit is meant for investment in fixed assets such as irrigation pumps, tractors, agricultural machinery and so on, thus accentuating capital formation.

The available evidence indicates a strong association between long-term (direct) agricultural credit and private sector gross capital formation in agriculture—the correlation coefficient between them comes out to be 0.84 between the period 2000-01 and 2013-14. Therefore, private capital formation in agriculture is predominantly dependent on long-term credit. There are obvious reasons behind this. Private investment in agriculture depends, among other things, mainly on investable resources and expected rate of return on investment, which, in turn, is determined by the prices of agricultural inputs and output. It is in the context of availability of investable resources that the credit from financial institution becomes critically important.

Notwithstanding the impressive gains made by the rural credit delivery system in terms of resource mobilisation, geographical coverage and functional reach during 2000s, inadequacy of farm credit remains one of the major bottlenecks hindering the growth in investment in agriculture. Despite having manifold increase in the volume of direct finance to agriculture in the 2000s—17.8% per annum as compared to 8.5% 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% in 1991-92 to 37.9% in 2011-12; therefore, only an increasingly smaller portion of credit supplied to agriculture was transformed into capital formation agriculture in the 2000s.

According to the data on target and achievement under investment credit from the NABARD, though the 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% of investment credit targets, which declined sharply to 58% in 2012-13. Although the percentage of achievement has increased to 69% in 2013-14, it was on account of reduction in target limit—the target was reduced to R2 lakh crore from the previous year. Declining investment credit in agriculture in recent years has been a major cause of concern for banking institutions.

Continued higher proportion of short-term credit could probably be due to relatively higher comfort level of those who demand and those who supply credit. From the demand side, the increase in short-term credit points to the fact that since the expenditure on farm inputs is inevitable to sustain agricultural operations, farmers prefer to borrow short-term credit as it provides them necessary control over resources through continued liquidity. Along with this, declining farm size and the changing pattern of operational holdings is another factor that has adversely affected capital formation or demand for investment credit. For instance, as over 70% operational holdings are under the small and marginal size category, their limited investable surplus doesn’t allow for substantial investments in fixed assets. Similarly, farmers who take land on lease do not show much interest in creating assets. Suppliers, on the other hand, prefer it because of its relatively lower lending and risk cost, supervision and monitoring cost, and better asset-liability management.

However, as capital formation in agriculture in recent decades has acquired a largely private character—it accounted for around 85% of total capital formation in the sector in 2011-12—the recent sluggish performance of investment credit may turn out to be costly for agricultural growth in the years to come.

As investment credit is a specialised subject, so in order to step up long-term finance to agriculture, banks need to have well-trained and technically-qualified agricultural credit specialists to carry out technical and financial appraisal, and also for field monitoring of the units created out of credit support. Further, to ensure proper utilisation of investment credit and also the viability of the asset created, banks have to follow systematic procedures not only in identifying the requisite borrower, but also engaging him in proper capacity building for the purpose for which he requires investment credit.

The author is faculty, National Institute of Bank Management, Pune. Views are personal

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