How Does Debt Relief Impact Consumption?: Evidence from a Policy Experiment

49 Pages Posted: 18 Mar 2015

See all articles by Prasanna L. Tantri

Prasanna L. Tantri

Indian School of Business

Nagaraju Thota

BITS-Pilani Hyderabad Campus

Date Written: March 17, 2015

Abstract

We investigate the impact of a large scale debt waiver program for small agricultural borrowers in India on the short term and long term consumption levels of the beneficiaries. We obtain consumption data from three national level surveys conducted before and after the waiver by a federal statistical agency. We find that even a 100% debt waiver does not lead to increase in consumption expenditure. In fact, in the short run, beneficiary households experience a 13.6% decline in overall consumption, which includes a sharp decline in spending on essentials such as food, clothing and education. Monthly consumption expenditure of the beneficiary households remains subdued even after 4 years from the waiver announcement date. In our theoretical framework, we attribute this negative shock to the collapse of the informal bailout mechanism, which was developed by the loan officers in order to avoid defaults. This breakdown is a result of increased moral hazard, which in turn increases expected default rates and hence makes such bailouts costly from the point of view of a loan officer. This leads to increased credit constraints and hence the waiver beneficiaries are left with fewer resources to invest and consume. We point out a significant unintended consequence of a political intervention in debt contracts.

Keywords: Banks, Foreclosures, Government Policy and Regulation, Agricultural Finance, Consumption

JEL Classification: D10, D14, G20, G21, G28, G30, G38, H310, Q14

Suggested Citation

Tantri, Prasanna L. and Thota, Nagaraju, How Does Debt Relief Impact Consumption?: Evidence from a Policy Experiment (March 17, 2015). Indian School of Business Research Paper Series. Available at SSRN: https://ssrn.com/abstract=2579617 or http://dx.doi.org/10.2139/ssrn.2579617

Prasanna L. Tantri

Indian School of Business ( email )

Hyderabad, Gachibowli 500 032
India
9160099959 (Phone)

Nagaraju Thota (Contact Author)

BITS-Pilani Hyderabad Campus ( email )

Shameerpet
Medchal
Hyderabad, 500078
India

HOME PAGE: http://universe.bits-pilani.ac.in/Hyderabad/thotanagaraju/profile

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