Priority Sector Lending
However, the argument of high NPAs was used to encourage banks to cut back on lending to the priority sector. Among the directed credit programmes followed by the banks, priority sector lending has been perhaps one of the most effective. In 1969, banks provided only 14.6 per cent of their total credit to the priority sectors, with the percentage of credit disbursed to agriculture being only 5.4 per cent.  In 1991, 40.9 per cent of net bank credit was advanced to priority sectors, and total credit to agriculture, even though remaining below the prescribed level of 18 per cent, was 16.4 per cent by 1991.

Unfortunately, since 1991, there has been a reversal of the trends in the ratio of directed credit to total bank credit and the proportion thereof going to the agricultural sector, even though there has been no known formal decision by government on this score.  At the same time, serious attempts have been made in recent years to dilute the norms of whatever remains of priority sector bank lending.

As mentioned earlier, the Committee on the Financial System (CFS) recommended phasing out of the bulk of priority sector targeting by the banks.  The changes recommended by the committee in the field of priority sector lending were as follows:

The directed credit programmes should cover a redefined priority sector consisting of small and marginal farmers, the tiny sector of industry, small business and transport operators, village and cottage industries, rural artisans and other weaker sections.

Credit targets for this redefined priority sector should be fixed at 10 per cent of aggregate bank credit.

Stipulations of concessional interest to the redefined priority sector should be reviewed with a view to its eventual elimination, in about three years.

A review should be undertaken at the end of three years to see whether the directed credit programmes need to be continued.

While the recommendations of the Narasimham Committee on priority sector lending were not completely accepted, various policy measures, aimed at diluting the norms of priority sector lending were adopted, so as to ensure its gradual phase-out in the future.

While the authorities have allowed the target for priority sector lending to remain untouched, they have widened its coverage.  At the same time, shortfalls relative to targets have been overlooked.  In agriculture, both direct and indirect advances to agriculture were clubbed together for meeting the agricultural sub-target of 18 per cent in 1993, subject to the stipulation however that "indirect" lending to agriculture must not exceed one-fourth of that lending sub-target or 4.5 per cent of net bank credit.

It was also decided to include indirect agricultural advances exceeding 4.5 per cent of net bank credit into the overall target of 40 per cent.  The definition of priority sector itself was also widened to include financing and distribution of inputs for agriculture and allied sectors (dairy, poultry, livestock rearing) with the ceiling raised to Rs. 5 lakh initially and Rs. 15 lakh subsequently. The scope of direct agricultural advances under priority sector lending was widened so as to include all short-term advances to traditional plantations including tea, coffee, rubber, and spices, irrespective of the size of the holdings.

Apart from this, there were also totally new areas under the umbrella of priority sector for the purpose of bank lending.  This meant that banks defaulting in meeting the priority sector sub-target of 18 per cent of net credit to agriculture, would make good the deficiency by contributing to various other institutions such as the Rural Infrastructure Development Fund of NABARD. They could also make investments in special bonds issued by institutions like State Financial Corporations and treat such investments as priority sector advances.

The changes thus made in the policy guidelines on the subject of priority sector lending were obviously meant to enable the banks to move away from the responsibility of directly lending to the priority sectors of the economy. It is in the light of this that the trends in priority sector lending during the post liberalisation period of 1991-2001 should be understood.

Priority sector lending as a proportion of net bank credit, after reaching the target of 40 per cent in 1991, had been continuously falling short of target till 1996. It has subsequently been in excess of the target for the reasons specified above, and stood at 43 per cent in 2001, which was mainly  due to the  inclusion  of  funds  provided to  Regional Rural Banks by  their  sponsoring  banks,  that were eligible to be treated as priority  sector  advances.  Advances to agriculture also declined from 16.4 per cent in 1991 to 15.3 per cent in 2002, well below the target of 18 per cent of net bank credit. In the year ending March 2003, direct agricultural advances amounted to only 10.8 per cent of net public sector bank credit.

The fall in the ratio of priority sector lending to deposits from 26.6 per cent in 1991 to 22.8 per cent in 2001 was partly due to the decline in the overall credit deposit ratio of banks and partly due to the decline in the ratio of priority sector advances to total bank credit. 

Private banks in general and foreign banks in particular have been lax in meeting regulatory norms. The sector most affected was agriculture, in whose case private bank lending amounted to just 10.8 per cent of net credit, which was far short of the stipulated 18 per cent in the year ending March 2003. Direct agricultural advances were only 6.3 per cent of net private sector bank credit.

Within the private sector, the foreign banks were the major defaulters. According to the annual report of RBI, the advances of foreign banks to the priority sector were only 34 per cent of net credit in the year ending March 2003. Here again, agriculture was the prime area of neglect. Foreign banks' performance on credit to the small scale industries and export sectors was much better, with lending to these sectors accounting for 9 and 19 per cent, respectively, of the net bank credit against the sub-sectoral targets of 10 per cent and 12 per cent.

Clearly, even to the extent that priority-sector lending targets had been met, the choice was in favour of the more cost effective and profitable sectors. Overall, nearly 60 per cent of the priority sector lending by foreign banks was directed towards export credit.

The difficulty is that, faced with the demands made on them by the advocates of liberalisation and the effects of competition from the private sector banks, banks in the public sector are also being forced to change. They are trying to trim operating expenses, by reducing the wage bill by reducing employment through retrenchment under the VRS scheme and computerisation. They are also seeking to reduce costs by limiting branch expansion and reducing the number of bank branches.

The latter, which affects the rural areas first, reduces access to credit in rural areas that were well-served by the post-nationalisation branch expansion drive, and worsens the tendency towards reduced provision of credit to the agricultural sector.

In consequence of all this, the formal credit squeeze upon Indian agriculture is now acute. This has led to severe problems of accessing working capital for cultivators, and has also meant the revival of private money lending in rural areas. Such retrogression has extremely disturbing implications for the future of Indian agriculture.