EAC-PM pitches for changes in priority sector lending to enhance efficiency

New Delhi: The priority sector advances norm should be changed from economic to social equity, as diversion of credit to potentially inefficient sectors can harm total factor productivity, the Economic Advisory Council to the Prime Minister (EAC-PM) has suggested.

EAC-PM, in a working paper titled 'Economic impact analysis of Priority Sector Lending', said emphasis should be placed on its original goals of making credit available to small and marginal farmers (SFs/ MFs), small-scale industries and weaker sections.

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"Given this economic inefficiency, the focus of priority sector advances (PSAs) should be changed from economic to social equity.

"Emphasis should be placed on its original goals of making credit available to SFs/ MFs, small-scale industries and weaker sections," the paper said.

It further noted that legacy inclusions in the definition of priority sector that are no longer relevant can be removed.

"Targets can be adjusted commensurately. For example, while retaining sub-targets for SFs/ MFs and non-corporate farmers, the separate target on agriculture (which constitutes lending towards corporate farmers) can be removed," it said.

Similarly, the paper said, while retaining the sub-target for micro

enterprises and weaker sections, others can be removed from the definition of priority sector, and the overall target can be lowered.

"With these changes, banks will have more flexibility in allocating capital

while restoring emphasis on the social goals of PSAs," it said.

According to the paper, directed lending policies are also associated with significant economic risks.

"Diversion of credit to potentially inefficient sectors can harm total factor productivity," it said, adding that directed lending policies are also known to impact bank profitability due to the associated risk of asset default and high asset management costs.

The paper, which examines the status and distribution of priority sector lending in India using district-level quarterly data obtained from the Reserve Bank of India for the period 2020-2025, further said that the distribution of priority sector credit in India is heavily skewed.

It further said that priority sector lending certificates (PSLCs) provide flexibility to banks without significantly altering regional PSA distribution, terming them as effective and efficient indirect PSA instruments.

The policy on priority sector lending has been in place in India for almost five decades, and banks are required to direct at least 40 percent of their overall credit towards the priority sector.

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The priority sector encompasses a broad range of economic activities, such as the provision of credit to small and marginal farmers, micro enterprises and weaker sections, and aims to address systemic equity gaps.

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