Farm loan waivers will set the economy on an even more slippery slope
Costly bailouts to farmers by states such as Maharashtra and Madhya Pradesh will perpetuate a bad credit culture; and worsen inflationary risks, limiting the Reserve Bank of India’s ability to bring down interest rates.editorials Updated: Jun 12, 2017 18:18 IST
Maharashtra and Madhya Pradesh have now joined a lengthening list of states that have announced costly bailouts for farmers. Their profligacy is bad news for India. First, it perpetuates a bad credit culture. Second, it threatens to undo the recent years of parsimony by the central government. It also worsens inflationary risks, limiting the Reserve Bank of India’s ability to bring down interest rates.
Over time, states’ revenues have stagnated but spending ballooned, pushing their combined deficits to their highest in 13 years. Sure, our states are sub-sovereign. But writing off loans can eventually affect the national balance sheet through fiscal slippages and inflationary spillovers. The financial rectitude of the central government helped cut the annual deficit from 5% of GDP in 2013 to about 3% now. But our debt-to-GDP ratio still stands at about 68%, one of the highest among the emerging economies. That must fall below 60% over the next three years to warrant a rating upgrade. The financial profligacy of states can derail this.
Already, state finances are under strain. In 2015-16, the consolidated Gross Fiscal Deficit - Gross Domestic Product ratio of states breached the 3% ceiling of fiscal prudence for the first time in a decade. Things are unlikely to get better soon. States are obliged to take over the debt of power utilities under the Ujjwal DISCOM Assurance Yojana (UDAY) scheme, budget for distortion in their food credit accounts and provide for an off-balance sheet. Further, debt write-offs are often a plain perverse political incentive that increase the likelihood of reckless copycat borrowing. A recent Bank of America Merrill Lynch (BofA-ML) report estimated that states were likely to waive off at least $40 billion, or 2% of national GDP, in farm loans in the run-up to the 2019 general elections.
A big part of the problem is the central government. It underwrites states’ borrowings and forces banks, insurers and pension funds to invest depositors’ money in their bonds. This means states don’t have to go looking for a market for their bonds. Unless the government moves to end this self-defeating sop, the states will feel little need to balance their books.
The answer lies in disciplining state spending. One way can be to limit the federal guarantee on their borrowings, especially for politically expedient projects such as farm loan waivers.
Once markets discriminate between prudent spenders and recklessly borrowers, easy money will dry up.