Unsustainable welfarism

India needs a strong bond market to check electoral populism

Addressing a political rally in Durgapur, West Bengal, on Saturday, Prime Minister Narendra Modi hailed the interim Budget for 2019-20 as a “historic” step towards empowering peasants, workmen and the middle class, and promised more benefits for all sections in the full Budget if his party returned to power after the Lok Sabha polls. The interim Budget had several steps towards creating a welfare state, including an income support scheme for farmers owning up to 2 hectares — about 120 million households — who would receive income support worth Rs 6,000 a year. It introduced a pension scheme for unorganised sector workers — with the government making a matching contribution — to provide a pension of Rs 3,000 a month after 60 years of age. Then there was an income tax rebate for those with a taxable income of up to Rs 5 lakh.

What is creditable is that the government has managed to do all this with a limited impact on the fiscal deficit. The broader point, however, is whether a country with relatively meagre financial resources can afford such open-ended welfare programmes. It would be unfair to blame this government alone; in fact, Mr Modi deserves compliments for coming out strongly against more damaging measures such as farm loan waiver because they destroy credit discipline while doing precious little to improve the condition of farmers. It’s a different matter that the Bharatiya Janata Party did nothing to stop the Uttar Pradesh and Maharashtra governments from announcing the same in the run-up to the state elections. Competitive populism is something the opposition parties have also adopted with enthusiasm — Congress President Rahul Gandhi, for example, has said he would not allow Mr Modi to sleep till a pan-Indian farm loan waiver was announced and has promised a minimum income guarantee for all if re-elected in the Lok Sabha elections in May.

What these promises underline is a steady move towards welfarism that can’t be reversed, binding the Indian state into fiscal commitments that would be increasingly difficult to sustain. Indeed, the evidence of the developed world over-committing and then slipping, as a result, is there for all to see. It would appear that the Indian political system is also making the same mistake. The truth is India’s decision-makers do not have any effective guardrails to hold them back from promising something that could be exorbitantly costly. In a big way, the question is about the financial cost of such schemes. For example, in the absence of a well-developed bond market, there is no fully effective way for the markets to raise the red flag by means of higher yields and interest rates. India’s half-hearted efforts to wean its lenders to the bond market have met with limited success. A strong bond market is a necessary institutional mechanism to check unrestrained fiscal populism. Its success would hinge on liquidity for lower-rated paper, investor appetite for the entire debt spectrum, adequate hedging mechanism, and an increasing supply of bankable papers. Given that the inexorable appeal of populism is unlikely to disappear soon, India must prioritise the development of a bond market.