Waiver politics

Populist states will have to either avoid paying banks or slash capex

Pressure is growing on state governments to step up and waive agricultural loans ahead of the Lok Sabha elections, scheduled for early 2019. Congress President Rahul Gandhi’s assertion that he would not allow the prime minister to sleep till farm loans are waived in all states is plain irresponsible. The Bharatiya Janata Party isn’t far behind. Finance Minister Arun Jaitley’s suggestion (in an interview to this newspaper last week) that states “that can afford it” should go ahead with loan waivers can only be seen as playing to the gallery. Such loan waivers cause distortions up and down the chain of agricultural finance and do not in the long run help the farmers who are their intended beneficiaries. Some of these consequences are already beginning to be visible. For example, the National Bank for Agriculture and Rural Development, or NABARD, has written to state governments, asking them to ensure that banks are not left holding the baby after politicians conduct a loan waiver. NABARD warns that unless the dues of banks writing off loans are cleared immediately, the credit cycle would be injured beyond easy repair. The problem is that in some states, banks had written off loans based on notifications from state governments, but their dues had subsequently not been reimbursed by states. At that point, the banks would naturally undergo some stress and cut down on farm lending.

It is absolutely correct that banks should not bear the stress of a politically determined farm loan waiver — it is not only unjust, but it also would cause crucial farm lending to shut down and thus exacerbate rural distress. But this would mean that states would have to carefully examine their fiscal position before announcing a waiver, since the money would have to come from their budgets immediately. This is difficult to manage, and would severely stress state finances. The three new Congress governments in the Hindi heartland states that the party won in the recent elections have all promised loan waivers of considerable size. Madhya Pradesh has promised a loan waiver, which will cost around Rs 350 billion; Rajasthan’s will be around Rs 200 billion. In the latter case, it is only slightly less than its capital expenditure. The consequence, of course, would be a serious shrinkage in capital spending in states that have gone for loan waivers. The consequence for overall macro-economic stability and growth momentum will be severe. It is a little-commented on fact that the Union government’s capital expenditure is in fact smaller than that of state governments, particularly after the Fourteenth Finance Commission redistributed revenues between the Union and the states. After the Finance Commission award, capital expenditure by state governments grew swiftly — it is budgeted to be 37.5 per cent higher than the ongoing financial year as compared to the previous year’s revised estimates.

State governments that have promised a loan waiver thus face a difficult choice: They will have to either starve banks and see an increase in rural distress; or they will have to slash capital expenditure and thus growth momentum and lose jobs; or they will have to break through deficit targets. None of these is a palatable option, and of course state government deficits have a cap. Even states “that can afford” a waiver face unpleasant fiscal mathematics, and the outcome will be worse for all stakeholders — including farmers.