RBI sounds note of caution on fallout of farm loan waivers
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New Delhi: Since April, when the Uttar Pradesh government first announced a farm loan waiver for small and marginal farmers amounting more than Rs36,000 crore, the Reserve Bank of India (RBI) has cautioned states and the central government thrice on its imminent fallout and risks associated with the move.
RBI governor Urjit Patel warned that governments borrowing to pay for loan waivers could eventually affect the national balance sheet.
“(Farm loan) waivers undermine an honest credit culture... It leads to crowding-out of private borrowers as high government borrowing tend to (impose) an increasing cost of borrowing for others,” Patel said after the April monetary policy announcement.
On 7 June, after another monetary policy review, Patel was more scathing. The risk of going down the “slippery path” of farm loan waivers could dissipate the gains that the states have made through fiscal rectitude over the past several years, he said.
“Past episodes in our country had shown that when there are significant fiscal slippages, they do permeate to inflation sooner or later. So, it is a path that we need to tread very carefully and before it gets out of hand,” he said.
Uttar Pradesh has since been followed by the Maharastra, Punjab and Karnataka governments in announcing farm loan waivers and farmers protests in many other states may make it a national trend.
To be sure, a farm loan waiver may not necessarily impact banks immediately. But lenders are against the move as it will have an impact on the country’s credit culture and disincentivize future borrowers from repaying loans.
On 15 March, State Bank of India (SBI) chairman Arundhati Bhattacharya said support to farmers is necessary but not at the cost of credit discipline as people who benefit from loan waivers often expect further waivers in future, which leads to many more loans remaining unpaid.
A Citibank NA report released on 19 June said there was a clear impact on the credit culture in the aftermath of a loan waiver, with evidence of institutional credit base shrinking in areas where loan waivers had been implemented in the past, suggesting banks view those districts as toxic in the immediate period following a waiver. “However, given the priority sector lending requirements, aggregate agri-credit is unlikely to be affected much,” the report said.
What is more worrying is the farm loan waivers come at a time when the finances of several state governments have already been worsening after implementation of the Ujwal Discom Assurance Yojana (UDAY) under which states took over the debt of their electricity distributors.
RBI, in a state finances report released in May, said for fiscal 2017, the revised figures for 25 states show that the consolidated fiscal deficit to gross state domestic product ratio (CFD-to-GSDP) was 3.4%, compared with the budgeted 3%. “An increase in capital outlay and loans to power projects under UDAY worsened fiscal indicators. Excluding UDAY, the CFD of these states would have been 2.7% of GSDP,” the report said.
Increased calls for farm loan waivers and potential pay hikes for state government employees are other pressure points on state finances, RBI warned.
A Bank of America-Merrill Lynch report published in June estimated that farm loan waivers will amount to 2% of GDP by the 2019 polls as other states follow suit. “Ministry of finance (MoF) will have to fund farm loan waivers by UDAY-type bonds to limit market impact. Although the MoF has said that states have to fund their own farm loan waivers, that is scarcely possible without disrupting bond markets,” it said.
A Standard Chartered Bank report held that the additional burden on the fiscal deficit is likely to be limited to 0.5-0.7% of GDP, lower than the feared 2% (which is equivalent to outstanding small-farm loans). “Also, such waivers are likely to be implemented over two years or more, rather than widening the fiscal deficit in FY18,” it added.
It reasoned that since states like Andhra Pradesh and Telangana have already factored in farm loan waivers in their budgets and most states are likely to absorb some of the additional costs of farm-loan waivers by reducing other expenditure, the additional impact on state finances will be limited to that extent.
However, the only silver lining that could limit further worsening of state finances is the successful implementation of the goods and services tax (GST) which will result in additional revenue through simpler and easier tax administration, DBS Bank Ltd said in a recent report.
“The GST is expected to reduce administrative costs for collection of tax revenue and improve revenue efficiency. Moreover, uniformity in tax rates and procedures across the country will economize on compliance cost. It will also lead to an increase in the shareable pool of resources, resulting in larger central transfer to the states which, in turn, will enable them to undertake much needed developmental expenditure. Such an outcome would ensure debt sustainability for states in the long term,” it said.
In the medium-to-long-term, GST is likely to increase the tax buoyancy of the central and state governments by 0.6%, which is likely to reduce the gross fiscal deficit by 0.7-1.2% of GDP if disinvestment receipts and non-tax revenues remain unchanged from the trend of the previous five years, the DBS report added.