Farm loan waivers are becoming a contagion

Costly bailouts will perpetuate a bad credit culture and undo fiscal deficit gains

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 and can limit the scope for interest rate cuts. 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 affect the national balance sheet through fiscal slippages and inflationary spillovers. The financial rectitude of the Centre 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 under 60% over the next three years to warrant a rating upgrade. The financial profligacy of states can derail this.

State finances are already under strain. In 2015-16, the consolidated Gross Fiscal Deficit - Gross Domestic Product ratio of states breached the 3% ceiling 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 UDAY scheme, budget for distortions in food credit accounts and provide for off-balance sheet spending.

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. Unless the government ends this self-defeating sop, the states will feel little need to balance their books.The answer lies in disciplining 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 reckless borrowers, easy money will dry up.