How waived loans impact states (Indian Express)

Mains Paper 3 : Economy
Prelims level: Internal Working Group
Mains level: Farm loan waiver process

Context

• The RBI recently shared the report of an Internal Working Group (IWG) set up to primarily look at the impact of farm loan waivers on state finances.

Requirement of IWG

• A farm loan waiver by the government implies that the government settles the private debt that a farmer owes to a bank.
• Since 2014-15, many state governments have announced farm loan waivers for a variety of reasons including relieving distressed farmers.
• Farmers were, notably, struggling with lower incomes with repeated droughts and demonetisation.
• In this context, the RBI set up the Internal Working Group (IWG) in February 2019 to analyse the impact of farm loan waivers.

How have loan waivers been?

• Once announced, farm loan waivers are staggered over 3 to 5 years.
• Between 2014-15 and 2018-19, the total farm loan waiver announced by different state governments was Rs 2.36 trillion.
• Of this, Rs 1.5 trillion has already been waived.
• In comparison, the last big farm loan waiver by the Centre was announced by the UPA government in 2008-09 and it was Rs 0.72 trillion
• Of this, actual waivers were only Rs 0.53 trillion, staggered between 2008-09 and 2011-12.
• In other words, in the past 5 years, just a handful of states have already waived three-times the amount waived by the central government in 2008-09.
• The actual waivers peaked in 2017-18 in the wake of demonetisation and its adverse impact on farm incomes.
• It amounted to almost 12% of the states’ fiscal deficit.

How do waivers affect state finances?

• Farm waivers eat into the government’s resources, which, in turn, leads to one of the following two things: the concerned government’s fiscal deficit (or, in other words, total borrowing from the market) goes up; and government has to cut down its expenditure.
• Even at the state level, a higher fiscal deficit implies that the amount of money available for lending to private businesses (big and small) will be lower.
• It also means the cost at which this money would be lent (interest rate) would be higher.
• If fresh credit is costly, in turn, there will be fewer new companies and less job creation.
• So, if the state government does not prefer borrowing from the market and wants to keep to its fiscal deficit target, it will be forced to cut expenditure to manage.
• More often, states choose to cut capital expenditure instead of the revenue expenditure.
• [Capital expenditure is that which leads to the creation of productive assets such as more roads, buildings, schools etc.
• Revenue expenditure is in the form of committed expenditure such as staff salaries and pensions.]
• The point to note is that cutting capital expenditure undermines the ability to produce and grow in the future.

How significant are state finances?

• The National Institute of Public Finance and Policy (NIPFP) study of state finances reveals that all the states, collectively, now spend 30% more than the central government.
• Moreover, since 2014, state governments have increasingly borrowed money from the market.
• In 2016-17, the total net borrowings by all the states were almost equal (roughly 86%) of the amount that the Centre borrowed.
• In other words, state-level finances are as important as that of the centre’s for India’s macroeconomic stability and future economic growth.

Way forward

• Farm loan waivers are not advisable as they hurt overall economic growth apart from ruining the credit culture in the economy.
• This is because they incentivise defaulters and penalise those who pay back their loans.
• The IWG thus recommends that central and state governments should undertake a holistic review of the agricultural policies and their implementation.
• They should also evaluate the effectiveness of current subsidy policies with regard to agri inputs and credit.
• This should be towards improving the overall viability of agriculture in a sustainable manner.

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 Prelims Questions:

Q.1) Which of the following Smart City becomes first to run on 100% Renewable Energy during Daytime-
a) Diu
b) Bombay
c) Bhopal
d) Jaisalmer

Answer: A
Mains Questions:
Q.1) In recent years, many state governments have waived farm loans. How did this impact their respective finances?