As Finance Minister under the United Progressive Alliance Regime, P Chidambaram had to handle many difficult situations. Most of these he managed with the élan expected of a person well-versed in finance and economics as befits the finance minister of India. But the one instance where he surrendered his objective judgment and financial prudence to populism, presumably at the command of his political bosses, was when he waived farm loans totalling Rs 52,000 crore in his 2008 Budget. The budget, which came a year before the 2008 elections in which the UPA returned to power, may or may not have played any part in the Congress-led government’s victory, but it set a dangerous precedent that had the potential to shake our financial edifice. Indeed, it is doing precisely that now and the blame squarely falls on Chidambaram’s shoulders.

For instance, Uttar Pradesh in June waived Rs 36,359 crore of farm loans, up to Rs 1 lakh each, shortly after the new government under Chief Minister Adityanath assumed charge in March. This has put the state’s finances in jeopardy as its fiscal deficit in 2015-’16 had already breached limit of 3% (of the GDP) set by its Fiscal Responsibility and Budget Management Act.

Maharashtra followed suit with a similar farm loan waiver in June, which would cost the state exchequer Rs 34,000 crore. In a competitive populist measure, sacrificing all fiscal prudence, Punjab then announced farm loan waiver for loans worth up to Rs 2 lakh each, which would cost the state more than Rs 10,000 crore.

Both Punjab and Uttar Pradesh are among the most highly indebted states in the country.

Haryana, Madhya Pradesh, Gujarat and Rajasthan are also waiting in the wings, with farmers in each state demanding waivers. Of these Gujarat and Karnataka, along with Himachal Pradesh, will face the electorate within a year and are sure to promise waivers and may be more. The race for populism will only get hotter, because Chhattisgarh, Madhya Pradesh and Rajasthan will go to polls before January 2019.

Banks are already complaining that in anticipation of waivers, farmers have stopped repaying loans, which was to be expected. Courts have also jumped into the fray, with Madras High Court directing the Tamil Nadu government to extend its crop loan waiver scheme to all farmers, including those with land holdings exceeding five acres – an order the Supreme Court had to stay. The Domino effect will reach all states very soon, throwing our state finances back to the days before the Twelfth Finance Commission for 2005-2010, when states had to borrow just to be able to repay, with repayments exceeding the borrowings for many.

A contagion

A recent report by the Bank of America-Merrill Lynch estimated that the total farm loan waivers in the run-up to the 2019 polls could total 2% of India’s GDP, amounting to $40 billion. The contagion is spreading like a cancer in our body-politic, with competing populism forming the economic and political agenda of all parties. Days of austerity and fiscal prudence seem to be over.

Significantly, Chidambaram’s loan waiver had not solved any of the problems of distressed farmers. The 2008 UPA loan waiver scheme was audited by the Comptroller and Auditor General, whose 2013 report revealed huge gaps in delivery, besides serious lapses and corruption. It was also bad in design, being limited to bank borrowings only. According to the National Sample Survey Office 70th round, a majority of small and marginal farmers were indebted to informal or non-institutional sources like local money lenders, traders, or bigger farmers – they would not get the benefits of these loan waivers.

The smaller the land holding of a farmer, the less likely he is to get a bank loan. Thus, 85% marginal farmers with less than 0.01 hectare of land borrow from non-institutional sources, mainly money lenders (64%). This percentage gradually decreases to 35% for small farmers (with holdings sized between one and two hectares). Thus the intended objective of providing relief to small and marginal farmers in distress will remain a myth. All such waivers achieve is to vitiate the credit culture and loan discipline, and consequently worsen already precarious situation of banks that are burdened by non-performing assets. By encouraging willful default in expectation of a future bailout, such waivers disincentivise repayment and promote a culture of irresponsibility.

Bad economics is never good politics and political parties need to realise this sooner than later. According to the RBI Report on State Finances - A Study of Budgets (2016-’17) released in May, the states that cumulatively exercised more fiscal prudent than the Centre until about three years ago are now sliding into a regime of higher deficits. Relaxations in market borrowings given by the Fourteenth Finance Commission had led to an increase in the debt burden of the states, the report observed, and the consolidated fiscal position of states deteriorated sharply between 2014-’15 and 2015-’16.

Uttar Pradesh and Punjab are not even eligible for additional market borrowings, not having fulfilled fiscal prudence norms prescribed by the Fourteenth Finance Commission. For Uttar Pradesh, the fiscal deficit will rise to Rs 49,960 crore in 2016-17, or 3.9% of Gross State Domestic Product, while for Punjab it would Rs 13,090 crore (2.9% of Gross State Domestic Product), as per the Budget estimates, the RBI said. Actuals are likely to be far higher.

Other factors

Evidently, states have taken to indulging in the kind of populism that was earlier a prerogative of the Centre under the UPA regime. This is partly because the states have been boosted by the 10% hike in the share of Union taxes and duties that goes to them, based on recommendations of the Fourteenth Finance Commission, which had increased the tax devolution from 32% to 42% The state-level Gross Financial Deficit-GDP ratio in 2015-’16 had breached the Fiscal Responsibility and Budget Management Act ceiling of 3% for the first time since 2004-’05, and is likely to worsen in 2016-’17. Even though the Centre has reversed the trend of profligacy so visible during the previous regime, as per the RBI Report, the combined fiscal deficit of the Centre and the states could soar to 7% or even higher due to the swelling state deficits.

Apart from the farm loan waivers, another contributing factor to the rising burden is loans and advances for power projects based on the Ujwal Discom Assurance Yojana or UDAY scheme, under which, the states had to own over 75% of the outstanding debt of distribution companies – 50% of it in 2015-’16 and the remaining 25% in 2016-’17.

Eight states had borrowed Rs 98,960 crore under UDAY during 2015-’16 alone, hiking the states’ consolidated Gross Financial Deficit to GDP ratio by 0.7 percentage points during the year. The borrowing is done through UDAY bonds, interest on which becomes an additional liability for the states. States would also have to discharge additional liabilities if discoms continue to incur losses.

State governments provide guarantees to their public sector undertakings for taking loans from banks and financial institutions; in the event of their failure to repay the loans, the states have to guarantee that they will discharge the liability on behalf of the undertakings in case the PSU fails to do so. Though a contingent liability, these are emerging as a major source of potential risk to the debt sustainability of the states.

Austerity and old conservative ways are seemingly dead. But they will need to be resurrected, before it is too late.

Govind Bhattacharjee is a senior civil servant. The opinions expressed here are personal.