Andhra loan waiver: Why Raghuram Rajan should win battle against populism

Managing finance is a difficult affair, no matter whether it is of a house or that of a country of 1.23 billion people. More than the finance minister, who is designated by a political party, the first guardian and watchdog of an economy is the central bank.

More than managing the complexity of a financial system, the biggest challenge of a central banker is to fight politically sponsored populist ideas of the incumbents, where the real conflict is between the fiscal prudence and political populism.The Reserve Bank of India (RBI) has fought many such battles in the past and is fighting yet another one now.

The conflict happens to be between Raghuram Rajan, the man who predicted one of the major global financial crises, and a few politicians in the southern states of Andhra Pradesh and Telangana, who had promised the millions of voters that they can forget about paying back loans if they were voted to power.

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The RBI has ruled out its consent to give special regulatory dispensation for an estimated Rs 43,000 crore loan waiver announced by Andhra Pradesh chief Minister, Chandrababu Naidu, but the latter is adamant to go ahead, because that was his key poll promise, and the failure of which could cost Naidu dearly the next time he seeks the public mandate. The central bank has officially informed Naidu about its decision .

Rajan, a former chief economist at the International Monetary Fund, doesn’t want to give his nod to the waiver because he is convinced that the implications of a loan waiver are much more disastrous to the poor compared with a temporary relief. It kills the credit culture of a large section of borrowers at one go for years and is hard to recover even with the best tools of economics.

To be sure, Rs 43,000 crore is only an estimated figure of the waiver promised only in Andhra Pradesh, one of the newly born twin states.

The other - Telangana - is also planning a similar waiver, and the figures are hard to estimate at this stage. Both, together could be anywhere between Rs 80,000 crore to Rs 1.20 lakh crore, according to the chairman of a state-run bank, which will have to forego its loans if the waiver is implemented.

Both Andhra Pradesh and Telangana have offered to waive off not just the farm loans, but also the gold loans taken by thousands of borrowers from several banks and financial institutions. What is the logic of including gold loans as part of a loan waiver scheme intended to “assist” the stressed farmers? Are farmers taking agricultural loans pledging their gold? Only Naidu knows the logic.

The real impact of the waiver announcement has already begun when even good borrowers stopped paying back loans to their banks, thinking why should only I be the _imaandaar_citizen when all others are going to get a free loans.

That is the power of freebies. Whenever they are offered to public world over, it has at once destroyed their socio-economic, discipline. There isn’t time to think and rethink about the righteousness of the action and the only priority becomes claiming their share.

Among the banks, state-run ones have the most exposure to the farmers in the two southern states. In the event of a waiver, Naidu promises to pay back the money to banks using the future revenues of the state government.

But that is a promise Naidu himself knows is difficult to fulfill unless Modi aides the state with a central package. Post the spilt, Andhra Pradesh is left with a half-filled exchequer with a deficit of Rs 15,000 crore. The state government is likely to repair the fiscal gap first before reimbursing money to sarkari banks. Remember, India’s state-run banks are already reeling under severe stress of bad loans. Until end March, about 14 percent of the loans given by banks are under the stressed category.

If Andhra is planning to pay banks through long-term bonds, banks are likely to take a hit in one way or another.

For one, they won’t get the money immediately, while they need to make the provisions on written off loans immediately in the absence of a regulatory dispensation from the central bank, which Rajan has ruled out already.

Second, such bonds will come with lower yields, forcing banks to sacrifice their expected returns. If the payment is planned by way of bonds of, say, three to four years of maturity, then that could be a big drag on their books, depending on the yield offered and maturity.

Whichever way, the banks stand to loose. Among state-run banks, Andhra Bank has the largest exposure to the waiver-prone segments - about Rs 20,000 crore.

Destroying the credit culture

This is not the first time loans are waived off by the government. In 2008, then finance minister P Chidambaram had written off Rs 70,000 crore worth of farm loans.

One thing in common between the two waivers is the potential to kill the credit culture of borrowers and that could prove fatal to state-run banks. Banks are worried as loan repayments in Andhra Pradesh is slowly coming to a grinding halt.

Several state-run bankers Firstbiz spoke to admitted that the situation was worsening with more and more borrowers happily joining the groups of defaulted borrowers. But none of the bankers would speak on record for fear of the wrath of the finance ministry.

“This is something where you don’t have a choice,” said the chairman a state-run bank.

“It will destroy the credit culture, affect the good borrowers and surely has long-term impact on the credit history of all borrowers who are subjected to the waiver,” the banker said.

The dangerous part is this - Andhra Pradesh is a state where the credit culture of several millions of borrowers have already deteriorated sharply in the aftermath of the 2010 microfinance crisis, when the state promulgated a law to control microfinance institutions following suicides in the state allegedly due to coercive recovery practice of microlenders.

More than the crisis, a state-wide political campaign launched by Andhra politicians then asking people not to repay their loans had proved disastrous, resulting in huge losses to the tune of about Rs 7,000 crore to banks. This chunk is yet to be recovered from Andhra Pradesh even after four years of the crisis.

Let’s wish Rajan victory in the fight against political populism.