Loan waiver, income scheme for farmers attractive from political outlook, but will damage economy in long-term

As per recently released central government finances for up to January 2019, the fiscal deficit stood at 121.5 percent of the revised estimates. Stagnancy in indirect tax receipts and decent growth in revenue spending (12.4 percent YoY in April 2018-January 2019 period) have led to a rise in deficit. Capital spending, notably, has declined 13 percent YoY up to January 2019 vis-à-vis estimated growth of 20 percent, as per revised estimates. While these numbers are dissected very carefully, the Big Brother — state governments — doesn’t receive its due attention. On an aggregate basis, total spending by states are at least 30 percent higher than the Centre’s spending. Further, the areas where the states spend such as irrigation, roads and bridges, power sector etc., are different from the areas where the Centre spends such as railway, highways and defense. Our analysis of finance accounts of 19 states, which together account for about 90 percent of all states, suggests that the aggregate fiscal deficit touched 62.5 percent of the budget estimates during 9MFY19 — the worst in at least the past eight years. [caption id=“attachment_5579321” align=“alignleft” width=“380”] Representational image. Reuters[/caption] Higher deficit was the result of weak tax receipts and higher spending. Total spending grew by a healthy 14.5 percent YoY in 9MFY19, led by strong growth of 23.1 percent in capital spending. However, growth in total receipts of 19 states lagged at 12.9 percent YoY during 9MFY19. High growth of nearly 23 percent in capital spending has come on the base of a decline of 15.3 percent in the corresponding period a year ago. The average growth of the last two years, thus, was only 4 percent — significantly lower than about 20 percent average growth in the previous five years. What led to this slowdown in the states’ capex from FY18? The populist schemes like farm loan waivers. Data for two largest states — Maharashtra and Uttar Pradesh — will make this analysis clear. In April 2017, Uttar Pradesh announced a farm loan waiver for small and marginal farmers costing Rs 36,400 crore. As per the actual data for FY18, while Uttar Pradesh’s revenue spending (including loan waiver) grew 12.5 percent in FY18, its capital spending halved – down from Rs 76,500 crore in FY17 to Rs 40,600 crore in FY18. Similarly, Maharashtra announced loan waiver in June 2017 and its capital spending declined 14 percent YoY in FY18 (provisional estimates). In both cases, total spending growth was also much lower than in FY17. While it declined 2 percent YoY in Uttar Pradesh (vis-à-vis 9.4 percent growth in FY17), it grew 10.9 percent YoY in Maharashtra (vis-à-vis 13.8 percent growth in FY17). What this suggests is in contradiction to the popular perception that farm loan waivers will support economic activity growth. In reality, what farm loan waivers have done is to shift investments (or capital spending) to consumption (or revenue spending) by the states. Since the efficiency of the former is higher than those of the latter, such shift reduces the overall efficiency (or productivity) of the fiscal spending, and thus, hurt economic activity growth.

Although the Union government has stayed away from farm loan waivers, several states including Rajasthan, Madhya Pradesh and Uttarakhand recently announced loan waivers aggregating more than Rs 2 lakh crore during the past couple of years.

In its 2019-20 interim Budget, however, the Centre announced a guaranteed income scheme of Rs 6,000 per annum for 12.5 crore small and marginal farmers in the country from FY20, following Telangana’s Rythu Bandhu scheme. It needs to be seen if states could manage to resist the trap of announcing a replica of this scheme locally to attract more voters. Some states such as Odisha and Jharkhand have already announced their own welfare schemes providing annual guaranteed income for the farmers. It is just a matter of time when the size of this scheme grows and more states adopt it. The problem, however, is that combined analysis of the Centre and 19 states (general government) reveals that total receipts of the general government were weak in 9MFY19, as tax growth (at just 8.6 percent) was the weakest in seven years.

Indirect taxes (including GST) were the key culprit, rising by a meagre 5.8 percent YoY in 9MFY19, as against an average growth of 16.1 percent in the last three years. Considering the historical trends in the final quarter of the fiscal year, our estimates suggest that indirect taxes could witness a shortfall of up to Rs 2.1 lakh crore in FY19.

If so, the ability of the states to grow spending in 4QFY19 would be as limited as the Central government. Further, the states may also have to follow the Centre by axing capital spending in order to meet (or remain close to) its fiscal deficit targets. Overall, while the schemes such as the loan waivers and guaranteed income schemes for the farmers are very attractive from political perspective, they are unlikely to be acceptable on economic grounds. Short-term gains are likely to create long-term losses and the latter will most likely come back to haunt the broader economy. (The writer is chief economist, MOFSL)