The Hindu Business Line : Loan waiver: Cheer without fear

Holding down inflation and interest rates, energising the production function, pushing investments, saving livelihoods, and raising incomes and consumption became the principal objectives of the Budget. The waiver of farm loans is a means to the accomplishment of these goals.

G. Ramachandran

First things ought to come first. There is an exaggerated view that the waiver of farm loans is senseless and indefensible. The waiver has been criticised on the grounds that it would vitiate the credit culture and exacerbate moral hazard in banking. The critics have no such views when commercial and industrial loans remain unpaid or are waived and written off.

The waiver of farm loans is a wholly sensible and defensible decision. The waiver at its worst estimate is expected to cost the exchequer a big sum of Rs 60,000 crore. But it will most likely trigger an increase in gross domestic product (GDP) of over Rs 3,72,000 crore over the next three years. The exchequer will earn at least Rs 44,000 crore if the tax-to-GDP ratio is 12 per cent.

The nominal net loss could at worst be Rs 16,000 crore. But there may be no loss at all. The loss could turn into a sizeable profit. There are three reasons for this optimism. First, the loss to the exchequer would be lower when the other robust stimuli to growth act upon the economy.

Second, the waiver would break the logjam in the fallow farmlands. It will put crops back on cultivable lands that have remained fallow. A spurt in output will kill inflation. Third, lower inflation will keep interest rates low. Nonperforming assets of banks will rebound smartly. Therefore, law-abiding taxpayers and conscientious borrowers that repay loans have nothing to fear.

Smartly managerial

The Finance Minister has acquired a reputation for smart and conscientious fiscal management since 2006. He has managed India’s fat fixed costs of running government pragmatically. He has outrun the beastly costs by taking a managerial view of tax revenues. He has stimulated tax inflows by lowering the unit excise duty rates. He has raised the threshold of the service tax.

The raising of the personal tax threshold level and the slabs expands incomes that can be allocated to consumption. It expands the size of the indirect tax market as a result. Yet, it ensures that the good times of ordinary people will continue. The cut in excise duties applicable to many consumption goods and consumer durables deserves special attention.

Compliant and conscientious

The boost to consumption may appear scandalous. But the Finance Minister has stayed steadfastly on course to meet the requirements of the Fiscal Responsibility and Budget Management Act (FRBMA). Ernst & Young, a global accounting confirm, has aptly commented that India has ‘outperformed its FRBMA commitments on revenue and fiscal deficit’. How was this accomplished?

The Finance Minister has successfully plucked more low-hanging fruits. He has harvested the fruits of tax buoyancy. Further, he has reinforced tax buoyancy by lowering the indirect tax rates in many visible cases.

It has, therefore, been possible for the Finance Minister to make broader and deeper allocations to social investments. This is the best way to put tax buoyancy to work. India needs public investments aimed at diffuse growth and equitable development.

Taxes from rising incomes and rising consumption should be applied towards improving India’s societal capability. People’s money should go back to the people. India’s budgets are beginning to be earnest about this.

Tax-to-GDP

India’s budgets have since 2003 been earnest about riding the consumption curve. Private final consumption expenditure (PFCE) had remained subordinate to government final consumption expenditure (GFCE). But government is not a taxpayer; private citizens pay all the taxes. So, India had to be a poor, low-growth economy.

PFCE is now seen as a good thing; raising PFCE is regarded as the best way to transform India into a rich, high-growth economy. Raising PFCE as a proportion of GDP produces two vital results. First, it accelerates GDP growth. Second, it raises the tax-to-GDP ratio at lower rates of income tax. Pushing incomes, consumption and aggregate tax collections is the wise thing to do; this is not a secret. Raising direct and indirect tax rates is the unwise thing to do. This too is no longer a secret.

But private consumption had been on a decline, albeit slightly, since 2007. India had managed smartly to overcome the unfavourable impact of rising commodity prices since 2000. Prices of commodities — including food — had risen globally at an annual rate of 14 per cent in US dollars (USD) since 2000. That is a monstrous rate; its impact had to show. The threat to consumption and the viability of lives, especially on the farm, had become real.

So, holding down inflation, energising the production function, holding down interest rates, pushing investments, saving lives and livelihoods, and raising incomes and consumption became the principal objectives of Union Budget 2008. The waiver of farm loans is a means to the accomplishment of these objectives. It is a necessary ingredient too. It could have been done earlier, say, in 2006. But it became possible in 2008.

Wisdom, at last

Since April 2007, India has wisely chosen to abandon the rather inapt, inept and iniquitous policy of keeping the rupee weak. Rising inflation is one of the harsh public outcomes of weakening the rupee through intervention by the Reserve Bank of India (RBI). The gains from intervention and the accumulation of foreign exchange reserves are usually private; they accrue only to exporting firms, their owners and shareholders, and their suppliers and employees.

There were other harsh but avoidable results. The public bore them most. Rising inflation then required appropriate monetary policy stances. Interest rates and cash reserve ratios were raised. Some public and many private investments were postponed. A crunch in supply of goods and good governance followed. Inflation was reinforced. Low and falling incomes and rising prices hurt the poorest the most. The poor were fried and pickled. Suicides followed. Inflation has a habit of hurting those at the bottom of the pyramid. It rewards those at the top of the pyramid. The suicide deaths went unnoticed at the top.

Though very late in understanding how and why keeping the rupee artificially weak hurts India, the RBI has now chosen to strengthen the hands of the Finance Minister by letting the rupee find its own strengths, especially against the USD. The need to suck out liquidity through high short-term interest rates has disappeared. Pressure on interest rates has eased. This has favourable implications for the private sector, especially the farm sector. This is a very important outcome to the government and has favourable implications for India’s fiscal robustness.

Fiscally robust

The policies and provisions of Union Budget 2008 make it possible for the government to comfortably see off the outcomes of the farm loan waiver. Rising aggregate tax collections, lower inflation rates, lower interest rates and a stronger rupee will lead to both private and public surpluses. If the Pay Commission acts morally and wisely, it will reckon with the lower inflation rates and lower interest rates in the future. It will, it is hoped, keep in mind the principle that people’s money should go back to the people.

Let us return to lower interest rates. The optimism that interest rates will be lower is based on two factors. The first is that the RBI will not unwisely return to accumulation of reserves aimed at weakening the rupee. It will not impose monetary policies that raise interest rates. The second pertains to net incremental borrowing by government.

Government’s net incremental borrowing in 2006-07 was 3.38 per cent of GDP. Revised estimates for 2007-08 show that this will decline to 3.17 per cent. The Budget for 2008-09 estimates this to decline further to 2.42 per cent of GDP. Government is on its way to lower indebtedness. In such happy circumstances, it seems morally necessary and right that government should waive farm loans.

(The author is a financial analyst. Feedback may be sent to indiagrow@yahoo.com and pari@thehindu.co.in)