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Modi’s first fiscal challenge

Published Jun 11, 2014, 12:24 pm IST
Updated Apr 1, 2019, 2:05 am IST
If loans are waived in AP, people will be encouraged to not pay their future loans back
Prime Minister Narendra Modi (Photo: PTI/File)
 Prime Minister Narendra Modi (Photo: PTI/File)

N. Chandrababu Naidu, the Chief Mi-nister of new Andhra Pra-desh (what remains of the state after the creation of Telangana), wants to waive bank loans to farmers and women’s self-help groups amounting to a whopping Rs 54,000 crore.

Mr Naidu promised this freebie during the course of the election campaign and now wants to fulfil it.


The trouble of course is that the banks which extended these loans will have to be adequately compensated. And for that the newly elected state government will need money, which it does not have. It is estimated that the revenue deficit of Andhra Pradesh will amount to Rs 13,579 crore during the course of this financial year (April 1, 2014 to March 31, 2015). Revenue deficit is the difference between the revenue expenditure and the revenue income of a government.

Hence, the question is, where will the government get this money from? Mr Naidu is hoping that the Narendra Modi-led government at the Centre (BJP fought elections along with
Mr Naidu’s Telugu Desam Party both at the state and the national level) will help him fulfil his electoral promises.

But the Central government is already stretched on the finance front. In the interim budget presented in February 2014, the fiscal deficit for this financial year was projected to be at Rs 5,28,631 crore, or 4.1 per cent of the GDP. Even this projection was primarily achieved by cutting down on the asset creating planned expenditure and by not recognising “certain” expenses which in total amounted to more than Rs 1,00,000 crore. When this is taken into account, the actual fiscal deficit is significantly higher. Fiscal deficit is the difference between what a government spends and what it earns.

If the Central government chooses to assist the new Andhra Pradesh government with the entire Rs 54,000 crore that is needed, then it will end up adding to its already high fiscal deficit. In fact, the amount that the new Andhra Pradesh government needs to waive loans is more or less equal to the assistance that the old Andhra Pradesh received from the Central government over the last 10 years (between 2004-2005 and 2013-2014). This assistance amounted to a total of Rs 54,613.4 crore.  

One reason that the Modi government might choose to entertain Mr Naidu is the fact that it does not have enough numbers in the Rajya Sabha.
But if it entertains Mr Naidu, then it will also have to entertain the likes of Naveen Patnaik and J. Jayalalithaa, who have been demanding special packages for their states in return for their support in the Rajya Sabha. And where is all this money going to come from?

In any case, any such move will go against Mr Modi’s entire electoral pitch of the government creating an enabling environment that allows people to progress, instead of doling out privileges. It is worth remembering here that the new Andhra Pradesh has around five per cent of India’s population. Given that, should the Central government be spending such a huge amount of money in a single year on one single state? And the answer is no.

The only other option for Mr Naidu then is to borrow money by issuing bonds. The trouble is that a state cannot borrow an unlimited amount of money. The borrowing limit for old Andhra Pradesh had been set at Rs 29,000 crore at the beginning of this financial year. The borrowing limit for the new Andhra Pradesh will clearly be less. Also, as pointed out earlier the state is already expected to run a revenue deficit of Rs 13,579 crore during this financial year.

The moral of the story is that the mathematics for waiving loans extended to farmers and self-help groups, does not really work out. News reports suggest that bankers have requested the ministry of finance to try and convince the new Andhra Pradesh government not to go ahead with this plan. Other than the figures not adding up, there are other reasons why the new Andhra Pradesh government shouldn’t be waiving loans.

First and foremost, it rewards those who have defaulted on their loans. This is not fair to people who have honestly repaid their loans. In any case, loans being waived benefits those who are in a position to take a bank loan in the first place. Typically, farmers with large landholdings tend to fall in this category. The small farmer is not in a position to fulfil the requirements needed to take a bank loan. Hence, only large farmers will be subsidised.

Second, it brings the issue of moral hazard to the core. Economist Alan Blinder in his book After the Music Stopped writes that the “central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it.” What this means in the current context is that if loans are waived, the people of Andhra Pradesh will think twice before repaying their loans in the days to come. If the government can waive loans once, it can do it all over again.

Third, the government of Andhra Pradesh needs to build a new capital over the next years. It will need a lot of money in order to do that. Hence, it makes sense for it to be fiscally responsible during its initial years.

Vivek Kaul is the author of the Easy Money trilogy.
He can be reached at vivek.kaul@gmail.com