The farm loan-waiver schemes being discussed and rolled out across an increasing number of Indian states could have a significant impact on state government finances, and might undermine efforts to bring down general government debt, says Fitch Ratings. The impact on India's debt dynamics and capital spending will depend on the total size of loans waived, how the scheme is financed, and whether there are possible offsets from cuts to other forms of spending, including capital projects.
Larger state deficits would delay an expected gradual reduction in general government debt, which includes central and state government debt. When India's rating was affirmed at 'BBB-'/Stable in May, Fitch forecast general government debt to fall to 64.9% of GDP by FY21, from 67.9% in FY17, and we highlighted that potential changes to India's fiscal position are a rating sensitivity. Public finances are a key weakness in India's sovereign credit profile, with general government debt well above the 'BBB' median of 40.9% and the fiscal deficit of 6.6% of GDP in FY17 much higher than the 'BBB' median of 2.7%.
India's central government has gradually consolidated its fiscal position in recent years, and has indicated it will not participate in the waivers. However, the combined finances of the states - which are included in general government debt and deficits - have been under pressure. Public pay hikes, election spending and higher interest costs stemming from the UDAY scheme-under which state governments have taken on debt from power distribution companies - are all likely to add to expenditure.
There is a risk that farm loan waivers - which we have not previously factored into our assumptions-will lead to further fiscal slippage at the state level or will reduce the funds available for public investment. The central government has the authority to block states from borrowing to finance persistently large deficits, but it could be reluctant ahead of approaching elections in some states, and with the 2019 Lok Sabha election drawing nearer.
The last widespread farm loan-waiver scheme was rolled out in 2008 by the central government, and covered 43 million farmers. It reportedly cost around 1.3% of GDP. The combined cost to the states could also become large this time. Schemes have already been announced in Uttar Pradesh, Maharashtra, Punjab and Karnataka, which account for around one-third of India's population. Other governments are likely to feel pressure to implement similar policies, particularly in states with upcoming elections. A roll-out across much of India is not unthinkable.
Banks could also be affected by the waiver schemes. The schemes will benefit banks to the extent that they offload farm loans with weak repayment prospects to state governments. Uniform farm loan waivers could lead to moral hazard and weaken the general repayment culture among financially healthy farmers, but they will still have an incentive to repay loans in order to retain access to future funding. Agricultural loans account for 14% of total bank lending, according to the Reserve Bank of India, and are equivalent to around 6.5% of GDP.
