Friday, February 29, 2008

Budget 2008

Rs.60,000 crore of debt waiver

This is a dubious idea at so many levels.

Periodic debt waivers set up incentives for farmers to be irresponsible in borrowing, knowing that they will get a waiver at a future date. The bad farmer (who had no intention to repay) benefits, while the good farmer (who thought carefully about leverage) feels stupid. The bad bank (which has a bad credit processes) gets away scot free; the good bank (that spent money on building sound credit process) feels stupid. Expect vol of bank stock prices as the speculators calculate out who gains and who loses how much by the financing strategy that's put out by the government in coming days.

I think this is the exactly wrong way to shoot for financial inclusion: it contaminates the opportunity to build a genuine financial ecosystem surrounding farmers, which can cope with the risks and requirements of these users. This decision will help to bring out the worst behaviour amongst farmers and financial firms in the future.

If the intent is to help `poor people', then landholders are the wrong target audience; poor people are those who don't have land. While 80% of holdings are covered in the debt waiver plan, the government has gone on to offer a 25% writeoff even to the top 20% of holdings. You would have got a lot more bang for the buck for agriculture by spending Rs.60,000 crore on (say) roads.

What do I think is going on? I think the UPA got started with one big idea: to do a massive expansion of welfare programs. The spending is underway, but it hasn't been delivering results. The `flagship programs of the UPA' aren't working too well, and the UPA isn't winning elections. Desperate measures suggest desperate times. This debt waiver program is a desperate effort at trying to somehow get State money to some voters. They are unwilling to question the holy cows of how education, health or poverty programs work. So they're down to this. I think it suggests elections in October 2008.

I was truly depressed watching the MPs responding to these sentences of the speech. Why on earth would they be so thrilled at something that is so patently wrong, something that can't possibly be in the interests of the people of India? On the best of days, democracy is only the least bad form of government. On a day like this, it looked truly gloomy.

This is the sort of behaviour which leads me to have a bias in favour of a market-dominated financial system. Banks are too juicy a target for politicians. A bank-dominated financial system is inherently unsafe for a country with weak institutions. With such depredations in the fray, it is safer for India to have less resources going through banking.

In addition, a culture of not repaying on debt is bad for debt-style financial contracts. As a consequence, India is turning into not just a market-dominated financial system but an equity market dominated financial system. By the latest numbers, the end-Jan market capitalisation of the CMIE Cospi index is Rs.59 trillion, which is well above 2x bigger than the 15-Feb value for non-food credit of all banks which is Rs.21.7 trillion.

Fiscal outlook

At first blush, it's an impressive fiscal consolidation - we're down to a fiscal deficit of 2.5% of GDP (budget estimates). You might like to see this spreadsheet representation of `budget at a glance'. The picture is good; it is better than what you would think if you only read the budget speech. (T. N. Ninan has more on this on 8 March).

Then you layer in the off-balance sheet items of food, fertiliser and oil subsidies. This is perhaps 1% of GDP or a bit worse than that. Then you're up to atleast 3.5% of GDP which is not so good.

In the speech, the finance minister says he initiated presentation of these facts in `budget at a glance'. I couldn't find it there. What is the calculation that needs to take place and be transparently disclosed? The size of the fertilise subsidy for 2009-09 should be defined as the money owed irrevocably owed to fertiliser companies owing to the operation of the existing subsidy regime over 2008-09, under reasonable projections for the market price of fertiliser and the subsidised price that will be administered. Some of this, unfortunately, doesn't show up in the apparent size of fertiliser bonds; the government often dumps the cost on fertiliser companies and does not issue fertiliser bonds on time. In this case, what ought to be bonds issued by the government as fiscal deficit show up as bonds issued by fertiliser companies. Hence, merely counting the size of fertiliser bonds issued does not correctly measure the true deficit implications of the fertiliser subsidy regime. In similar fashion, a correct calculation about the correct entry which should be in the budget as a consequence of the oil subsidy involves making assumptions about how much petroleum product prices will be revised in 2008-09 and how much the world price of the Indian basket will turn out to be.

Then I started hunting through the budget papers looking for a bulky entry of Rs.60,000 crore for the debt waiver. This is 1.1% of GDP. It isn't there. So there's another 1.1% of GDP that's off balance sheet. Why isn't it there? I suspect it was a last minute addition to the budget speech.

We're then in the worst of all worlds. If these calculations are correct, we're down to a central gross fiscal deficit of 4.6%. In other words, we failed to harness the great business cycle upturn of the recent years to do the fiscal consolidation in these good times. And, we did this in the worst possible way: by setting up a new level of mistrust of Indian public finance data.

Sound institutional arrangements involve a government that comes to Parliament with a clear statement of what it will spend and how this will be financed. A gap between the stated deficit and the true deficit of 2% of GDP (or worse) is an unprecedented breakdown of fiscal accounting in India.

The only saving grace here is the promise made by the FM that he'll request the 13th Finance Commission to regroup and take stock on how the fiscal consolidation should now proceed.

The flagship schemes of the UPA

Over the UPA period, plan expenditure has risen to 4.5% of GDP. The first task of the next government should be to evaluate how well these flagship schemes are doing, and close down schemes that have a poor bang for the buck. There is a good case for more money going down to the third tier, by reducing the size of plan expenditure.

Failing to cut the customs rate

In my opinion, this was a mistake. The claim was made that owing to INR appreciation, local firms are having difficulties competing with imported goods. This claim does not square with the buoyant profits and rising profitability of Indian firms. There is a loss of credibility here, when compared with the clock through which customs duties only went down every year. Now, Indian industry knows this fight is up for grabs.

There are the usual pro-export noises that are made. But India never exported by having tariff barriers. Exporting only took off when tariffs were cut, thus reducing the prices of raw materials in India and exposing Indian firms to heightened competition. Not cutting tariffs was an important mistake.

The Bond-Currency-Derivatives Nexus

This was pretty neat. An article of mine about this appears in Business Standard. Also, recall that the removal of double-taxation of dividends was one of the things that the MIFC Report had brought up, as an impediment that hurts holding company structures which are required for finance. See Section 2.1, titled `The holding company structure' in Chatper 11 `Reforming financial regime governance' of the MIFC report.

Commentary in the media


  1. The debt waiver scheme is really going to set a bad precedent. My wife naively asked me today morning why doesn't our father takes farm-loan when there are things like loan-waiving. Now i fear, even farmers who are well-off will be lured to take a loan anticipating a future debt-waiving scheme by govt. Making farmers live on largesse will hurt farmers in the long run.UP goverment in the past has ruined its Electricity Board in the form of One-time-settlement/complete waiver of electricity bills to farmers,only to leave villages with a power supply of 4 hours per day today as compared to 12-14 hours supply before 1990.

  2. I happened to read an article by economist Kamal Nayan Kabra where he estimates that the corporate taxes foregone by the gobvernment is to the tune of Rs 50,000 crores a year:

    "Public expenditure is equivalent to the policy-decision based foregoing of public revenue. On account of various tax concessions, exemptions and incentives, the total excise, customs, personal income tax and corporate income tax revenue foregone during 2004-05 was Rs 2.067 lakh crore. It increased to nearly Rs.2.352 lakh crore in 2005-06. Of this amount, the exemptions from corporate income tax alone amounted to about Rs 34,620 crore. This amount increased to over Rs 50,000 crore next year. Indeed, the corporate income tax foregone by the Union government is trivially less than the total amount spent by both the Union government and the 28 state governments on all rural development schemes."

    If this is indeed true, I wonder why there is so much of a hue and cry over a Rs. 60,000 crore loan waiver and none over the taxes not collected from the corporates.

  3. Haven't precedents already been set? Some of us have longer memories and remember what these star industrialists and financiers were doing in the go-go 90s. It was interesting to see those very people who destroyed the savings of the middle class and refused to repay loans in the 90s suddenly reemerge as captains of inustry in the last 2 to 3 years. So the precedents have been set. You can take out large loans and refuse to repay and you will go scot-free.

    I remember stories of NPAs in banks in the 90s. Whatever happened to that?

    I see the subsidies and loan waivers as the great social bargain between the rich and the massive number of poor in India. The rich keep their loot and the poor get some sops. Ideally it should stop but from both ends.

  4. PS: I agree with everything else you said. I even agree with the moral hazard argument but when they don't care about moral hazard when the rich break the law and don't repay loans why be so hard on the poor?

    Great blog btw.

  5. Shah,
    you need a good calculator.
    The total (central+state) fiscal deficit including those off the sheet items like oil bonds, is as high as 8% of the GDP..
    My forecast is indian growth will dip to 5-6% in the next 5 yr period

  6. The debt waiver scheme is really controversial, from many respects. First, there is a "moral hazard" argument. Second, its impact on bank profitability. But not many have analyzed to what extent it will benefit the farmers/ cultivators.

    If the major source of credit is informal sector, then clearly formal debt waiver is not much helpful. And various NSS reports have brought forth the fact that share of informal sector in rural lending has gone up. If some reports are to be believed, majority of farmers in A. P. who committed suicides, had huge debt from informal sector. Clearly in such a case, the waiver doesn't help.

    Secodnly, there is a ceiling of 2 hectres. But in Vidarbha and other cotton growing parts of Deccan, even an average farmer has a landholding greater than 2 hectres due to historical and agro- climatic reasons. So these farmers won't benefit.

    So the two major states witnessing farmer suicides may not much benefit out of this loan waiver schemes.

    Further, this may also pressurize, albeit indirectly, the state governments, especially the ones going in for the elections (like Maharashtra) to announce similar measures at the state level.

    Thus, apart from its fiscal implications for the central govt., the above points suggest that it is harmful in many other respects as well, which would become evident only over a course of time.

  7. Great Post on the debt waiver. Two points

    One: Could you please elaborate on the issue of the Indian financial system being dominated by Banks being inherently unsafe.

    Two: Watching all the discussions on the TV I was struck by a universal agreement that the village money lender was a "bad guy". What are your thoughts on this?

  8. ambudon,

    One has to take the debate on debt waiver with a grain of salt - for all the reasons you give. The whole tamasha is to get votes, not in AP or Vidarbha but in UP and Bihar, where seats matter. Suicides will continue and loan sharks will have their way.

    60,000 crores would have done wonders if it was spend properly on irrigation, improving market/trading facilities, getting co-operatives running, and providing disaster insurance to people whose farmers are in distress. Narender Modi has done much more with far less money over five year in Gujarat. But for UPA, that's too much hard work and surely won't buy votes in the next elections - no in AP or in Vidarbha.

  9. Agreed on everything. But this kind of profilgacy is likely to only increase, right? I mean look at the widening gap/disparity among people? The government will be forced to doll out this kind of money to prevent any uprising.

  10. as always, you have given a fantastic view on the economics of debt, i would like to see the debt analysis published in business standard in the same way as your other articles are published,

    sir i would like to know the inflationary impact of this budget, the business standard of 1/2 march on the very first page has explicitly mentioned that the budget is not inflationary...

    but does not provide the explanation why???

    there are few things which i went through which clearly implies that the budget is inflationary

    1. debt waiver(it is going to be bond funded which implies long term consequences of inflation)
    2. income tax slab effect(even though it is the right measure but can effect inflation in short run - two to three years).
    3. implementation of the pay commission.
    4. effect of subsidies.

    even though i haven't followed the budget but these things clearly imply a high potential for inflation.

    what is your take on this?

    what a hope less paper is business standard on the first page they say that the budget is not inflationary with all the measures and on the very next page they say that the consumer are left with more money to spend.

    what kind of editor must be the control of this.


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