Month: April 2017

With Farmer Loans Waived Off, UP Govt Has Its Oh Darling Ye Hai India Moment  

Given that I am a big film buff, I have watched my share of trashy cinema over the years and continue to do so. A particularly trashy film that I watched in 1995 (which was also the year that Dilwale Dulhaniya Le Jayenge (DDLJ) released) was called Oh Darling Ye Hai India, and like DDLJ it also happened to star Shah Rukh Khan.

The title song of the movie had the line: “Jo bacha nahi wo baant dia,” which when translated into English essentially means, what has not been saved has already been distributed. Every time a government decides to waive off farmer loans, I am reminded of this song. And as I keep telling anyone who cares to listen, Hindi film lyricists have written songs for almost every situation that one can encounter in life, including farmer loans being waived off.

The question is why am I reminded of the song whenever a government waives off farmer loans or even talks about it. The government waiving off loans needs to compensate banks which had given loans to the farmers in the first place. Of course, the government hasn’t saved money to pay off these banks. And in that sense what has not been saved has already been distributed.

The newly elected Yogi Adityanath government in Uttar Pradesh has decided to waive off loans worth Rs 30,729 crore to small and marginal farmers in the state. By doing this, it has met its major electoral promise. The state has 2.3 crore farmers. Of this number 1.85 crore are marginal farmers and 0.3 crore are small farmers. Farmers with landholdings of less than 2.5 acres are marginal farmers. Those with landholdings of 2.5 to 5 acres are considered as small farmers.

The waive off amounting to Rs 30,729 crore will benefit 86.68 lakh small and marginal farmers in the state. Over and above this, the state government has also decided to settle bad loans of 7 lakh farmers worth Rs 5,630 crore, with banks.

This puts the total cost at Rs 36,359 crore. The first question that comes up is where is the government going to get this money from? As I said earlier, what has not been saved has been distributed. The state government will bear the cost of funding the farmer loan waive offs and the bad loans settlement with the banks, as well.

Can the state government afford this? The answer is no. In 2016-2017, the UP government was projected to run a fiscal deficit of Rs 49,961 crore or around 4.04 per cent of the state’s gross domestic product (GDP). A government is said to run a fiscal deficit if its expenditure is more than its revenue during the course of the year. The state ended up running a fiscal deficit of Rs 55,020 crore or 4.45 per cent of the state GDP.

Hence, an expenditure of Rs 36,359 crore would add majorly to the state’s fiscal deficit. It would also add to the overall fiscal deficit of India (i.e. the fiscal deficit the state governments plus the central government) which is extremely high to begin with. As Neelkanth Mishra of Credit Suisse wrote in a recent column in the Business Standard: “In the past seven years, even as the absolute fiscal deficit of the Union government has been largely unchanged, that of the state governments has increased two-and-a-half times.”

The state government plans to issue farmer relief bonds in order to generate money for waiving off banks loans. Doubts have been raised whether investors would subscribe to these bonds given the bad financial state of the UP government. A guarantee from the government of India on these bonds is going to help.

I guess this forms one part of the argument. The move will not work out well for the UP government. Nevertheless, that was a given. And honestly, the last things many governments are bothered about is their financial position. So, how will this move work out for the farmers is the more important question.

No doubt it will provide them immediate relief to farmers facing two consecutive years of bad monsoons. At the same time, the state government deciding to settle the bad loans of nearly 7 lakh farmers, has made farmers who paid their loans on time, look like fools

Further, overall this move might not be such a great deal for the farmers. It is important to understand that the waive off does not take away the farmer’s need to borrow money from banks in the days to come. As former RBI governor Raghuram Rajan said in a December 2014 speech: “In some states on certain occasions we have had debt waivers. How effective these debt waivers have been? In fact the studies that we have typically show that they have been ineffective. In fact they have constrained the credit flow post waiver to the farmers.”

There are several ways in which farmers who have taken on the benefit of defaulting on bank loans, are denied loans in the time to come. As N Srinivasan, a rural finance consultant writes in the College of Agriculture Business magazine: “The experiences of the past show that there are many ways of denying credit to farmers who chose to benefit from default of bank loans. Delay in sanctions, high collateral requirements, reduction of quantum of loans, lengthy and complex documentation requests, etc. are some of the well known methods of denial of credit. These would be employed to good effect in the post- waiver situations by banks to cut their exposure to farm sector.” And this is possibly not good news for the farmers. If banks deny them credit in the future, they will go back to the local moneylender.

The third constituent in the waive off are the banks. Given that they will be reimbursed by the Uttar Pradesh government, they will not face any losses on the loans that they had given to farmers. But as I had pointed out in the Diary entry dated March 23, 2017, the waive off will create the issue of moral hazard in the days to come.

The 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.”

This basically means that once the farmer sees a loan being waived off today, he will wait for elections in the future for the newer loans he takes on to be waived off as well. Essentially, he will see little incentive in repaying loans that he takes on in the future.

As the SBI Chairperson Arundhati Bhattacharya said recently: “We feel that in case of a (farm) loan waiver there is always a fall in credit discipline because the people who get the waiver have expectations of future waivers as well. As such future loans given often remain unpaid… Today, the loans will come back as the government will pay for it but when we disburse loans again then the farmers will wait for the next elections expecting another waiver.” And this isn’t possibly a good thing, if the idea is to promote financial inclusion and take banking to more and more people.

Over and above, all these points, the decision of the Uttar Pradesh to waive off loans, is likely to lead to a similar demand and decisions from other states. Such demands have already been made in Maharashtra. They may soon be made in other states where elections are due in the months to come. And this is something which isn’t good for the nation as a whole.

If several state governments raise money in a quick time, it can push up interest rates as well, despite the fact that currently the demand for bank loans is low. It will also push up the combined fiscal deficit of the state governments and the central government, which as I said earlier in the piece, is already high.

To conclude, India, as well all know, is a land of contradictions. If one thing is true, then it’s possible that the opposite maybe true as well.

Hence, this brings us to the last question of the day: “If banks can write-off lakhs of crore of corporate loans, why can’t they be forced to waive off loans worth around Rs 36,000 crore?” Indeed, that is a good question to ask. (I know some people here would like to point out to me that a write off is different from a waive off. In case of a write off the bank can still try and recover the loan that has been defaulted on. I would request these people to look at the recovery rates of banks, before trying to explain the difference to me).

As I said at the beginning of this piece, Oh Darling Ye Hai India. And that perhaps, explains everything.

The column originally appeared on Equitymaster on April 5, 2017

The Bolbachan of Cleaning Up Black Money in India

One of the issues that I have often written about in the Diary is black money.  And I honestly feel that the total amount of black money going around in India will come down only once the electoral funding of political parties is cleaned up. This is an issue I have been talking about for a while now, and I first started writing about it even before notebandi happened, and the issue wasn’t fashionable enough.

Unless electoral funding of political parties is cleaned up, the other steps taken are what we in Mumbai lingo call bolbachan. Simply translated this means just plain talk and nothing else.

In the budget (or the annual Finance Bill of the government) presented on February 1, 2017, a few amendments which were supposed to clean up electoral funding of political parties, had been proposed.

Over and above these steps, a few other amendments were introduced as a part of the Finance Bill for 2017. The Bill was finally passed a few days back on March 30, 2017. These amendments along with the steps proposed earlier at that point of time when the budget was presented, essentially make sure that the Indian electoral finance system will continue to remain as opaque as it was. Or to put it simply, we went one step forward and two steps back at the same time.

Let’s examine the issues one by one.

a) One of the steps proposed in the budget was that the “maximum amount of cash donation that a political party can receive will be Rs 2,000/- from one person.” Earlier, this limit was Rs 20,000. Further, the political party did not have to declare the names of people contributing up to Rs 20,000.

The total amount of cash donation that a political party can receive has been lowered to Rs 2,000. This means political parties can still receive donations in cash. This basically means that the black money can still be channelised into electoral donations. Of course, all this has done is increase paper work. Instead of one receipt of lower than Rs 20,000 that used to be made earlier, multiple receipts of less than Rs 2,000 will now have to be made, to get around to the current rule.

As C Rammanohar Reddy writes in Demonetisation and Black Money: “The practice so far has been to split up large collections of black money into individual donations, each less than Rs 20,000 so that the anonymity of the source is maintained. The new rule only makes this more difficult; it does not prevent it… The Rs 2,000 rule will continue to keep the door open for black money.”

Some of you might feel that I am being sceptical here, but what else can one be regarding Indian political parties. Interestingly, while the cash donation limit has been reduced to Rs 2,000, political parties still don’t have to disclose the names of people donating of up to Rs 20,000.

As Milan Vaishnav the author of  When Crime Pays: Money and Muscle in Indian Politics pointed out in a recent column: “While the government has lowered the cash limit to Rs. 2,000, it has not touched the disclosure threshold, which remains at Rs 20,000. Politicians are already privately joking that the new cash cap will easily be gamed; the only difference is that their chartered accounts will demand a raise.”

This is the point I had made about bolbachan—just talk without any concrete steps that are likely to make a material difference. On the face of it, this seems like a move which basically makes sure that any donation of greater than Rs 2,000 made to a political party will have to made through the banking system. But as mentioned earlier, the donation can easily be split into multiple transactions and black money can continue to finance political parties.

b) In his budget speech, the finance minister Arun Jaitley had introduced the concept of electoral bonds. As he had said: “An amendment is being proposed to the Reserve Bank of India Act to enable the issuance of electoral bonds in accordance with a scheme that the Government of India would frame in this regard. Under this scheme, a donor could purchase bonds from authorised banks against cheque and digital payments only. They shall be redeemable only in the designated account of a registered political party.”

The proposed electoral bond is a bearer bond. As Reddy points out: “It would seem that the idea is for the RBI to issue electoral bonds, which individuals/organisations can purchase at banks (by cheque, thus keeping out unaccounted cash). The buyers can donate these bonds to political parties, which can deposit them only into their bank accounts. Because they are bearer bonds the banks will know the identity of the buyer, but the political parties receiving them would not know who the donor is. This opacity about the donor may free the political party from returning favours. However, the interests of transparency are not met by such features. In any case, which donor would not want his identity to be known to the recipient political party?”

Interestingly, the Wall Street Journal points out that the bearer bonds were phased out in the  United States, in the 1980s “because they are anonymous and easily used by money launderers and tax evaders.”

And this precisely what the electoral bonds will encourage in India as well, as we shall see.

Getting back to the point, the electoral bonds seem to move things above board. Hence, instead of donating cash to a political party, a donor can now use the banking system.

The trouble is this that the electoral bonds need to be seen together with other amendments which were introduced towards the end and were not originally a part of the Finance Bill.

c) So, corporates can now donate money to political parties using electoral bonds and maintain secrecy. But that is just one part of it. Earlier, a company could donate up to 7.5 per cent of the average net profit for the last three years to political parties. Further, the company had to disclose the total amount of donations made to political parties in its profit and loss account. It also needed to disclose the names of the political parties it had donated money to.

The recently passed Finance Bill of 2017 does away with these needs. What does this basically mean? It essentially means that a company can donate any amount of money to a political party without the company or the political party having to disclose it. And this, in a country like India, where the governance mechanisms are shaky, makes for a deadly combination.

This is precisely the fear that led to the phasing out of bearer bonds in the United States. As Reddy writes: “The donor’s books will only record that bonds have been bought, they will not record who the bonds have been donated to. The political party receiving the bonds will record receipt of the bonds but the identity of the benefactor will not be known. This is the perfect cover of the anonymity for pay-offs to take place. It would seem that the business-politics links are going to be strengthened and not weakened with such ‘reform’.”

As a senior CAG official told The Telegraph: “This means, for example, that an infrastructure firm could theoretically pay up to 50 per cent of its net profits to a single party as donation without anyone getting wiser as to which party has been paid… this throws open the possibility that an order to build a highway or a railway bridge could be given to a firm and that firm could pay the donation to the party in power which placed the order with it… The beauty is that if this happens, it will be legitimate and no questions can be asked by any ethics committee of Parliament or by any CAG audit.”

To cut a long story short, these changes will take the corporate-politico nexus to altogether another level. We have seen in the past how the nexus has messed both the real estate and the banking sector in India. It remains to be seen how the consequences of this year’s changes in the Finance Bill pan out.

Of course, while the political parties can continue to be opaque and non-transparent, come July 1, 2017, all income tax payees will compulsorily need to quote their Aadhaar number while filing their income tax returns.

Welcome to the new India. As I said earlier, it’s all about bolbachan.

The column originally appeared on Equitymaster on April 4, 2017