19 April 2017

(The author is a Reuters Breakingviews columnist. The opinions expressed are her own.)

By Una Galani

MUMBAI, April 19 (Reuters Breakingviews) - India is eyeing populist politics. The country's biggest state, Uttar Pradesh, is writing off farm loans worth $5.6 billion, fulfilling a pledge made by Prime Minister Narendra Modi in the run-up to local elections in which his ruling Bharatiya Janata Party won a landslide victory. Pressure is building for politicians in other states to follow suit, with opposition parties calling for waivers too.

A nationwide waiver of farm loans would be the third since 1990. This one might cost India around 2 percent of GDP, according to Bank of America Merrill Lynch. The Reserve Bank of India and the country's largest lender, State Bank of India , have already warned that writing off such loans is bad for the credit culture, blunting incentives for future borrowers to repay.

It will also deal a blow to state finances. Despite hard work to reduce the deficit of the central government to 3.5 percent, the consolidated deficit of states has risen steadily from 2.5 percent of GDP in 2015 to 3.6 percent in 2016. BAML reckons most states will blow through their 3 percent fiscal deficit limit were there to be a similar waiver of farm loans across the country, which would ultimately raise New Delhi’s borrowing costs.

There are big political incentives, however. It is an obvious vote-winner for upcoming state elections. Agriculture accounts for about 18 percent of GDP, but the sector still employs just under half the workforce. Forgiving loans would provide immediate relief to a rural economy, where wage growth is weak, and which suffered most from Modi's radical currency reform last year. Modi enjoys a strong mandate but he still does not control the country's upper house of lawmakers, which could help to push his reform agenda. He also faces a general election in 2019.

Finally, the waivers might provide cover for any bailout of India's troubled state-controlled lenders. This would not involve cancelling loans to tycoons, but any move by New Delhi to make a one-off big injection of cash into lenders would still look like a bailout of the rich as poor farmers are committing suicide.

If Modi plays farmyard politics, the best hope is that India’s prime minister has his eye on a bigger reform agenda.

On Twitter https://twitter.com/ugalani

CONTEXT NEWS

- India's most populous state, Uttar Pradesh, said on April 4 it would waive loans to farmers worth almost 364 billion rupees ($5.6 billion).

- The move fulfils a pledge made by Prime Minister Narendra Modi in the run up to polls in the state in which his ruling Bharatiya Janata Party had a landslide victory.

- Subsequently, the main opposition Congress party has said that it would make farmers "debt-free" if elected in the neighbouring state of Gujarat, the Hindustan Times reported on April 9. A number of opposition parties in the state of Maharashtra have also demanded a similar waiver.

- Farm loan waivers undermine an honest credit culture, impact credit discipline, and blunt incentives for future borrowers to repay, Reserve Bank of India Governor Urjit Patel warned during a regular monetary policy announcement on April 6.

- The latest monthly report of the RBI showed that vegetable prices fell by 21 percent between November 2016 and February 2017 and acknowledged anecdotal evidence of distressed sales by farmers following New Delhi's move in November to cancel most of the country’s banknotes by value.

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(Editing by Pete Sweeney and Liam Proud)

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