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Great Farmer Bailout Imperils India Sovereign-Rating Upgrade

  • Fiscal finances the ‘Achilles’ heel’ in credit profile: Fitch
  • Rise in states’ borrowing may hurt bond-market sentiment: SBI

India’s states are lining up to rescue indebted farmers hammered by depressed crop prices and rising costs, a trend that may further hurt the nation’s prospects for a sovereign-rating upgrade.

Prime Minister Narendra Modi’s government has criticized ratings companies for keeping Asia’s third-largest economy at the lowest investment grade, and his administration has pursued fiscal targets aimed at limiting borrowing needs. Those efforts could now be jeopardized by states taking on the obligations of farmers, the majority of whom stay in villages that make up about 70 percent of India’s population.

Karnataka this week became the fourth state to say that it would waive certain farm loans. CLSA India Pvt. predicts such waivers -- a type of political tool in India -- will rise to about $30 billion over five years as more than a dozen regional governments head to polls in that period.

“Good politics may not necessarily be good economics,” said Rajeev Radhakrishnan, Mumbai-based head of fixed income at SBI Funds Management Pvt.. “One of the factors why you don’t get a ratings move is that the general government deficit is very high, and now states rushing to waive off farm loans is like throwing fiscal discipline out of the window.”

Additional stress on public finances could ring alarm bells for rating agencies, who already see India’s high debt burden as a constraint. A farmer bailout may not just prove inflationary and impinge on the central bank’s ability to cut interest rates, but also cause states to increase their borrowings, hurting sentiment in the debt market, according to SBI Funds, a unit of the nation’s largest lender.

“The rising fiscal risks due to growing demand for farm loan waivers also pose a risk to inflation,” minutes of the RBI’s latest policy meeting that were released this week showed Governor Urjit Patel as saying.

The combined federal and state government debt was at 67.5 percent of gross domestic product in 2016, according to Moody’s Investors Service, which rates India Baa3. There’s a significant risk that productive capital spending may end up being reduced to fund a portion of the loan waivers, said Aditi Nayar, an economist at ICRA Ltd., Moody’s local unit.

Uttar Pradesh, the nation’s most populous state, and Maharashtra have announced waivers on more than 665 billion rupees ($10.3 billion) in agricultural loans this year, Nomura Holdings Inc. wrote in a June 13 report. Punjab projected the cost of such a bailout at 240 billion rupees, while Karnataka said it would let go of an amount worth 81.7 billion rupees.

“India’s ‘BBB-’ rating balances a strong medium-term growth outlook and favorable external balances with a weak fiscal position and difficult business environment,” Thomas Rookmaaker, Hong Kong-based director of sovereigns and supranationals group at Fitch Ratings, wrote in an email. “The fiscal finances form the Achilles’ heel in India’s sovereign credit profile.”

One of the main factors that Fitch believes could trigger positive rating action is the implementation of fiscal initiatives that would likely reduce India’s general government debt burden over the medium-term, Rookmaaker said, adding that such a reduction will be delayed if farm loan waivers cause significant fiscal slippage at the state level.

The federal government aims to narrow its budget deficit to 3.2 percent of GDP in the 12 months to March 2018, which would be the lowest in 10 years. The shortfall for states combined is projected to be 2.6 percent of their GDP, according to data from the Reserve Bank of India based on information pertaining to 25 states.

To read about how previous such bailouts have fared, click here.

“The at-times populist nature of policy-making at the state-level means that the central government’s fiscal consolidation path would not be straightforward,” said Yee Farn Phua, a sovereign ratings analyst at S&P Global Ratings in Singapore. “Should the farm loans waiver materialize in a significant manner, it may place further constraints on already-stretched state budgets.”

That raises the risk of states tapping the bond market even more, where the higher yields commanded by their securities are already seen posing a challenge for the federal borrowing program. The spreads between so-called state-development loans and sovereign notes have widened to a range of 66-72 basis points, from 50-56 basis points 12 months ago, and may even rise above 100 basis points this year, ICRA’s Nayar said.

Counter View: Bond Market Is Likely to Digest Farm Loan Waivers

“A large chunk of the waivers may be financed through borrowings and that won’t be good news for the bond market,” said Arvind Chari, head of fixed income and alternatives at Quantum Advisors Pvt. in Mumbai. “Yields on central government bonds will have to adjust higher.”

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