Interview: 'Financial crisis imminent, India risks going the Sri Lanka way', says former RBI Chief

States can borrow for investment spending. However, it is worrisome that they are borrowing for day-to-day expenses, salaries, subsidies and even welfare schemes. "Financial management and payments are appearing trouble-free. But we have no idea what’s going on behind the scenes," warns Duvvuri Subbarao, former Governor of RBI in an exclusive interview with Eenadu.

Hyderabad:Since the onset of the pandemic, several states in India have their debts hovering around 40 per cent or more of the respective gross state domestic products (GSDPs). Populist schemes and limitless borrowing even for day-to-day expenses are majorly impacting the country's financial discipline and spending ability.

With an upward turn in the trajectory of interest rates and record borrowings by both union and state governments, the interest cost of the government is set to see a spike in the current financial year. In an interview with Eenadu, Duvvuri Subbarao, noted economist, Central Banker and former Governor of RBI spoke in detail about the issue. According to him, to understand the extent of debt hovering over Indian states, it was necessary to add up the additional debts undisclosed in the budget, debt guaranteed to corporations unaccounted for in ledgers and contingent liabilities.

"The crisis is imminent. Centre needs to intervene in the debt situation to prevent a financial emergency," said Subbarao as he discussed the impending debt crisis. "States can borrow for investment spending. However, it is worrisome that they are borrowing for day-to-day expenses, salaries, subsidies and even welfare schemes. If the situation continues, we may go the same way as Sri Lanka," he warned.

Though the Centre has enacted the Fiscal Responsibility and Budget Management (FRBM) Act to reduce the fiscal deficit, the states have been borrowing off-budget. The government of India, he said, should intervene in this matter and suggest measures to reduce debt. It should consider imposing conditions, and should not hesitate to impose financial emergency on the states which are still acting irresponsibly, he added.

The problem is limitless borrowing

Asked why were states incurring excess debt instead of focusing on optimizing or creating their own sources of income, the former RBI Governor said that while debts may be required as a part of financial management, the real problem was limitless borrowing. "If the government spends the debt to invest on something, it will generate income. They can repay the debt. But if taxes are slashed, and loans are spent for subsidies and populist schemes, we may find ourselves in a severe economic crisis like Sri Lanka. Few states in our country are going this way. According to the latest report by the RBI, Andhra Pradesh is among the top five states with the highest debt," he said.

Should we be worried?

Corporate bonds must also be calculated. There are states whose debt to GSDP is 50 per cent or more, passing over the borrowing limit. Asked why isn’t the RBI interfering, Subbarao said that he cannot comment on any state in particular. "The RBI report is for all the states. As per the report, states’ debts and consequently, interest rates are rising. There is no money for development works. You are right about off-budget debts though. We usually look at any report based on the numbers presented in the budget. Financial management and payments are appearing trouble-free. But we have no idea what’s going on behind the scenes. Borrowings from corporations with guarantees should also be included in the budget," he said.

A lesson in Sri Lanka

Drawing parallels, Subbarao said the two major causes of the Sri Lankan financial crisis were decreasing foreign reserves and the government’s populist schemes. Sri Lanka, he said, was largely dependent on remittances sent by their citizens working abroad and income from tourism. However, the 2019 Easter bombings and Covid-19 terribly impacted the country’s economy. Tea and textile exports came to a grinding halt during the pandemic.

"As a result, it was unable to repay high-interest loans borrowed from other countries, including China. On the other hand, the government had earlier reduced taxes and given interest-free loans. Food grain prices shot up owing to the ban on import of chemical fertilizers. The ongoing Russia-Ukraine war led to increased fuel prices. Revenues plummeted as expenses grew. The growth rate sunk. The currency depreciated as inflation intensified. As the economy defaulted on debts, prices of essential commodities skyrocketed," he said.

The problem with populist schemes

Asked about imposing rules to limit spending, the noted economist said that ruling parties announce populist schemes to further their chances of power and end up getting into the debt trap. According to Article 293, any state government needs the permission of the Centre to take loans. "The Centre will consider the situation and may impose some conditions to go ahead with the borrowing. A financial emergency may also be imposed, though it never happened in India before," he said.

The onus, he said, was on the Centre to ensure that states adhere to financial discipline. "The RBI plays the role of a manager here. It reports to the Centre. There will be no problem if the Centre treats all the states equally. The states in the USA balance their revenue and expenditure," Subbarao said.

Since there was no social audit on government spending, can the government keep borrowing indiscriminately and is there any mechanism to question on behalf of the people? Answering this question, he said that in a democracy like India, it was the responsibility of the Legislature as it was the one that approves the budget. "Even the Opposition does not question when it comes to populist schemes and subsidies. Because all such schemes are tied to the vote bank. In fact, there is no information about some of the debts. This leaves no chance for checks and balances," he said.

Learn from the 1991 economic crisis

Subbarao said that India should learn from the economic crisis of 1991 and understand how crucial financial and monetary management was to keep a nation afloat. Fiscal deficits and debts, he said, push the country and the states into crisis and cause severe hardships to the people. "If the borrowings are diverted to freebies instead of spending on infrastructure and development projects, the state governments will not be able to increase their revenue and interest rates will go up, pushing them into a debt trap."

Along with high-interest rates, certain mandatory payments like salaries and pensions will make it impossible for the government to focus on development, he said. Subbarao also pointed out the recurrent delays in publishing CAG reports. "The CAG releases reports on financial issues. Since they come in late, the bureaucracy does not bother to look into them. Take Andhra Pradesh for example. The CAG report for FY 2019-20 was recently released. The government would not bother to consider a report from 2 years ago," he said.

"As per the report, 80 per cent of the loans taken in 2019-20 were utilized for revenue accounts balance, which has impacted infra creation in the state. But the report appears to have elicited no response from the state. The importance of audits is lost on the government," he concluded.