There is an ongoing debate about a possible waiver on interest payments for the six months of the moratorium period granted by the RBI. While a waiver might provide short-term, immediate relief to the borrowers, if history teaches us anything, waivers come with far-reaching long-term concerns.
First, who should be entitled to receive the waiver? In the ongoing case at the Supreme Court, the RBI is reported to have stated that a moratorium has been offered roughly to 65% of the outstanding loans. Borrowers in case of the other 35% loans are assumed not to be facing any liquidity issue thus far. This forms the argument for waiving off interests only for those who are under moratorium.
A selective waiver, biased against those who repaid on time, could set a wrong precedent and weaken the credit quality and credit culture in the country. For instance, the debt waiver of 2008 specifically targeted borrowers who had defaulted and induced moral hazard among non-defaulting borrowers. Careful research has shown that those borrowers who were otherwise unlikely to default also started defaulting on future payments, especially close to elections, in the expectation of receiving more such waivers.
The only sensible way to waive off interest, therefore, is to waive it off for all the borrowers. While this could still induce moral hazard, it brings us to another, bigger concern. A waiver is no free lunch. Based on the data on Scheduled Commercial Banks released by the RBI last year, the total interest income for the banks in the six months of moratorium should amount somewhere close to Rs 4 lakh crore. This translates to over 2% of our GDP. Who would bear this massive cost of the waiver? Unsurprisingly, most of the lending comes from public sector banks and therefore, the government will have to fund at least a majority amount.
How can the government finance this? It has three options. First, it could raise taxes. However, given the ongoing crisis, it seems unlikely that the government would overburden the taxpayers. The second option is to cut on welfare spending or defence expenditure. This again seems unreasonable amidst escalating border issues and the call for the government to boost spending in order to assist those adversely impacted by the crisis. The third and the last resort for the government is to run large deficits and borrow money. This seems the only probable option at hand but has its own costs.
Fiscal deficit shall subsequently lead to inflation shooting up in the long run. The massive shortfall in government’s revenues—a `2.35 lakh crore shortfall in GST collection announced recently—has already exacerbated the fiscal space. The current inflation rate is just under 7%, and any increase could be disastrous for depositors as real interest rates would likely turn negative—as had been the case in the aftermath of the 2008 crisis.
A negative interest rate would mean that the money deposited in bank accounts and fixed deposits would lose value because the inflation rate will be higher than the interest paid on them. In other words, the return generated would be lower than the rise in the cost of living. That would disincentivise saving and inflate the cost of borrowing in the future. While risk-takers could switch to investing in the financial market or real estate, it would be particularly devastating for pensioners, who mostly rely on deposits. Their purchasing power would decline and they would be at the risk of outliving their savings as their expenses stand higher than their income.
While we do not oppose the introduction of a relief measure for borrowers, we hope that policymakers would take into account the long-term cost of a large-scale waiver. The current plight of the borrowers is genuine and must be addressed to prevent viable entities from collapsing. Considering the recent signs of economic recovery, extending the moratorium and gauging the revival after a while might be a reasonable response at the moment. If conditions improve, it will be beneficial for all stakeholders. If they don’t, the costs and benefits of providing immediate debt relief must be evaluated once again. A sudden waiver would alleviate existing concerns of current borrowers but it will come at the cost of future hardships for new borrowers and senior citizens.
Prasanna Tantri And Naman Nishesh
The authors are with the Indian School of Business
(prasanna_tantri@isb.edu)