Reserve Bank of India Governor Urjit Patel said the risk of going down the "slippery path" of waiver could dissipate gains made by states over the last few years and asked governments to "tread very carefully.
"The risk of fiscal slippages, which by and large, can entail inflationary spill-overs, had risen with the announcements of large farm loan waivers," the central bank said after the meeting of its monetary review policy committee that decides the benchmark policy rate required to contain inflation. The committee has turned down the finance ministry's proposal that its members hold discussions with the government before taking a decision to maintain its autonomy.
In April, the Yogi Adityanath government announced a 35,000 crores farm loan waiver in Uttar Pradesh that it had promised in the run-up to the elections.
Yesterday, Chief Minister Fadnavis pulled out the loan waiver plan to put the farmers' protests in the state behind him. Mr Fadnavis hasn't spelt out the size of the loan waiver or who would be eligible, saying these would be worked out. But he is determined to make sure that it was the largest.
Farm waivers increase budget deficits and raise inflation without fixing the basic problems that Indian agriculture faces.
Mr Patel said "past episodes in our country had shown that when there are significant fiscal slippages, they do permeate to inflation sooner or later".
A State Bank of India research paper reported by Bloomberg in March indicated the impact that Yogi Adityanath's loan waiver would have. The Uttar Pradesh government, it said, would wipe out 274 billion rupees or 8 percent of its total revenue when the loan waiver is implemented for small and marginal farmers. The state's total outstanding credit for the state's agricultural sector is around 862 billion rupees.