Everyone was pleasantly surprised with the projection of a fiscal deficit of 2.5% of GDP in the Union Budget 2008. There was also a fair bit of skepticism about this evidence of fiscal rectitude, even in those relatively halcyon days, with fears of slippage arising out of the farmers? debt relief scheme announced during the Budget speech.
Then inflation hit like a brick in April, rocketing up from 5.11% in early March to 7.41% at the end of March. All assumptions went haywire. The central government scrambled to contain this apparently hydra-headed beast, providing exemptions to, and imposing restrictions on, all commodities especially vulnerable to inflation?steel, cement, foodgrains, etc.
But this was before worse was to descend. There had been idle speculation about crude oil prices hitting $150a barrel. It has now actually come close, with crude futures crossing $133 a barrel.
This is not the place to wonder if all this is real or created through smoke and mirrors by global financial wizards. It?s better to look at the restrained under-statement of the RBI Governor that there were ?several underlying pressures not entirely evident in the numbers? on the fiscal situation. We had known about the contingent liabilities of the Centre for some time?the guarantees that the Centre had provided?and these had been previously estimated at anywhere between 1.5-2.5% of the GDP. In addition, there are the oil and fertiliser bonds. But the situation has now taken a shocking turn.
The government has hitherto taken on (to its own books as well as that of state owned oil companies) more or less all of the losses of the increase in global crude prices, resulting from not passing them on as price increases to consumers. But the latest increase in crude prices was the straw that should have broken this mule?s back; it has still not. It has variously been projected that, at $150 a barrel, under-recoveries by the oil marketing companies would be over Rs 2,00,000 crores in 2008-09 (compared to Rs 77,000 crores in 2007-08, when the average price of India?s crude basket had been about $79 a barrel).
The Ministry of Chemicals and Fertilisers then weighed in with an estimate of Rs 93,000 crores needed as subsidies for fertilisers, both produced in India, and imported from abroad?petroleum products are a feedstock into fertilisers, especially urea. Subsidies for fertilisers are budgeted at Rs 31,000 crs in 2008-09, a modest 2% increase over 2007-08 levels.
The total fiscal deficit budgeted for 2008-09, to put these numbers in perspective, is Rs 1,33,287 crores, in which the petroleum subsidy is Rs 2,884 crores and fertiliser subsidy of all kinds is Rs 30,986 crores. That leaves a gap of Rs 2,60,000 crores, about twice the budgeted fiscal deficit. If oil prices remain high, and there is now every reason to think that they will, this means a true fiscal deficit of the government of around 7.5% of the GDP.
Is there any way the gaps can be filled? The Centre currently uses all the tricks in its books. In the oil sector, for example, a very small part of the deficit is covered by actual subsidies by the government. Some amount is given by the upstream oil companies (like ONGC) as transfers to the oil marketing companies who bear the brunt of the diverging gap between crude prices and retail prices. Some small amount comes in as cross subsidies from decontrolled petro-products like aviation turbine fuel. A part is given by the government as bonds, which the oil companies can use as collateral to borrow short term loans from banks to fund operating costs or sell (at a discount) to insurance and provident funds. Periodically, there have been some small revisions in fuel prices. In the meantime, the net worth of the oil marketing companies is on the verge of obliteration.
There is simply no escape in moving retail prices of many of the controlled petroleum products (especially petrol and LPG) towards cost. The implications in the short term are indeed severe. Inflation will hit double digits, growth impulses will be damaged. Yet, there is a need to curb consumption and conserve. There is a need to be selective in reconfiguring which products (and which consumer segments) might withstand the price shock. Systems need to be devised to transfer lumpsum amounts to low-income consumers. The government should not increase farm gate fertiliser prices at the moment, although even this is a contentious issue; the impact on food prices will be severe, something India can ill afford at the moment. Alternative energy sources must be utilised, which will have become very cost competitive at current oil price levels. The haphazard ?eye of newt and toe of frog? approach needs to be replaced with a coordinated, coherent strategy.
The article is co-authored with Rituparna Banerjee. The authors work at Business & Economic Research, Axis Bank