India?s oil subsidy burden this fiscal could cross R1 lakh crore, nearly one and half times the budgeted amount, if the country does not revise fuel prices to pass on the high cost to the consumer, warned Morgan Stanley Asia. At R1,04,400 crore estimated by the global financial services firm, the subsidies add up to 1% of the country?s gross domestic product (GDP).
India has earmarked R43,580 crore as oil subsidy for the year and expects upstream companies ONGC, Oil India and Gail India to meet about 38% of the losses incurred by retailers IOC, HPCL and BPCL. Morgan Stanley said if oil subsidy is to be limited to the budgeted levels, regulated domestic fuel prices must rise by 19.5%, assuming the government bears a subsidy share of 22%-39%.
It said the country faces a high risk of stress on the balance of payment (BoP) front because of the higher crude prices and the only way to stave off the crisis was to cut subsidies by freeing diesel price. The current account deficit (CAD) had shot up to an alarming 4.3% in 2011-12 against 2.3% in the previous fiscal on declining capital inflows and rising trade deficit, which had touched $185 billion last fiscal against exports of $303 billion.
The last time India faced a major BoP crisis was in 1991, which triggered economic reforms. The Reserve Bank of India and the finance ministry are comfortable with a CAD of 2.5% of GDP. In this year?s Union budget, finance minister Pranab Mukherjee doubled custom duty on gold imports to 4%, which accounted for over $50 billion last fiscal and were the second highest contributor to CAD after oil imports.
Morgan Stanley further said India would remain exposed to slowdown in capital inflows triggering problems on the BoP front, unless the government reduced subsidies or international crude oil prices declined sharply. A slowdown in capital inflows will increase pressure on the exchange rate, which will raise the cost of capital and in turn, end up hurting growth further, it said. Foreign institutional investors (FIIs) have already started paring their equity and debt holdings in India after the government proposed general anti-avoidance rules, which could ending up taxing short-term capital gains made by FIIs.
Morgan Stanley said even if the country avoids a BoP shock by issuance of sovereign dollar bonds or dollar deposits, bringing down the cost of capital will be difficult unless fiscal policy is tightened. This year?s budget has highlighted the possibility of selling sovereign bonds to foreign investors.
The research report said that lack of pass-through of rising crude oil prices have also suppressed headline inflation, while the government?s fiscal deficit would overshoot target even in 2012-13. Fiscal deficit stood at 5.9% in 2011-12, as compared to the target of 4.6%. For 2012-13, it has been pegged at 5.1%. ?Headline inflation has moderated to 6-7% after two years from at 9-10%, but we believe the delay in pass-through to administered products has suppressed headline and core inflation to a significant extent. The government?s fiscal deficit (central plus state and off-budget subsidies) is still likely to be expansionary at 8.5% of GDP in FY2013,? it said.
