Increasing diesel prices would have given the signal that the govt will come out of its slumber to trigger investment
It has truly been a long wait for a policy break by the government for both India Inc and foreign investors. It was hoped that the government will act after the elections in Uttar Pradesh and then, after the Presidential election. Now, with the new finance minister taking over, the hopes have revived. The challenges of fast-tracking the reforms in the prevailing environment are formidable, but Mr Chidambaram has all the credentials to meet them.
In the meantime, the fiscal situation threatens to become worse. The fiscal deficit of the Union government in the first quarter covered 27% of the budgeted deficit for the year and there are serious questions about the ability to contain it at the budgeted 5.1% of GDP. The deficit target is predicated on the assumption that there will be an increase in the tax-GDP ratio by 0.5 percentage points. This implies that the gross tax revenue of the Centre will grow at 19.5% and the excise and service tax revenue will grow by almost 30% during the current year. With the manufacturing sector not showing signs of a fast recovery and with an expanded negative list and an inability to include the Railways to pay the service tax, it is not clear how the assumed buoyancy of excise and service taxes can be realised. On the expenditure front, the archaic economic measures are not a solution. Unproductive expenditures will continue to proliferate unless we are prepared to undertake serious expenditure reforms.
Primary among them is containing the subsidy bill. Far from reducing the oil subsidy from R68,481 crore in 2011-12 to R43,580 crore as envisaged in the budget, the outlay threatens to explode. With no action seen to increase the prices of diesel, the under-recovery is close to R10 per litre of diesel sold. The failing monsoon has denied the benefit of even the seasonal decline in demand and, in June, diesel consumption increased by over 11% as against an increase of just 2.8% last year. In addition, the ministry of agriculture wants to further subsidise diesel for agricultural consumption. With regional satraps flexing their muscles, policy action on this front will not be easy.
With the current account deficit over 4% of GDP and the flow of foreign investment down to a trickle, it has become difficult to defend the falling value of the rupee against major currencies. Even in this unstable exchange rate environment, there has been a surge in foreign institutional investment by over R9,255 crore in June after pulling out R1,957 crore in the previous three months. This shows that despite the poor investment climate, foreign investors still have tremendous hope in India. A single act of increasing diesel prices?even if it was by only R5?would have given the signal that the government will come out of the slumber to trigger investment inflow. Further inaction on this front will only create a greater loss of trust and credibility every passing day.
Inaction on the policy front will lead the country to a very difficult situation. The large fiscal deficit and persisting high inflation has not given much room for the Reserve Bank of India to reduce policy rates. Even as India Inc has been arguing that the source of inflation is on the supply side and high interest rates are not going to reduce inflation, RBI has argued that other factors, and not high interest rates, are the cause of growth deceleration! In any case, the prevailing situation does not provide much room for reducing interest rates. With the monsoon playing truant and inadequate rainfall seen globally, there can be a sharp surge in food prices in the coming months and this will not allow RBI to reduce the policy rate in the near future. In this situation, if the credit rating agencies decide to downgrade the outlook of the country, not only will the FIIs stay away but there can be exodus from the Indian market. The exchange reserves will prove inadequate to prevent a slide in the exchange rate and this could land the economy in a crisis situation. Therefore, it is imperative for the government to act, and act fast, to save the situation.
It is necessary to realise that the days of populism are over. We have seen the cost of negligence in the Railways and the power sector in the last week. The failure of the grid is as much due to a lack of adequate modernisation as it is due to excess drawals from the states. The total neglect of renewal, maintenance and upgrade in the Railways will create many more incidents like the one seen on the Tamil Nadu Express, where scores of people were charred to death. These require funds, and a reluctance to increase fares will only result in travellers paying a heavy price in terms of their lives! Similarly, reluctance to charge rational prices on petroleum products and an inability to provide them with budgetary subsidies to contain the deficit may result in long queues for getting diesel and cooking gas and that might set the prices of all commodities on a spiral. The backlash of this can be harsh for any political party and, therefore, it is in the interest of everyone to undertake reforms.
These are short-term measures that must be undertaken swiftly. There are medium-term and long-term measures too, which must be initiated if we have to return to the 8% growth path. The most important medium-term measure is on the energy front. Given the constraints in the medium-term, unless a stable arrangement is made to augment the supply of coal by at least 8% every year, we will continue to be constrained by a lack of power and steel, and Coal India Ltd has clearly demonstrated that it is incapable of augmenting the supply. The proposed debt restructuring of the state utilities may infuse some oxygen into them, but the lasting solution to them has to be found in reducing transmission and distribution losses and aligning the price of power in keeping with cost increases. The days of populism and free power are over. Free power will mean no power and that is certainly not a happy solution. Bad economics cannot be good politics and vice versa. Bad economics will take the economy to crisis and pursuing such a policy is akin to courting disaster.
The author is director, NIPFP. Comments at mgovinda.rao@nipfp.org.in