Over the last few weeks, many commentators have graded the performance of United Progressive Alliance-II’s (UPA-II) first year in office. Few were effusive while the rest deferred to facts on the ground.
The ruling coalition had a mandate to govern. However, unsurprisingly, the mandate was interpreted as a green signal to continue with the policy of redistribution through entitlements—a throwback to the failed policy framework of the 1970s and late 1980s after Rajiv Gandhi, then prime minister, lost the election in 1989.
The fiscal situation slipped out of hand before the global financial crisis struck and hence the government had little room to stimulate the economy through fiscal measures. It was a show of prudence dictated by earlier imprudence.
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The government’s budget balance is far from returning to stability. Jahangir Aziz of JPMorgan shows in his latest note that notwithstanding the record collection of licence fees for 3G spectrum allocation, fiscal deficit would hardly be dented.
His calculations show that, in the best-case scenario where crude oil prices remain at $70 per barrel, the fiscal deficit would be 5% of gross domestic product (GDP) against the budgeted 5.5% of GDP. If the price of crude oil hovers near $75 per barrel, the fiscal deficit at 5.2% of GDP would not be materially different from the budget estimate.
The reason is the continued under-recovery of oil prices due to persistent under-pricing of cooking gas and transport fuels. Two to three weeks ago, there were some rumours that the government would fully decontrol all fuel prices and let international price of crude oil (plus government taxes) dictate retail prices in India. Taxes have to be there to discourage the use of fossil fuels that are not replenishable.
Further, pollution from the use of fuels is a public externality that users have to account for, apart from paying the economic cost of fuel.
The anticipated decontrol has not happened and perhaps, the decline in the price of India’s imported crude oil basket has brought about a lack of urgency on this long-postponed reform. The best remedy for excess reliance on individualized mode of transport in a country with an underdeveloped infrastructure and high pollution is to let prices encourage right behaviour. Instead, the government is subsidizing unhealthy, unsustainable and undesirable modes of transport.
Further, there is no guarantee that the recent decline in the price of crude oil, while significant, would remain. First, economic growth could yet surprise on the upside in the second half, particularly in Asia and in the euro zone. Citing uncertainties in the world, China might prematurely suspend its administrative tightening measures. India, too, has been reluctant to rein in inflation. Germany, France and Benelux countries, which constitute nearly two-thirds of the euro zone economic size, could benefit from a weak euro and grow stronger than expected, if sentiment is not further damaged.
Even if this confluence of pro-growth developments is hard to contemplate, we need to pay attention to supply-side factors that could keep oil price from falling further. One is that the BP oil spill in the Gulf of Mexico is leading to a halt in further offshore drilling there.
Second, the National Oceanic and Atmospheric Administration (NOAA) of the US government released its 2010 hurricane season outlook.
It calls for an 85% chance of an above-normal hurricane season. Further, the Accumulated Cyclone Energy index of NOAA is expected, with a 70% probability, to be 155-270% of the median. This means an exceptionally active or hyperactive hurricane season.
This should help the government to focus its mind better on the problem. Financial markets are now more unforgiving of countries with sovereign debt problems. India’s growth rates shield it from any contagion. Nonetheless, adamant insistence on fiscal indiscipline would not help the Indian rupee. That would raise India’s inelastic crude oil import burden. All the more reason for the government to muster courage and free up the price of oil, leaving it to the oil marketing companies and consumer behaviour to do the rest.
In a country with a naturally rising trend growth rate due to favourable demographics and grass roots entrepreneurship, the opportunity cost of not doing the right things might not be felt immediately.
However, given the well-known lag effects in economics, the economist at the helm of affairs in this government should know rather well that next-generation historians could well be more uncharitable on his legacy than contemporaneous chroniclers.
Columbia University professor Emanuel Derman in his interview to Edge is hoping, in the US and global context, in terms of leadership, for “that occasional, miraculous, moment when people who are in a position to make a difference cease to behave mechanically—to take some recent examples, Mandela and de Klerk, perhaps Gorbachev—and who, rather than fulfilling their pre-programmed destiny, break the cycle of karma.” Indians too.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer and Co. Ltd in Singapore.These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org