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Avoiding a fiscal hole

Avoiding a fiscal hole
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First Published: Thu, May 26 2011. 10 48 PM IST
Updated: Thu, May 26 2011. 10 48 PM IST
The next few days will test the United Progressive Alliance’s (UPA) resolve to stand by its convictions. The pillar on which the budget rests —reduction in fiscal deficit—is likely to be threatened from within by a temptation to avoid short-term discomfort regardless of long-term consequences. The UPA must stay the course on its fiscal policy. The alternative is to watch a big part of a decade’s economic gains unravel.
Chief economic advisor Kaushik Basu feels it is time to bite the bullet and increase price of administered fuel, particularly diesel. At present, they are being sold well below cost and threaten to send the deficit spiralling out of control.
For sure, an increase in price of administered fuel will lead to a spike in inflation from its already high level of 8.66% (Wholesale Price Index, or WPI) in April. Both the budget and the Reserve Bank of India’s (RBI) monetary policy stance rest on the assumption that this is the best of the options available. A fiscal deficit that spirals out of control will lead to persistence of high inflation over a longer period.
The GDP deflator, the most comprehensive measure of inflation, best captures how generalized it is as also its relentless increase over the last three years. During this period WPI as well as the Consumer Price Index for industrial workers have seesawed.
The challenge from within will likely be a move to cut indirect taxes on administered fuel so as to offset an increase in retail selling price. On paper, the idea sounds good. In practice, it’s disastrous. The baggage of endless exemptions in indirect taxes means fuel makes up around half the collections. In a year when a slowdown in growth looks likely with negative fallout on tax collections, measures to cut taxes would widen the fiscal deficit.
The UPA must resist the temptation to pander to popular sentiments on the economy. If it doesn’t, it makes a mockery of RBI’s last policy announcement, when it surprised the market with the magnitude of its rate hike.
Besides that, the credibility of the UPA’s economic managers is at stake. Within a quarter of the current fiscal, if the UPA is going to dismantle the assumptions holding together its budget, its credibility among international investors will dip.
It is all very well to be dismissive of international investors and emphasize on the superiority of domestic interests. The reality is that to protect domestic interests, an economy that runs a current account deficit close to 3% of its GDP has to care about its credibility. After frittering away two years, the UPA must show the resolve to stand by the conviction of its economic managers.
Cheap fuel or balanced budget: what is more important? Tell us at views@livemint.com
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First Published: Thu, May 26 2011. 10 48 PM IST