The Indian government is at it again. More specifically, I am talking about the finance minister. The innovative ways he can design to keep fiscal deficit under check is simply mind-boggling. The end result is always shifting of burden away from government finance.
His first experimentation had to do with issuance of bonds on various items – oil, food and fertilizer. The express reason for issuance of the bonds were to not use any cash to make good the under recoveries of the affected companies. These companies were issued bonds of various maturities in lieu of subsidies payable to them. During the period when this charade was played out, the government was able to show lower deficit as compared to what it should have been. However, these will come back to haunt government finances when these bonds mature as this has to be finally paid out of government revenue. As they, there’s no free lunch.
Having learnt the pitfalls of this strategy, the clever again finance minister devised a new strategy of making the oil companies take a hit by partially absorbing the loss they made by selling oil products (at government’s behest) at less than the cost price and the share of their burden increased progressively over the years to touch 40% of the total under recoveries.
Unfortunately, even that did not help bring the finances in order, given the rising pressure of populism on limited financial resources. The government has now started to borrow from the future to make good its contribution to the total oil subsidy. For the second year in a row, the government decided not to pay a significant amount of oil subsidy (I am talking of only their share) during the year and spill it over to the next year. During the last financial year, the government paid only 55000 crore rupees out of its total contribution of 100,000 crore rupees (total under recovery for the year being 161,000 crore rupees). The remaining 45000 crore rupees will be paid this year. There’s of course the small mater of the oil companies now being able to use the comfort letter thus issued and finalize the books of accounts for the financial year 2012-13 and show profit, as otherwise their balance sheet would have ended up with big blotch of red.
But even this is not the end of the story. For the current financial year, the government had budgeted 65000 crore rupees for oil subsidy. After paying our 45000 crores (as decided now), they would be left with only 20000 crores. Now, with election looming, the government cannot afford to spend more on oil subsidy when the need of the hour is to use as much financial resource as possible to buy votes by increasingly focusing on populist schemes. Remember food security bill is going to hit us soon. So, the next logical step is to increase the subsidy burden on the oil companies even further. For the current year, the government estimates that the total oil subsidy will be 80000 crores. With a mere 20000 crores being available, they want to shift the majority of the burden to the oil companies. Hence the current thinking of the finance minister is that, the oil companies should absorb the remaining 60000 crores i.e. the same amount they absorbed in the previous financial year. This would mean that the oil companies would now absorb as much as 75% of the total oil subsidy burden. How blatant can this be?
But hang on. The finance minister is still not done. Election still needs to be managed. Having failed miserably in controlling inflation, the government now wants to provide the feel good factor to the electorate before the elections are on us. An important way of achieving this would be by way of reducing petrol and diesel price. So what do we have now? In order to reduce the price of petrol and diesel, the government wants to move the domestic pricing norm from export parity to import parity.
Currently, oil companies are compensated for losses depending on trade parity – the ratio of imports to exports, which is 80:20. This means their losses are calculated to the extent of 80 percent on the basis of the prices of imported crude and petro-products, and 20 percent on the basis of domestic output.
The finance minister wants to shift to export parity pricing, since oil companies will then be compensated for losses based on the prices at which they export petro-products – which are lower, since import prices include freight, port and transportation charges. With this sleight of hand, the domestic price of motor fuel would come down while the burden on the oil companies would increase even further, as their business dynamics do not change in any way.
The burdened oil companies are getting increasingly leveraged while at the same time are having less and less of surplus to be able to invest in the future – an imperative for surviving in this investment intensive industry. As they say, there’s no free lunch. But that’s for later. For the time being lets count the wounds.
Finally the congress decided to dump the railway minister and the law minister. Is it a case of too little too late? That’s what it seems. The congress could have done that when the parliament was in session. After the CBI reports, they could have taken the high moral ground of asking the ministers to resign till proven innocent. That way they could have stolen BJP’s thunder, thereby forcing them to relinquish their militant path. In turn, the BJP would have had no other option but to allow the parliament to function. The country would have been immensely benefitted as some important bills could have been passed.
Instead, what we witnessed was one of the most unproductive sessions of the parliament, which was finally adjourned sine die, two days before the scheduled close.
It is quite unfathomable why they chose to stick to their guns till the Supreme Court came out with scathing comments. And now that they have taken this action, how can the Prime Minister stay at the helm? His position becomes increasingly untenable as it is a clear admission of guilt. As a result, what we can see now is even more militant opposition which could result in further policy paralysis.
The curious ways of Indian politics.
India released its Industrial production data for March 2013 yesterday. A growth of 2.51% yoy (year-on-year) in industrial production provided some sense of comfort during a period, when myriad corruption cases and parliamentary deadlock ruled the headlines. The index, which contracted during six out of the first nine months of the year, managed to show expansion in all the three months of the last quarter of FY13. What is also heartening is that the capital goods sector is showing some sense of stability after having contracted during nine out of the first ten months.
Overall, industrial production grew by 1% yoy during the full year as compared to a growth of 2.9% yoy a year before. Within this, manufacturing grew by 1.2% yoy during the year as compared to 3% yoy growth recorded a year before.
However, while the performance of the index over the last three months does lend credence to the belief that the worst may be over for the economy, the sense of comfort vanishes as one takes a closer look at the data. For starters, the February Index was revised downward (though at the margin) from 0.57% yoy to 0.46% yoy. In fact, during six out of the past eleven months, the index was revised downward when we moved from preliminary to final data. More importantly, the quality of data continues to remain suspect. When one considers the disaggregated data at the two-digit level, a major distortion is visible in the category ‘wearing apparel; dressing and dyeing of fur’. The index value for this segment dropped to 68.4 in March 2012 from 154.2 in February 2012 and then jumped back to 124.2 by April 2012. Clearly, a major base effect came into play here during March 2013 as a result of which, production for this category jumped by 152.3% yoy in March, thereby pulling up the index considerably. In fact, despite having a weight of only 2.78% in the IP, this segment contributed as much as 2.9 points to the overall index on an annual basis, while the IIP in itself increased by only 4.7 points over the same period.
Like most other categories, manufacturing of this product also exhibits high degree of volatility. If we extrapolate the average growth rate in production of this segment for the first eleven months (April till February) to March, it would have grown by only 3.3% and not 153% as is the situation currently. Had that been the case, overall IP would have increased by only 0.99% yoy in March and not 2.51% yoy as the official data suggests.
As expected, the RBI, in its latest monetary policy announcement yesterday stuck to saner counsel and opted for a 25 bps cut in repo rate while there has been increasing clamour for a 50 bps cut. While some analysts felt slighted by the move, I enumerated here why a more dramatic action is less desirable. Thankfully, RBI remains vigilant to the dangers of faster easing. Slowing credit growth despite substantially low real rate (policy rate minus official inflation) has to do with deteriorating investment climate in the country and not because of absolute level of interest rate. Source: CEIC dataWhat is also important is that RBI believes that the economic recovery would be shallower than what the government officials believe. I mentioned here why the optimistic assumptions behind the growth estimate put forward by the PMEAC (6.4% growth in GEP for FY14 as against RBI’s expectation of 5.7%) fails to stand scrutiny. Clearly RBI is worried about slower growth but they rightly believe that the government should be able to walk the talk rather than only talk while expecting RBI to shoulder all the responsibility. Monetary policy is essentially a signaling mechanism and as I explained here that despite a 1.25% cut in repo rate, 1.5% cut is CRR and 1% cut is SLR since March 2012, lending rates have hardly budged clearly shows that the problem lie elsewhere. Clearly, the transmission mechanism has weakened. The only way this channel can be effective would be when the confidence on the economy is back. And, for this, the government has to act. Question is, given the political reality of a weak & corruption tainted government and advancing general election, can the government do anything meaningful? Don’t bet on that. India will be well served if indeed we have an early election and a fresh government takes guard sooner rather than later.
Being blessed with many armchair policy makers, it is not a surprise that India needs to occasionally bank on divine intervention to stay on track. One could actually hear an audible sigh of relief when the met department announced that India can expect normal monsoon this year. It is a different matter altogether that the same met department also did forecast a normal monsoon last year at around the same time.
Before I go to the real reason behind this piece, I think it is worthwhile to narrate an experience at a very early stage in my career. I had joined Dalal Street Investment Journal (my first job) a few months back. A few days after the budget, my colleague and I went to talk to the then Minister of State for Finance. To our sheer irritation and dismay we realized that he is not the least clued to anything finance and economics and only wanted to talk about POTA. With the time well wasted, we the exasperated lot came out of the room pondering over the unexpected turn of events.
But then, was it really unexpected when quite often we have wrong people handling wrong portfolio and making mess of things. We want to spend humongous sums of money to tackle hunger when the main problem facing the country is malnutrition. We want to show the world that literacy levels in India are improving (and dropout rates falling) while turning a blind eye to the quality. At a particular eureka moment a wise minister (and his coterie) decided to eliminate the concept of failing a student till the 8th standard. Result – poor quality of students getting even poorer. Repeated learning outcome surveys conducted by both the government and by independent education think-tanks have shown a consistent dip in reading and math levels coinciding with the introduction of the policy. While the industry laments employability of graduates in India, the situation will only get worse because a minister thought he had a revolutionary idea. This is another example of how clueless we Indians are about harnessing the dividend that a positive demography entails.
Our Prime Minister expressed anguish at the painfully slow progress at international climate talk. What he should realize is that at least things are moving. Back home, policy is virtually at a standstill. Debates and discussions continue endlessly till cocks come home to roost, but hardly any visible action. No wonder the economic problems fester.
Was reading this discussion paper on food subsidies by the Commission for Agricultural Costs and Prices (CACP). Good to see my views being echoed.
India’s current account deficit (CAD) for the third quarter of FY13 shoots up to 6.7% of GDP. As a result, the CAD for nine months (Apr-Dec) is at 5.4% of GDP. The high CAD for Q3 was caused by trade deficit being just shy of US$60 billion, the highest ever. With the trade deficit for the first two months of Q4 being close to US$35 billion, the trade deficit for the full quarter could be close to US$50 billion. While this will mean an improvement in CAD for Q4 as compared to Q3, the overall CAD for FY13 will still be above my initial expectation of 5% of GDP.
What is even dangerous is that this CAD is being financed mostly by portfolio inflows and not be FDI. Rise in CAD is inevitable since domestic savings have been falling faster than the fall of investment. With the government failing to ensure fiscal prudence (save for the lip service) and unable to put the inflation genie back in the bag, domestic savings have taken a big hit.
I have explained on a number of occasions earlier, India’s real fiscal deficit for FY13 will be north of 5.5% of GDP. As a result, India’s twin deficit for the year will tot up to 10.5% of GDP. In fact, closer to 11% -higher than what it was last year.
Being helpless in tackling the problems facing the economy and unable to attract adequate FDI (by failing to meaningfully walk the talk), the government is taking every possible steps to attract portfolio flows to help finance the CAD. This, however, is the least desirable solution. Given the current state of the economy, even the relative attractiveness of the Indian economy remains questionable, atleast till the elections. Till then, if the situation does not improve for India and, even worse, if the European situation worsens (which is quite likely given the potential ramification of the Cyprus decision) the FIIs can exit India in large numbers. In such a situation, forex reserves will dwindle, the rupee will depreciate and inflation would remain elevated. A pretty scary situation, to say the least.
Unfortunately for India, the biggest policy driver is hope. The policy makers prefer to do nothing but hope that things will improve. Since September last, we have seen a plethora of announcements but hardly anything coming to fruition. The very fact the India is as yet unable to attract even a single investment commitment after FDI is multi-brand retail was liberalized, speaks volumes of how our policy and policy makers continue to fail India.
Bottomline – be prepared for the worst, at least till the elections are over. And, hope for the best, post that.
All this time we were witnessing increasing austerity fatigue in Europe. The result of the recent Italian election lend further credence to this belief. The fatigue that was (not surprisingly) first visible in Greece also spread to Spain and France. As the crack between disciplinarian Germany and the recipient nations (including the potential recipients) widened, comes the news the right-wing populists of Hungary passed a controversial constitutional amendment (with overwhelming majority of 265-11) which threatens the democratic values of the nation. As the Hungarian lawmakers threaten to transform the nation into an authoritarian state, it will strike at the very heart of EU thereby putting to danger the very concept of the union. Did someone say that the tail risks have vanished?