Raghuram Govind Rajan, the chief economic advisor to the government of India, likes to talk straight and call a spade a spade. He was the first economist of some standing to take on Alan Greenspan’s economic policies at a public forum. In a conference in 2005, Rajan said “The bottom line is that banks are certainly not any less risky than the past despite their better capitalization, and may well be riskier. Moreover, banks now bear only the tip of the iceberg of financial sector risks…the interbank market could freeze up, and one could well have a full-blown financial crisis.”
This was during the time when the United States of America was in the middle of a real estate bubble. Everyone was having a good time. And no one wanted to spoil the party.
Alan Greenspan hadn’t achieved the ignominy that he now has, and was revered as god, at least in economic circles. Hence, any criticism of the American economy was seen as criticism of Greenspan himself. Given this, Rajan came in for heavy criticism for what he said. But we all know who turned out to be right in the end.
Recalling the occasion Rajan later wrote in his book Fault Lines “I exaggerate only a bit when I say I felt like an early Christian who had wandered into a convention of half-starved lions. As I walked away from the podium after being roundly criticised by a number of luminaries (with a few notable exceptions), I felt some unease. It was not caused by the criticism itself…Rather it was because the critics seemed to be ignoring what going on before their eyes.”
What this tells us is that Rajan doesn’t hesitate in pointing out what is going on before his eyes, even though it might be politically incorrect to do so. This clearly comes out in the Economic Survey for the year 2012-2013. A part of the summary to the first chapter State of the Economy and Prospects reads “With the subsidies bill, particularly that of petroleum products, increasing, the danger that fiscal targets would be breached substantially became very real in the current year. The situation warranted urgent steps to reduce government spending so as to contain inflation.”
The last sentence of the above paragraph makes for a very interesting reading. This is probably the first occasion where a government functionary has conceded that it is the increased government spending during the second term of the UPA that has led to a high inflationary scenario. This is not surprising given that Rajan holds a full time job teaching at the University of Chicago.
Rajan’s thinking is in line with what the late Milton Friedman, a doyen of the University of Chicago, had been talking about since the early 1960s. As Friedman writes in Money Mischief – Episodes in Monetary History: “The recognition that substantial inflation is always and everywhere a monetary phenomenon is only the beginning of an understanding of the cause and cure of inflation…Inflation occurs when the quantity of money rises appreciably more rapidly than output, and the more rapid the rise in the quantity of money per unit of output, the greater the rate of inflation. There is probably no other proposition in economics that is as well established as this one.”
And that is what has happened in India with the government spending more and more money over the last five years. This money has chased the same number of goods and services and thus led to higher prices i.e. inflation.
Rajan has never been a great fan of subsidies and he looks at them as a short term necessity. In an interview I did with him after the release of his book Fault Lines, for the Daily News and Analysis(DNA), I had asked him whether India could afford to be a welfare state, to which he had replied “Not at the level that politicians want it to.”
In another interview that I had done with him in late 2008, for the same newspaper, he had said “There is a real concern in India that government in India is not doing enough of what it should be doing…I don’t agree that we should overspend and run large deficits but I think we should bite the bullet and cut back on subsidies where we can for the larger good of the public investment into agriculture, roads etc.”
This kind of thinking that Rajan is known for clearly comes out in the Economic Survey. The subsidy bill (oil, food and fertilizer primarily) for the current financial year 2012-2013 (i.e. the period between April 1, 2012 and March 31, 2013) is estimated to be at Rs 1,90,015 crore. This has to come down. As the Economic Survey points out “Controlling the expenditure on subsidies will be crucial. Domestic prices of petroleum products, particularly diesel and liquefied petroleum gas (LPG) need to be raised in line with the prices prevailing in international markets. A beginning has already been made with the decision in September 2012 to raise the price of diesel and again in January 2013 to allow oil marketing companies to increase prices in small increments at regular intervals.”
The question is that will this be enough. The amount budgeted for oil subsidies during the course of this financial year was Rs 43,580 crore. These subsidies are given to oil marketing companies because they sell diesel, cooking gas and kerosene at a loss.
The amount budgeted against oil subsidies will not be enough to meet the actual losses. As the Chapter 3 of the Economic Survey points out “The Indian basket crude oil was $107.52 per bbl (April-December) in 2012 and even with the pass through effected in the course of the year, under-recoveries of OMCs surged and were estimated at Rs1,24,854 crore during April-December 2012-13.”
So for the first nine months of the year the oil subsidy bill was more than Rs 81,000 crore off the target. By the end of the financial year this might well touch Rs 1,00,000 crore. This of course will need some clever accounting to hide. Chances are that the finance minister P Chidambaram might move this payment that will have to be made to the oil marketing companies to the next financial year.
Hence it becomes even more important to cut these subsidies in the years to come. As Rajan writes “The crucial lesson that emerges from the fiscal outcome in 2011-12 and 2012-13 is that in times of heightened uncertainties, there is need for continued risk assessment through close monitoring and for taking appropriate measures for achieving better fiscal marksmanship. Openended commitments such as uncapped subsidies are particularly problematic for fiscal credibility because they expose fiscal marksmanship to the vagaries of prices.”
The phrase to mark over here is that ‘open ended commitments such as uncapped subsidies are particularly problematic‘. This is something that Sonia Gandhi, president of the Congress party, and Chairman of UPA wouldn’t want to hear. This specially during a time when Lok Sabha elections are due in a little over a year’s time and this budget is the last occasion which the government can use to continue bribing the Indian public through subsidies.
It will be interesting to see whether the finance minister P Chidambaram takes any of the suggestions put forward by Rajan and his team, when he presents the annual budget tomorrow. Or will this Economic Survey, like many before it, be also confined to the dustbins of history?
The piece originally appeared on www.firstpost.com on February 27, 2013