[email protected]: The govt has captured most of the oil price fall

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010
In the column published on December 10
, I had discussed why the oil price has been falling and is now below $40 per barrel. Data from the Petroleum Planning and Analysis Cell (PPAC) shows that the price of the Indian basket of crude oil as on December 11, 2015, was at US$ 35.72 per barrel. In the last one month the price of oil has fallen by around 16%.

In the column published on December 10, I discussed the reasons behind the falling oil price and why the trend is likely to continue at least in the short run. In today’s column I will discuss how falling oil prices will impact India.

The biggest beneficiary of lower oil prices is the government. The oil marketing companies sell certain oil products like kerosene and domestic cooking gas at below the cost price. The government subsidises them for this. In the budget for this financial year, the government had assumed a total subsidy of Rs 30,000 crore. This included Rs 22,000 crore subsidy for domestic cooking gas and Rs 8,000 crore kerosene subsidy. There are no under-recoveries on petrol and diesel anymore.

Oil prices have fallen by close to 35% since the beginning of this financial year. Given this, chances are that the Rs 30,000 crore allocation towards oil subsidy should work just fine. In the past, the government used to share the total under-recoveries occurred by oil marketing companies at various points of time during the course of the year.

From what I could gather looking at government press releases, this practice seems to have been stopped since the beginning of this financial year. If the total under-recovery number on the sale of kerosene and cooking gas was available, I could have said with greater confidence that the Rs 30,000 crore put aside for oil subsidies would be enough. (The point again shows how difficult it is in India to do write stuff based on data).

Hence, with oil prices falling, the total expenditure of the government should remain under control. In the past, with rising oil prices, the government ended up under-budgeting for under-recoveries. This led to higher expenditure, a higher fiscal deficit and higher borrowing to finance the fiscal deficit. This is unlikely to happen this time around. Fiscal deficit is the difference between what a government earns and what it spends. A higher fiscal deficit pushes up interest rates as the government borrows more and this is not good for the economy.

Further, the government hasn’t passed on the benefit of falling oil prices to the end consumers. The price of petrol in Mumbai as on April 2,2015, was Rs 67.53 per litre. Currently petrol sells at an almost similar price of Rs 67.55 per litre.

During the same period the price of the Indian basket of crude oil has fallen by close to 35%. The price as on April 2, 2015, was $54.77 per barrel. By December 11, 2015, the price had fallen to $35.72 per barrel. The same is true for diesel as well. The price of diesel in Mumbai as on April 2, 2015, was Rs 55.69 per litre. Currently, it retails at Rs 53.09 per litre or around 4.7% lower.

The government has captured much of this gain by increasing the excise duty on petrol and diesel. Excise duty collections between April and November 2015 are up by a whopping 67% to Rs 1,70,693 crore. Much of this jump has come from an increase in excise duty on diesel and petrol.

In fact, a series of tweets by revenue secretary Dr Hasmukh Adhia gives more clarity on this front. Adhia said that the total indirect taxes between April and November grew by 34.3% to Rs 4,38,291 crore. Customs duty, service tax and excise duty, together make up for indirect taxes.

The increase has primarily come from “the excise increases on diesel and petrol, the increase in clean energy cess, the withdrawal of exemptions for motor vehicles, capital goods and consumer durables, and from June 2015, the increase in Service Tax rates from 12.36% to 14%.” If these increases are discounted for then the increase in indirect taxes was at 10.3%, Adhia tweeted.

Getting back to oil. Earlier this year the investment bank Goldman Sachs said that there is less than 50% chance that oil prices will drop to as low $20 per barrel. If that were to happen, it would be great if the government passed on the gain to the end consumers as well, instead of trying to capture all the gain for itself.

My guess is that the government will try and capture the gains from any further fall in the price of oil as well.  This ‘easy money’ will allow the government to go easy on other fronts. This will mean that the government will continue to subsidise loss making companies like MTNL and Air India. No hard decisions will be made on this front. Further, the disinvestment of public sector companies will take a backseat, as it already has, on the pretext of the stock market not doing well.

Theoretically falling oil prices should also push down the fuel bill of companies. But as the recently released data on the performance of non-financial private corporate business sector during the second quarter of 2015-16 (July- September 2015) by the Reserve Bank of India shows, that is clearly not happening. The power and fuel costs of Indian companies (a sample of 2,711 companies) went down by just 4.2%, despite the price of oil falling much more. The reason for this lies in the fact that the government hasn’t passed on this fall in price to the end consumer.

India imports close to 80% of the oil that it consumes. Given this, any fall in price of oil is beneficial to the country. Any fall in oil prices means that we will be paying fewer dollars for the oil that we import. And this means that our oil import bill will come down. That’s the good bit.

On the flip side, India is also a big exporter of oil products (we refine oil and export oil products). In October 2014, oil products were India’s biggest export at $5.73 billion. Since then with a fall in the price of oil, oil products have become India’s third largest export at $2.46 billion in October 2015. Hence, while falling crude prices are beneficial on the import front, they hurt on the export front as well.

The column originally appeared on The Daily Reckoning on December 15, 2015

Why oil prices have fallen below $40 per barrel

light-diesel-oil-250x250A few months back I wrote a series of columns on oil. In these columns, I maintained that it is very difficult to predict the price of oil over the long term, given that there are way too many factors involved, other than just demand for and supply of the commodity. At the same time I said that in the short-term the price of oil will continue to go down. And that is precisely what has happened.

Data from the Petroleum Planning and Analysis Cell (PPAC) tells us that as on December 8, 2015, the price of the Indian basket of crude oil stood at $ 37.34 per barrel. In fact, during the course of this week, oil prices have touched a seven year low.

What is happening here? The Organization of the Petroleum Exporting Countries (OPEC), an oil cartel of some of the biggest oil producers in the world, met last Friday on December 4, 2015.

The statement released by OPEC after the meeting as usual was very general in nature. It said: “emphasizing its commitment to ensuring a long-term stable and balanced oil market for both producers and consumers, the Conference [i.e. OPEC] agreed that Member Countries should continue to closely monitor developments in the coming months.”

What does this “really” mean? In the past, the OPEC has adjusted its oil production depending on oil demand. If the demand was high, it increased production so as to ensure that oil prices did not go up too much. This was done in order to ensure that other forms of energy did not become viable. If the demand was low, it cut production in order to ensure that oil prices did not fall too much.

In the last one year, OPEC has abandoned this strategy primarily on account of all the oil that is being produced by the shale oil companies in the United States. As shale oil started to hit the market, the OPEC countries started to lose market share. Hence, they decided not to cut production any further, and try and maintain market share, even if that meant low oil prices.

The major producers within the OPEC (the likes of Saudi Arabia, Kuwait and Iraq) produce oil at anywhere between $9 to $20 a barrel. It costs anywhere between $29 to $90 per barrel to produce shale oil, as per the International Energy Agency (IEA).

Hence, the idea was to engineer low oil prices and in the process make shale oil unviable and help OPEC countries maintain their market share. Nevertheless, despite low oil prices, the US shale oil industry is not shutting down at the rate it was expected to, when the price of oil started to fall, around a year back.
And this explains why OPEC continues to produce oil full blast. It wants to kill the US shale oil industry. Further, what the OPEC’s statement released last Friday really means is that the cartel will maintain its production at over 31.5 million barrels per day. In fact, members of the OPEC have always known to cheat on the side and produce more than their allocated quotas. Hence, the daily production is likely to be more than 31.5 million barrels per day.

As the newsagency Bloomberg reported: “There’s as much as 2 million barrels of oversupply in the market, and OPEC’s meeting on Friday means “everyone does what they want,” Iran’s Oil Minister Bijan Namdar Zanganeh said in Vienna on Dec. 4.”

Take a look at the following two charts from the International Energy Agency. One is a chart showing the World Oil Supply. And the other shows World Oil Demand.

world oil supply


world oil demand


As per the chart, the World Oil Supply during the period July to September 2015 was at 96.9 million barrels per day. The demand on the other hand was lower than the supply at 96.35 million barrels per day.

The OPEC oil supply during the period July to September 2015, went up in comparison to the period April to June 2015. The OPEC production between April to June 2015 was at 31.5 million barrels per day. Over the next three months it jumped to 31.74 million barrels per day. Hence, OPEC contributed significantly to the jump in global oil supply.
opec crude oil supply

In fact, the production of OPEC is likely to increase in the months to come as the sanctions on Iran are lifted and the country is allowed to export more oil.

Over and above this, the global oil inventory is at a record high. As a recent IEA report points out: “Stockpiles of oil at a record 3 billion barrels are providing world markets with a degree of comfort. This massive cushion has inflated even as the global oil market adjusts to $50/bbl oil. Demand growth has risen to a five-year high…with India galloping to its fastest pace in more than a decade. But gains in demand have been outpaced by vigorous production from OPEC and resilient non-OPEC supply – with Russian output at a post-Soviet record and likely to remain robust in 2016 as well. The net result is brimming crude oil stocks that offer an unprecedented buffer against geopolitical shocks or unexpected supply disruption.”

As the report further points out: “The stock overhang that first developed in the US on the back of soaring North American crude production, has now spread across the OECD. Since the second quarter, inventories in Asia Oceania have swollen by more than 20 million barrels. In Europe, record high Russian output and rising deliveries from major Middle East exporters are filling the tanks.”

What this clearly means is that oil prices are likely to stay low over the next few months. Further, the forecast is for a fairly mild winter in Europe as well as North America. This means that the demand for diesel, which is the fuel of choice for heating in Europe as well as North East America, is unlikely to go up at a rapid rate. The stockpiles of diesel are at a five-year high.

The column originally appeared on The Daily Reckoning on December 10, 2015

100 days of Modi govt: It’s been ekdum thanda on the economic front

narendra_modiVivek Kaul

In an essay titled Political Leadership (The Oxford Companion to Politics in India edited by Niraja Gopal Jayal and Pratap Bhanu Mehta) historian Ramachandra Guha writes about the various styles of political rhetoric: “The modern idiom is often expressed through a rhetoric of hope—the offer of a better and fuller life, whether expressed in material terms or otherwise. The traditional idiom, on the other hand, privileges a rhetoric of fear—warning the members of a caste, or religion, or region, that they would be swamped by their enemies if they do not bind together.”
Indian politics, over the last seven decades since independence, has largely been fought on what Guha calls the traditional idiom of fear. Given this, Narendra Modi’s campaign in the run up to and during the 16th Lok Sabha elections came as a breath of fresh air. Modi campaigned around the idiom of hope. “
Acche din aane waale hain,” was the line that he tried to sell to the voters of this country. And voters bought it lock, stock and barrel, giving an absolute majority to the Modi led Bhartiya Janata Party(BJP). This was the first time that a single party other than the Congress got an absolute majority in the Lok Sabha.
Once the majority was in place, the hope among analysts, economists and everybody who had some sort of an opinion on Modi and his politics, was that he would push big bang economic reforms, like the kind that had happened in 1991, when the Indian economy was thrown open to the world. Nevertheless, nearly 100 days since the Modi government assumed power on May 26, 2014, nothing of that sort seems to have happened. This is not to say that no economic reform has happened. The government allowed 100% foreign direct investment(FDI) in several areas in the railways sector. It notified that the FDI limit in the defence sector would be increased to 49% from the current 26%, through the approval route. At the same time it has cleared the FDI limit in the insurance sector to be increased to 49% from the current 26%. Further, land acquisition laws put in place by the Congress led UPA government are set to undergo a transformation.
But other than the “proposed” change in land acquisition laws these are not big bang reforms exactly. This is minor tinkering at best. The union budget presented by Arun Jaitley lacked a vision of what the Modi government plans on the economic and the financial front over the next five years. Also, it continued with the unrealistic estimates of both revenues and expenditure made by the previous finance minister P Chidambaram.
Given this, it is highly unlikely that the fiscal deficit number projected by Arun Jaitley and his team is a realistic one. In that sense Jaitley has continued the process of projecting lower expenditure and higher revenue, started by Chidambaram.
Also, like Chidambaram, Jaitley has started to suggest that the Reserve Bank of India (RBI) should start to cut interest rates.
But as I explain here, there is very little that the RBI can do to cut interest rates. Interest rates will only come down once the government starts to manage its fiscal defict, borrower lesser and leave more money on the table for everyone else to borrow. Fiscal deficit is the difference between what a government earns and what it spends. The government spends it through borrowing money.
Over and above this, there has been almost no talk about what the government plans to do on the Goods and Services Tax(GST) and the Direct Taxes Code (DTC) front. These are two big bang economic whose implementation has been pending over the last few years.
In his independence day speech Modi announced that his government was doing away with the Planning Commission. There is no doubt that it was an institution that had outlived its utility, nevertheless, with what and how does the government plan to replace it. More than two weeks after the independence day speech, there is almost no clarity on this front. As economist Bibek Debroy,
wrote a recent column in The Economic Times “We are in end-August. In 2014-15, what happens to the (central assistance) money disbursed to states through the Planning Commission? Will that be released in December 2014 to be spent by March 2015?”
Oil prices have been falling for a while now. Given this, it was widely expected that the government would use this lucky streak to move towards market determined price for diesel and do away with some of the “under-recoveries” that the Oil Marketing Companies have to face everytime they sell diesel, cooking gas and kerosene. It was also expected that the cooking price would be raised by an equal amount every month and the “under-recoveries” on it would be done away with over a period of time. But nothing of that sort has happened.
Also, no moves have been made to sort out the food subsidy mess that the country finds itself in.
A recent new report pointed out “Food corporation of India has informed the food ministry that dues on the food subsidy have piled up to Rs 50,000 crore at the end of 2013-14 over the last three-to-four years as it has not been allocated enough funds.” This is something that needs to be sorted out immediately.
A possible explanation for economic reforms being put on the back-burner being bandied around by Modi sympathizers has been that economic reforms will start streaming in after the Maharashtra elections are done with. The government does not want to make any publicly unpopular decisions before the Maharashtra elections are over. The thing is that state assembly elections will keep happening all the time. After there Maharashtra there is Bihar in 2015. And by the time the state assembly elections are over, the next Lok Sabha elections will be upon us. The government, like most other governments in the past, is likely to get into the election mode by 2017, two years before the next Lok Sabha elections are due. So, when will it actually get around to implementing any big-bang economic reforms is a question worth asking? Given this, the explanation does not really make much sense.
If the government is serious about economic reforms, the best time to do it is now. These are the early days for the government and it still has a lot of leeway to push through these reforms. An excuse offered here is that the Modi government does not have a majority in the Rajya Sabha and hence, legislation required to push through these reforms can get stuck there. This is indeed true, but then the government also has the option to call a joint session of Parliament and pushing through these reforms.
To conclude, it is worth pointing out what Guha writes about being the bane of almost all the governments in India over the last 25 years, before the Modi government came to power: “[The] deepening of Indian democracy has come at a cost, namely that there is now no political leader who can really think of or act for the country as a whole. When a single party was dominant at the Centre, it was possible to design long range policies; now, when the government is constituted by a coalition of a dozen or more parties, each representing a specific sectarian interest—these based variously on caste, language, region, or religion—its policies are determinedly short-term, aimed at placating or satisfying one or other of those interests.”
Modi doesn’t have to go through all this. His government has absolute majority on its own and it can use this opportunity to push through economic reforms, which will be beneficial for India in the days and years to come.
The article originally appeared on www.FirstBiz.com on September 1, 2014
(Vivek Kaul is the author of the
Easy Money trilogy. He tweets @kaul_vivek)

More trouble for Chidu: Fiscal deficit hits 75% of target in first 5 months

The finance minister P Chidambaram has reiterated time and again that the government will adhere to the fiscal deficit target of Rs 5,42,499
 crore or 4.8% of the GDP(gross domestic product) that it has set for itself. On September 5, 2013, he had said that the fiscal deficit target of 4.8% of GDP was a “red line and the red line will not be crossed.” Fiscal deficit is the difference between what a government earns and what it spends.
But the latest data released by the Controller General of Accounts (CGA) on September 30, 2013, shows that fiscal deficit has already reached 74.6%(or Rs 4,04,651 crore of the targeted Rs 5,42,499 crore) of the full year target, as on August 31, 2013. Hence, three fourth of the fiscal deficit target has been reached during the first five months of the financial year (i.e. the period between April 1, 2013 and August 31, 2013).
Now how does the situation look in comparison to the past data? For a period of 16 years since 1998-1999 (for which the data is publicly available on the CGA website), the average fiscal deficit for the first five months of the financial year stands at 54.2% of the annual target.
During the period of the Congress led UPA government has been in power (i.e. Since 2004-2005), the average fiscal deficit for the first five months of the financial year has been 60.4% of the annual target. Last year it was 65.7% of the annual target.
In fact, only in 2008-2009 was the number greater than this year. As on August 31, 2008, the fiscal deficit for the first five months of the financial year had already reached 87.7% of the annual target. This was the year when the Congress led UPA government was getting ready for the Lok Sabha elections which happened in April-May 2009, and hence, had gone overboard on the spending front.
The fiscal deficit in 2008-2009 was estimated to be at Rs 1,33,287 crore or 2.5% of the GDP. It finally came in at Rs 3,36,992 crore or 6% of the GDP. The point being that when the Lok Sabha elections are scheduled to happen next year, the initial estimates of the fiscal deficit can be way off the mark. Lok Sabha elections are due in May 2014 as well. Before that there are several state assembly elections as well. So, it remains to be seen whether the Congress led UPA government sticks to the fiscal deficit target of 4.8% of the GDP or goes overboard with the expenditure as it did last time when the elections were due.
What also does not help the government is a slowdown in tax revenues. As Sonal Varma of Nomura points out in a note dated September 30, 2013, “Fiscal year to date (FYTD), net tax revenue growth was muted at 4.9% year on year (versus the budget target of 19.3% year on year) due to weak indirect tax collections (excise, services, customs), while government expenditure rose 17.3% year on year FYTD, within the budget target of 18.2% year on year.”
When the revenue is growing at around one fourth of the expected rate, meeting the revenue target will be very difficult. Expenditure on the other hand continues to rise more or less at the rate assumed in the annual budget.
Given this, the government will have to make a significantly greater effort to control its expenditure, if it has to get anywhere close to meeting its fiscal deficit target. As Varma puts it “In our view, the government will have to announce another round of spending cuts to offset the fiscal slippage from slowing revenue collections and to meet its financial year 2013-2014 budgeted fiscal deficit target of 4.8% of GDP.”
The government had announced some measures to cut expenditure on September 18, 2013. A mandatory cut of 10% in non plan expenditure of all departments was announced. This did not include expenditure on interest and debt repayment, defence capital, salary, pension and grants to states. Over and above this, restrictions have been put on holding seminars/conferences as well as air travel. These measures will not be enough and more expenditure cuts will have to be put in place. In fact, when the government was in a similar but slightly better scenario last year, it simply froze spending, during the last few months of the year.
As Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley, said
 in a recent interview to the Forbes India magazine “We achieved the [fiscal deficit] target last year, but you have to understand how that was done. The government will have to really freeze spending, and that in turn will compress consumer demand. The issue is whether they have the political appetite to do that…So can the government meet its fiscal deficit target? Of course it can. But the price in this case will be economic growth.”
Varma had written along similar lines in a note titled 
Government Announces Austerity Measures and dated September 18, 2013. As she wrote “The spending cuts will adversely impact growth. High government spending was one of the main drivers of real GDP growth of 4.4% year on year in Q2 2013. With spending likely to be slashed and financial conditions much tighter starting July, we expect private demand to slow down further.” And this will impact economic growth.
The other option before the government is to raise diesel prices. 
The under-recovery on diesel being sold by oil marketing companies(OMCs) for the fortnight starting October 1, 2013 is at Rs 10.51 litre. In the previous fortnight the under-recovery on diesel stood at Rs 14.50 litre. This fall has been primarily on account of the rupee rallying against the dollar, leading to the price of oil falling in rupee terms. Despite the fall, at Rs 10.51 per litre, the under-recovery on diesel continues to be substantially high.
The government compensates the oil marketing companies for a part of this under-recovery and this means higher expenditure for the government. The oil producing companies like ONGC and Oil India Ltd, compensate the oil marketing companies for the remaining part of the under-recovery.
If the government has to meet its fiscal deficit target it needs to bring down the under-recovery on diesel. And this can only be done by raising diesel prices significantly. Currently, the oil marketing companies increase the price of diesel by 50 paisa every month, which is clearly not enough, given that the under-recovery is greater than Rs 10 per litre.
As Sharma put it “The government will have to raise diesel prices. Currently, they are Rs 9-10 behind on under-recoveries. They need to raise diesel prices by such a massive amount to stick to the fiscal deficit target.”
Other than diesel, there are significant under-recoveries on cooking gas as well as kerosene. The under-recovery on cooking gas for the week starting October 1, 2013, stands at Rs 532.86 per cylinder whereas the under-recovery on kerosene is at Rs 38.32 per litre.
The government is essentially in a situation where it has to decide between either meeting the fiscal deficit target or sacrificing economic growth. If it looks like that the government will be unable to meet its fiscal deficit target then India is likely to be downgraded by rating agencies.
A sovereign downgrade will see India’s rating being reduced to ‘junk’ status. This would lead to many foreign investors like pension funds having to sell out of the Indian stock market as well as the bond market, given that they are not allowed to invest in countries which have a “junk” status.
When they sell out, they will will be paid in rupees. In order to repatriate this money, they will have to sell rupees and buy dollars. This will increase the demand for dollars and put further pressure on the rupee, in the process undoing all the damage control carried out by the RBI to prevent the rupee from falling.
A weaker rupee will mean that our oil import bill will shoot up further. We will also have to pay more for the import of coal, fertilizer etc. This will put further pressure on the fiscal deficit as the government expenditure will increase given that it currently offers subsidies on oil as well as fertilizer.
To conclude, in order to meet its fiscal deficit target the government will have to raise diesel prices and at the same time cut its expenditure dramatically, which will have an impact on economic growth. As things currently stand, it looks like the government will have to sacrifice economic growth on the altar of the fiscal deficit.
If the government does not meet its fiscal deficit target then the repercussions of that will also have a huge impact on economic growth. Hence, the choice is between the devil and the deep sea. As Franklin Roosevelt, the President of America between 1933 and 1945, put it “Any government, like any family, can, for a year, spend a little more than it earns. But you know and I know that a continuation of that habit means the poorhouse.” The Congress led UPA government has been running high fiscal deficits for way too long and the negative consequences of that have started to catch up.
The article originally appeared on www.firstpost.com on October 2, 2013

(Vivek Kaul is a writer. He tweets @kaul_vivek)

Under-recoveries on diesel at record Rs 14.50 a litre, price hike inevitable now

light-diesel-oil-250x250Vivek Kaul 
The under-recovery on diesel being sold by oil marketing companies(OMCs) for the fortnight starting September 16, 2013, has shot up to Rs 14.50 per litre. It has gone up by 42% in a period of one month. For the fortnight starting August 16, 2013, the under-recovery had stood at Rs 10.22 per litre.
So what are under-recoveries? The Rangarajan Committee report of 2006 stated that the OMCs are “are currently sourcing their products from the refineries on import parity basis which then becomes their cost price. The difference between the cost price and the realised price represents the under-recoveries of the OMCs.”
The price that OMCs charge dealers who sell diesel is referred to as the realised price or the depot price. If this realised price that is fixed by the government is lower than the import price, then there is an under-recovery. Having said that under-recoveries are different from losses and at best can be defined as notional losses. (For those interested in a detailed treatment of this point,
 can click here).
The OMCs need to be compensated for the under-recoveries. One part of the compensation comes in directly in the form of additional cash assistance from the government. Another part comes by the way of financial assistance from upstream national oil companies. Hence, companies like ONGC and Oil India Ltd, which produce oil, need to compensate the OMCs i.e.
 Indian Oil, Bharat Petroleum and Hindustan Petroleum, for a part of their under-recoveries.
The government has budgeted 
Rs 65,000 crore this financial year for petroleum subsidies. This is for the payment that it makes to the OMCs, for the under-recoveries they incur on the sale of diesel, cooking gas and kerosene. As per the data released by the Ministry of Petroleum and Natural Gas yesterday, the under-recoveries currently stand at Rs 486 crore per day.
The trouble is that a part of the budgeted subsidies have already been utilised for payment of under-recoveries for the last financial year. Also, most finance ministers over the years have under-budgeted for these payments.
Like in the financial year 2012-2013, the petroleum subsidies had been budgeted to be at Rs 43,580 crore. The actual subsidy bill finally came in at Rs 96879.87 crore. A similar trend was observed in the financial year 2011-2012 as well. The government had budgeted Rs 23,640 crore for petroleum subsidies. The final bill came to Rs 68,481 crore.
The Financial Express reports that “At current rate, the three oil PSUs are projected to lose Rs 156,000 crore in revenues in the financial year ending March 31, according to Indian Oil Corp (IOC), the nation’s largest oil firm.”
This number is similar to the total under-recoveries of Rs 
1,61,029 crore last year. Of this the government had paid around Rs 1,00,000 crore to OMCs, the remaining cost was borne by the upstream national oil companies.
So what this means is that the government will have to incur a higher expenditure to compensate the OMCs for the under-recovery than the Rs 65,000 crore it has budgeted for. This would mean a higher fiscal deficit. Fiscal deficit is the difference between what a government earns and what is spends.
Data put out by the Controller General of Accounts shows that as on July 31, 2013, the fiscal deficit for the first four months of the financial year 2013-2014 was at Rs 3,40,609 crore. The fiscal deficit targeted for the financial year is Rs 5,42, 499 crore.
Hence, 62.8% of the targeted fiscal deficit has already been exhausted in the first four months of the year. If the government continues at this rate, by the end of the financial year it will overshoot its fiscal deficit target by a huge mark.
The finance minister P Chidambaram has said over and over again that the government will stick to the fiscal deficit target come what may. The numbers as of now tell a completely different story.
In the last financial year 2011-2012, the government had exhausted 51.5% of the targeted fiscal deficit during the first four months. To meet the fiscal deficit target, the expenditure was slashed majorly in the last few months of the year.
Given this, if the government has to meet its fiscal deficit target, the first thing that it should be doing is to raise diesel prices. Of course, it cannot raise the price of diesel by Rs 14.50 per litre at a single go. But a significant increase of at least Rs 5 per litre is due.
If it is not carried out, the chances of a sovereign downgrade of India by the rating agencies will become extremely high in the months to come. This is because the fiscal deficit of the government will bloat up. A sovereign downgrade will see India’s rating being reduced to ‘junk’ status. This would lead to many foreign investors like pension funds having to sell out of the Indian stock market as well as the bond market, given that they are not allowed to invest in countries which have a “junk” status and that will put further pressure on the rupee, which has recovered nicely over the last few days.
At the same time any increase in the price of diesel pushes up freight and transport costs. This will lead to a higher inflation, especially food inflation. Data released yesterday shows that food inflation currently stands at 18.8%. As Sonal Varma of Nomura pointed out in a note yesterday “
The jump was mainly due to a steep rise in primary food price inflation, which rose to 18.2% year-on-year in August from 11.9% in July from higher inflation of vegetables, fruits and protein-rich food. Vegetable price inflation jumped 78% year-on-year in August from 47% in July, led by a steep increase in the prices of onions (245%).”
 state elections are due over the next few months and any further rise in food prices is going to cost the Congress led UPA government dearly. Many an election in India has been lost on spiralling onion prices.
But if the government doesn’t increase diesel prices then there is a considerable threat of being downgraded by the rating agencies to junk status and that will put further pressure on the rupee. So that’s the catch 22 that the government finds itself in. Having said that, its a problem created by the Congress led UPA government by refusing to de-control the prices of oil products. Also, a higher inflation number will make it difficult for Raghuram Rajan, the new RBI governor, to announce any interest rate cuts in the months to come, as the government wants him to.
So what will the government bite the bullet on hiking diesel prices? Oil Secretary Vivek Rane had an answer for this. As he said yesterday”Some burden has to be borne by consuming population. That is the challenge government faces. It is a political challenge, it is an economic challenge. It is a challenge we cannot run away from.”
The article originally appeared on www.firstpost.com on September 17,2013

(Vivek Kaul is a writer. He tweets @kaul_vivek)