Why the Modi govt finances won’t see acche din any time soon

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010
In a report titled
How Will the New Government Cut the Fiscal Deficit dated June 16, 2014, Chetan Ahya and Upasana Chachra of Morgan Stanley write that “a national fiscal deficit below 5% of GDP would allow real borrowing costs for the private sector to decline meaningfully and encourage private investment.”
Fiscal deficit is the difference between what a government earns and what it spends. The national fiscal deficit includes the deficit run by the central as well as the state governments. In the financial year 2013-2014 (April 1, 2013 to March 31, 2014) this number stood at 7.6% of the GDP.
This number the Morgan Stanley analysts believe should be less than 5% of the GDP. Governments make up for their fiscal deficit through borrowing. A lower fiscal deficit means lower borrowing by the government (s) leaving more money on the table for everyone else to borrow.
Also, with the government borrowing less, the interest rates are likely to come down. Further, businesses are more likely to borrow at lower interest rates and this will encourage investment. Or so goes the story.
If the national fiscal deficit has to come down the onus lies primarily on the central government to cut down on its fiscal deficit. As Ahya and Chachra point out “The state governments’ deficit is closer to the trend line…Hence…the bulk of the reduction in the fiscal deficit needs to be at the central government level.”
The question is how well placed is the central government to cut down on its fiscal deficit? Cutting down on subsidies is one option that is suggested by the analysts. Subsidies stood at 1% of the GDP in mid 1990s and since then have ballooned to 2.3% of the GDP.
The trouble with this argument is that a lot of subsidies are offered by the government under programmes which have been cleared by the Parliament. So these subsidies cannot be suddenly done away with.
What can be cut are the so called “oil subsidies”. The central government taxes oil products and earns revenue in the process. Over the years, a major portion of this revenue has been used to pay oil marketing companies for the “under-recoveries” they suffer on selling diesel, cooking gas and kerosene.
the year 2012-2013 the central government earned Rs 1,17,422 crore by taxing oil products and oil companies. It paid out Rs 1,00,000 crore in the form of cash assistance to oil marketing companies for their “under-recoveries”. What this basically tells us is that unlike earlier, the government did not gain much from taxing oil. In 2012-2013, the gain was only Rs 17,422 crore.
If the fiscal deficit has to come down, this gain has to go up. This can only happen if oil marketing companies are allowed to increase the price of oil products. The trouble is that given the amount of central and state taxes built into the price of oil, Indians are already paying one of the highest prices in the world for these products.
Also, an increase in the price of these products will add to inflation. For a party whose main election plank was “
acche din aane waale hain” this can’t be a good sign. What makes the situation even more difficult is the war in Iraq which has led to a spike in the price of oil. The price for the Indian basket of crude oil stood at $111.25 per barrel on June 18, 2014. It had averaged at $106.72 per barrel for the period between May 29 and June 11, 2014. Hence, in a matter of days, the price has gone up by more than 4% in a matter of days.
If oil marketing companies are allowed to pass on this increase to the end consumer it would lead to higher inflation (including higher food inflation). If they are not it would mean increasing “under-recoveries” for these companies. The government will have to compensate the oil marketing companies for these “under-recoveries” and this in turn would lead to a higher fiscal deficit. Also, it is worth remembering that the war in Iraq might continue and lead to the price of oil shooting up further.
What does not help the cause of the government is the fact that the Congress led UPA government had postponed expenses of greater than Rs 1,00,000 crore to this financial year (this includes food, fertizlier and oil subsidies). This money will have to come from somewhere. Ideally, the government should settle this expenditure during the course of this year and try and start on a clean slate from the next financial year, even if it leads to a higher fiscal deficit.
Another major factor that not many people seem to be talking about is the fact that the recapitalization of public sector banks will need a lot of money in the years to come. The
Report of The Committee to Review Governance of Boards of Banks in India (better known as the PJ Nayak committee) released in May 2014, estimates that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.”
The report further points out that “a
ssuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.” That clearly is a lot of money. If the government spreads it over a period four years, it would mean an expense of around Rs 90,000 crore (Rs 3,50,000 crore/4) per year. Where is this money going to come from?
The situation becomes even more difficult given that the situation on the tax revenue front has been very weak. As Ahya and Chachra of Morgan Stanley point out “g
ross tax revenue has declined from the peak of 11.9% of GDP in F2008 to 10% of GDP in F2014.” The analysts go on to suggest that the government should look to “roll back the excise duty cuts for the automobile industry that were introduced in the interim budget.” But that would mean hitting the automobile industry, which in the recent past has looked like coming out of the doldrums that it has been in for a while. Car sales grew by 3.08% in May 2014.
One way out for the government is to start to look at disinvesting its stake in public sector companies in a very serious way, through the next few years. The disinvestment target in the interim budget presented by P Chidambaram had been set at Rs 56,925 crore. This is clearly not enough. The government needs to aim at much more than this. One way of doing this is to cede managerial control and sell out lock, stock and barrel to the private sector. In that scenario the government is even likely to get a premium above the current market price of the company’s stock. But that is not going to go down well with the employee unions. Further in a lot of companies the government will need a new legislation which will allow it to drop its stake below 50%. This includes nationalized banks as well as Coal India.
Having said that it is not a good practice to finance current expenditure by selling things that one owns. But in the short run that is the only way out for the government.
(Vivek Kaul is a writer. He can be reached at [email protected]

The secret is out: The end consumer does not get any oil subsidy

light-diesel-oil-250x250Vivek Kaul
Over the last few days, there has been a lot of talk in the media about the government considering petroleum subsidy reforms (You can read about it
 here and here). One of the most well kept secrets in India has been the fact that the end consumer does not get any subsidy on petroleum products. But what we have been told is exactly the opposite.
What we have been told over the years is that the oil marketing companies have been selling products like petrol, diesel, cooking gas and kerosene, at a loss (The price of petrol was deregulated on June 26, 2010, so that is no longer the case). To a large extent, the government compensates the oil marketing companies for this loss. Hence, these products are subsidised. Subsidies are bad and they need to be done away with. 

The truth is however a little more nuanced than that. Let’s take a look at the following table.


In 2012-2013, the under-recovery of the oil marketing companies on selling oil products had stood at Rs 1,61,029 crore. Of this the government provided a cash assistance of Rs 1,00,000 crore. Rs 60,000 crore came in from upstream oil companies like ONGC and Oil India Ltd.
So far so good. But does this amount to a subsidy to the end consumer? As Surya P Sethi writes in an article titled
 “Analysing the Parikh Committee Report on Pricing of Petroleum Products“It is clear that Indian consumers are paying the highest price for lower quality petrol and more for lower quality diesel when compared to the US and Japan – the two most vociferous proponents of removing fuel subsidies. Also, Japan and the UK and, indeed, several other countries tax diesel at a lower rate.”
A major portion of the price that we pay on buying petrol and diesel essentially consists of taxes collected by both the central and the state governments. At the central government level a huge amount of tax on oil products is collected through excise duties. At the state level, the value added tax on petroleum products is the major contributor.
For the calculations here, we will ignore the various taxes collected by the state government on petroleum products. We will consider only taxes earned by the central government. This includes excise duty, customs duty, cess on crude oil, income tax, dividend and dividend distribution tax paid by oil companies, as well as profit from exploration, among other things.
If all this is taken into account for the year 2012-2013 the central government earned Rs 1,17,422 crore. In comparison it paid out Rs 1,00,000 crore in the form of cash assistance to oil marketing companies. That still meant a surplus of Rs 17,422 crore.In 2011-2012, it earned Rs 1,19,850 crore from petroleum products and companies. The cash assistance to oil marketing companies during that year stood at Rs 83,500 crore. That meant a surplus of Rs 36,350 crore.
The scenario looks similar during the first nine months of 2013-2014 as well. The cash assistance to oil marketing companies stood at Rs 35,772 crore. In comparison, the central government had earned Rs 83,619 crore, leading to a surplus of Rs 47,847 crore.
Hence, the end consumer does not get any subsidy on petroleum products as a whole, even though the oil marketing companies suffer huge under-recoveries in the sale of diesel, cooking gas and kerosene.
A criterion that the International Energy Agency uses for defining something as a subsidy is whether it “lowers the price paid by energy consumers.” As A Citizens’ Guide to Energy Security in India points out “consumer subsidies, as the name implies, support the consumption of energy, by lowering prices at which energy products are sold.” That is clearly not the case in India.
Given this, the government and the media should stop using the word subsidy when it comes to talking about petroleum products as a whole. Second, the surplus that the government generates through taxing petroleum products and companies, should actually be paid out as cash assistance to the oil marketing companies. Once, that is done the burden on the upstream oil companies like ONGC and Oil India Ltd, which finance a part of the under-recoveries, will come down.
This is very important given that India imports more than 80% of the oil that it consumes. With the pressure on ONGC to finance the under-recoveries coming down, it can spend more money on exploring for oil. This will go long way towards beefing up the energy security of India.
The trouble is that the surplus that the government makes by taxing petroleum companies and petroleum products goes towards bringing down the fiscal deficit. The fiscal deficit is the difference between what a government earns and what it spends.
In fact, once we consider the total amount of taxes earned by the state government the real situation comes to the fore. During the first nine months of 2013-2014, state governments earned Rs 1,01,493 crore from taxing petroleum products. The state governments are highly dependent on these taxes to finance their expenditure. If the price of petroleum products needs to be controlled, it is this dependence that needs to come down. And that is easier said than done.

Vivek Kaul is a writer. He can be reached at [email protected]

The article originally appeared on www.firstbiz.com on June 15, 2014

A day ahead, who is Chidambaram fooling?


An important part of finance minister P Chidambaram’s job for a while has been to keep telling us that “all is well” on the economic front.
He continued with this on the last day of the financial year when he said “the Indian economy is now stable and the fundamentals have strengthened.” The statement was in response to 18 questions on the economy posed by former finance minister and BJP leader Yashwant Sinha.
So how strong is the Indian economy? “We have contained inflation. Our biggest success is containing fiscal deficit,” said Chidambaram.
But how do the numbers stack out? In February 2014, inflation as measured by the consumer price index was at 8.1%. It has come down from levels of greater than 10%. The primary reason for the same has been a rapid fall in food prices. Food products make up for around half of the consumer price index. The question is how much credit for the fall in food prices goes to the government? Not much. Also, it is worth reminding here that unseasonal rains and hailstorms in parts of the country have damaged crops, and this is likely to push up prices again.
If we look at non fuel-non food inflation, or what economists refer to as core inflation, it stood at 7.9% in February 2014. This number has barely budged for a while now. Non fuel-non food inflation takes into account housing, medical care, education, transportation, recreation etc.
What about the fiscal deficit? “We will end FY14[period between April 2013 and March 2014] with a fiscal deficit of 4.6%, as planned,” Chidambaram said. Fiscal deficit is the difference between what a government earns and what it spends.
But how has this target been met? A lot of expenditure has simply not been recognised. Oil subsidies of Rs 35,000 crore have not been accounted for. Estimates suggest that close to Rs 1,23,000 crore of subsidies (oil, fertilizer and food) have been postponed to next year. A March 4 report in this newspaper pointed out that the central government owes the states Rs 50,000 crore on account of compensation for the central sales tax.
On the income side, public sector banks have been forced to give huge dividends to the government despite not being in the best of shape. Coal India Ltd has paid the government a dividend and a dividend distribution tax of close to Rs 19,600 crore. India has the third largest coal reserves in the world but still needs to import coal. Shouldn’t this money be going to set up new coal mines? Neelkanth Mishra and Ravi Shankar of Credit Suisse point out in a recent report titled 
Elections: Much Ado about Nothing dated March 19, 2014 that “True utilisation in thermal power generation is below 60%, near 20-year lows (reported plant load factor is 65%).” This is because we don’t produce enough coal that can feed into the power plants.
Getting back to Chidambaram, he further said “The CAD has contracted. We have added to reserves. FY14 CAD is likely to be about $35 billion.” The current account deficit is the difference between total value of imports and the sum of the total value of its exports and net foreign remittances.
This has largely happened because of two things. The government has clamped down on legal gold imports. But anecdotal evidence suggests that gold smuggling is back with a huge bang. This has a huge social cost. Also, over the last few months non gold non oil imports have fallen due to sheer lack of consumer demand. And that surely can’t be a good thing.
Chidambaram also expects “spirited growth going forward”. The finance minister has been spinning this yarn for a while now. In early February he had said that the economy will grow by 5.5% in this financial year.
Growth during the first three quarters of the financial year has been less than 5% (4.4% in the first quarter, 4.8% in the second quarter and 4.7% during the third quarter). A simple back of the envelope calculation shows that the economy will have to grow by 8.1% in January to March 2014, for the Indian economy to grow by 5.5% during 2013-2014. You don’t need to be an economist to realise that this is not going to happen.
Interestingly, in July 2013 Chidambaram had said that “People should remember India continues to be the second fastest growing economy after China.” By January 2014 this statement had changed to ““India remains one of the fast growing large economies of the world.” What happened in between? A whole host of countries in our neighbourhood have been growing faster than us. This includes countries like Cambodia, Philippines, Indonesia, Sri Lanka and even Bangladesh.
Given these reasons, it is fair to say that Chidambaram was cracking an April Fools’ joke, a day early.

The article appeared  in the Daily News and Analysis dated April 1, 2014
(Vivek Kaul is the author of Easy Money. He can be reached at [email protected]

It is Sonia who needs to read Rajan’s Economic Survey

Vivek Kaul 
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

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