The Congress led United Progressive Alliance (UPA) government finally acted hoping to halt the fall of the falling rupee, by raising petrol prices by Rs 6.28 per litre, before taxes. Let us try and understand what will be the implications of this move.
Some relief for oil companies:
The oil companies like Indian Oil Company (IOC), Bharat Petroleum (BP) and Hindustan Petroleum(HP) had been selling oil at a loss of Rs 6.28 per litre since the last hike in December. That loss will now be eliminated with this increase in prices. The oil companies have lost $830million on selling petrol at below its cost since the prices were last hiked in December last year. If the increase in price stays and is not withdrawn the oil companies will not face any further losses on selling petrol, unless the price of oil goes up and the increase is not passed on to the consumers.
No impact on fiscal deficit:
The government compensates the oil marketing companies like Indian Oil, BP and HP, for selling diesel, LPG gas and kerosene at a loss. Petrol losses are not reimbursed by the government. Hence the move will have no impact on the projected fiscal deficit of Rs 5,13,590 crore. The losses on selling diesel, LPG and kerosene at below cost are much higher at Rs 512 crore a day. For this the companies are compensated for by the government. The companies had lost Rs 138,541 crore during the last financial year i.e.2011-2012 (Between April 1,2011 and March 31,2012).
Of this the government had borne around Rs 83,000 crore and the remaining Rs 55,000 crore came from government owned oil and gas producing companies like ONGC, Oil India Ltd and GAIL.
When the finance minister Pranab Mukherjee presented the budget in March, the oil subsidies for the year 2011-2012 had been expected to be at Rs Rs 68,481 crore. The final bill has turned out to be at around Rs 83,000 crore, this after the oil producing companies owned by the government, were forced to pick up around 40% of the bill.
For the current year the expected losses of the oil companies on selling kerosene, LPG and diesel at below cost is expected to be around Rs 190,000 crore. In the budget, the oil subsidy for the year 2012-2013, has been assumed to be at Rs 43,580 crore. If the government picks up 60% of this bill like it did in the last financial year, it works out to around Rs 114,000 crore. This is around Rs 70,000 crore more than the oil subsidy that the government has budgeted for.
Interest rates will continue to remain high
The difference between what the government earns and what it spends is referred to as the fiscal deficit. The government finances this difference by borrowing. As stated above, the fiscal deficit for the year 2012-2013 is expected to be at Rs 5,13,590 crore. This, when we assume Rs 43,580crore as oil subsidy. But the way things currently are, the government might end up paying Rs 70,000 crore more for oil subsidy, unless the oil prices crash. The amount of Rs 70,000 crore will have to be borrowed from financial markets. This extra borrowing will “crowd-out” the private borrowers in the market even further leading to higher interest rates. At the retail level, this means two things. One EMIs will keep going up. And two, with interest rates being high, investors will prefer to invest in fixed income instruments like fixed deposits, corporate bonds and fixed maturity plans from mutual funds. This in other terms will mean that the money will stay away from the stock market.
The trade deficit
One dollar is worth around Rs 56 now, the reason being that India imports more than it exports. When the difference between exports and imports is negative, the situation is referred to as a trade deficit. This trade deficit is largely on two accounts. We import 80% of our oil requirements and at the same time we have a great fascination for gold. During the last financial year India imported $150billion worth of oil and $60billion worth of gold. This meant that India ran up a huge trade deficit of $185billion during the course of the last financial year. The trend has continued in this financial year. The imports for the month of April 2012 were at $37.9billion, nearly 54.7% more than the exports which stood at $24.5billion.
These imports have to be paid for in dollars. When payments are to be made importers buy dollars and sell rupees. When this happens, the foreign exchange market has an excess supply of rupees and a short fall of dollars. This leads to the rupee losing value against the dollar. In case our exports matched our imports, then exporters who brought in dollars would be converting them into rupees, and thus there would be a balance in the market. Importers would be buying dollars and selling rupees. And exporters would be selling dollars and buying rupees. But that isn’t happening in a balanced way.
What has also not helped is the fact that foreign institutional investors(FIIs) have been selling out of the stock as well as the bond market. Since April 1, the FIIs have sold around $758 million worth of stocks and bonds. When the FIIs repatriate this money they sell rupees and buy dollars, this puts further pressure on the rupee. The impact from this is marginal because $758 million over a period of more than 50 days is not a huge amount.
When it comes to foreign investors, a falling rupee feeds on itself. Lets us try and understand this through an example. When the dollar was worth Rs 50, a foreign investor wanting to repatriate Rs 50 crore would have got $10million. If he wants to repatriate the same amount now he would get only $8.33million. So the fear of the rupee falling further gets foreign investors to sell out, which in turn pushes the rupee down even further.
What could have helped is dollars coming into India through the foreign direct investment route, where multinational companies bring money into India to establish businesses here. But for that the government will have to open up sectors like retail, print media and insurance (from the current 26% cap) more. That hasn’t happened and the way the government is operating currently, it is unlikely to happen.
The Reserve Bank of India does intervene at times to stem the fall of the rupee. This it does by selling dollars and buying rupee to ensure that there is adequate supply of dollars in the market and the excess supply of rupee is sucked out. But the RBI does not have an unlimited supply of dollars and hence cannot keep intervening indefinitely.
What about the trade deficit?
The trade deficit might come down a little if the increase in price of petrol leads to people consuming less petrol. This in turn would mean lesser import of oil and hence a slightly lower trade deficit. A lower trade deficit would mean lesser pressure on the rupee. But the fact of the matter is that even if the consumption of petrol comes down, its overall impact on the import of oil would not be that much. For the trade deficit to come down the government has to increase prices of kerosene, LPG and diesel. That would have a major impact on the oil imports and thus would push down the demand for the dollar. It would also mean a lower fiscal deficit, which in turn will lead to lower interest rates. Lower interest rates might lead to businesses looking to expand and people borrowing and spending that money, leading to a better economic growth rate. It might also motivate Multi National Companies (MNCs) to increase their investments in India, bringing in more dollars and thus lightening the pressure on the rupee. In the short run an increase in the prices of diesel particularly will lead higher inflation because transportation costs will increase.
Freeing the price
The government had last increased the price of petrol in December before this. For nearly five months it did not do anything and now has gone ahead and increased the price by Rs 6.28 per litre, which after taxes works out to around Rs 7.54 per litre. It need not be said that such a stupendous increase at one go makes it very difficult for the consumers to handle. If a normal market (like it is with vegetables where prices change everyday) was allowed to operate, the price of oil would have risen gradually from December to May and the consumers would have adjusted their consumption of petrol at the same pace. By raising the price suddenly the last person on the mind of the government is the aam aadmi, a term which the UPAwallahs do not stop using time and again.
The other option of course is to continue subsidize diesel, LPG and kerosene. As a known stock bull said on television show a couple of months back, even Saudi Arabia doesn’t sell kerosene at the price at which we do. And that is why a lot of kerosene gets smuggled into neighbouring countries and is used to adulterate diesel and petrol.
If the subsidies continue it is likely that the consumption of the various oil products will not fall. And that in turn would mean oil imports would remain at their current level, meaning that the trade deficit will continue to remain high. It will also mean a higher fiscal deficit and hence high interest rates. The economic growth will remain stagnant, keeping foreign businesses looking to invest in India away.
Manmohan Singh as the finance minister started India’s reform process. On July 24, 1991, he backed his “then” revolutionary proposals of opening up India’s economy by paraphrasing Victor Hugo: “No power on Earth can stop an idea whose time has come.”
Good economics is also good politics. That is an idea whose time has come. Now only if Mr Singh were listening. Or should we say be allowed to listen..
(The article originally appeared at www.firstpost.com on May 24,2012. http://www.firstpost.com/economy/petrol-bomb-is-a-dud-if-only-dr-singh-had-listened-319594.html)
(Vivek Kaul is a writer and can be reached at [email protected])
If you are the kind who reads the pink papers religiously, you would have come to conclusion by now that good times are back again for the stock market investors in India, now that the finance minister has deferred the implementation of GAAR to next year. But before you open that champagne bottle and say cheers, here are some reasons why the stock market will remain flat or fall in the days to come.
Pain in Spain:
The gross domestic product (GDP) of Spain grew at the rate of 8% every year from 1999 to 2008. This primarily happened because Spain went all out and promoted the Mediterranean lifestyle. As Jonathan Carman points out in a presentation titled The Pain in Spain “Millions flocked to its sun-drenched shores, buying houses along the way. As the demand for houses increased, construction became the industry. Housing prices exploded, tripling in just over a decade.”
So far so good. The trouble was Spain ended up building way too many homes than it could sell. Even though Spain forms only 12% of the GDP of the European Union (EU) it has built nearly 30% of all the homes in the EU since 2000. As John Mauldin and Jonathan Tepper point out in Endgame – The End of the Debt Supercycle and How It Changes Everything “Spain had the mother of all housing bubbles. To put things in perspective, Spain now has as many unsold homes as the United States, even though the United States is six times bigger”.
All this building was financed through the bank lending. Loans to developers and construction companies amounted to nearly $700billion or nearly 50% of the Spain’s current GDP of nearly $1.4trillion. With homes lying unsold developers are in no position to repay. And Spain’s biggest three banks have assets worth $2.7trillion or that is double Spain’s GDP.
What makes the situation more precarious is the fact that the housing prices are still falling. Carman expects prices still need to fall by 35% from their current levels if they are to reach normal levels. This will mean more home loan defaults and more trouble for Spain. The Spanish stock market is already taking this into account and IBEX-35, the premier stock market index of the country is down a little more than 10% in the last one month. Banking stocks have fallen much more.
While countries like Greece may be in more trouble, they are not economically big enough to cause a lot of trouble worldwide. But if Spanish banks go bust, there will be a lot of trouble in the days to come. Spain has now emerged the basket case of Europe, but other countries in the European Union are not doing well either and this means trouble for China.
China’s After Party:
If things are not well in Europe, it has an impact on China because Europe is China’s biggest trading partner. The Chinese exports to Europe in March were down 3.1% in comparison to last year. Chinese exports had ranged between $475billion and $518billion in the last three quarters of 2011. In the first three months of this year the number has fallen to $430million. Falling exports are not the best news for China.
There are other things which aren’t looking good either. As Ruchir Sharma writes in Breakout Nations – In Pursuit of the Next Economic Miracles “In the last decade the main driver of China’s boom was a surge in the investment share of the GDP from 35% to almost 50%, a level that is unprecedented in any major nation…The investment effort focused on building the roads, bridges, and ports needed to turn China into the world’s largest exporter, doubling its global export market share to 10% in the last decade.”
This spending spree which was responsible for its fast growth is now slowing down. New road construction is down from 5000miles in 2007 to 2500 miles. Railway spending is down by 10%.
The other major factor likely to pull down growth is wage inflation i.e. salaries are rising at a very fast rate. In 2011, the average wage was rising at a rate of 15%, in a scenario where the consumer price inflation was around 5%. As Sharma points out “In fact hourly wages are now rising twice as fast productivity, or hourly output per worker, which is forcing companies to raise prices just to cover the cost of higher wages.” This has led to manufacturers moving to cheaper destinations like Bangladesh and Indonesia.
Given these reasons it is highly unlikely that China will continue to grow at the rates that it has been. Since 1998, China’s economic growth has averaged around 10% and it has never fallen below 8%. As Sharma points out “China’s looming shadow is about to retreat to realistic dimensions.” Sharma expects Chinese growth to slowdown by 3-4% percentage points in comparison to its current growth rate over the next decade.
A Chinese slowdown will mean disaster for nations which have been thriving by exporting commodities to China. In 1998, when China was a $1trillion economy, to grow by 10% meant it had to expand its economy by $100billion. This could have been done by consuming 10% of the world’s industrial commodities, raw materials like oil, steel and copper. In 2011, China is a $6trillion economy. If this economy needs to grow by 10% or $600billion, more than 30% of the world’s commodity production would be needed. With growth slowing down, China’s commodity requirements will come down as well. As Sharma puts it “It’s my conviction that China – commodity connection will fall apart soon”.
China’s stock markets remain largely closed to international investors. But the Hang Seng index listed in Hong Kong has a lot of Chinese companies. This index has gone up 0.9% over the last one month.
The Kangaroo Won’t Jump:
In fact the Aussies are already feeling the heat with a slowdown in Chinese exports. Australian exports to China in 2011 stood at A$72billion (Australian dollar), up 24% from 2010, or around 26% of total exports. An ever expanding China bought coal, iron ore and natural gas from Australia, driving up Aussie exports. But exports for the month of February fell to A$24.4 billion, the lowest in an year. Coal exports were down by 21% to A$3.4billion. The S&P ASX/200 one of the premier stock market indices in Australia, has been flat for the last one month.
Brazil – God’s Own Country:
The rise of China has led to huge demand for Brazilian commodities. As Gary Dorsch an investment newsletter writer points out in a recent column “Brazil has been enjoying an economic boom based on soaring prices for its natural resources including crude oil, agricultural products, such as soybeans, corn, and cattle, and metals such as iron ore and bauxite-aluminum.”
The rise of Brazil was captured very well by Glenn Stevens, governor of the Reserve Bank of Australia. Stevens pointed out that in 2006, money received from shipload of iron ore could buy 2,200 flat screen TVs. In 2011, the same shipload could buy 22,000 flat screen TVs.
Since the start of the financial crisis a lot of money printed by Western governments to revive their economies has flowed into Brazil. This has driven up the value of the real, the currency of Brazil, and made Brazil one of the most expensive countries in the world. As Sharma points out “Restaurants in Sao Paulo are more expensive than those in Paris. Hotel rooms cost more in Rio than French Riviera”.
An expensive currency has meant that imports rising faster than exports. This situation is expected to get worse as China’s slowdown and the demand for Brazilian commodities falls. In fact the impact is already being felt. As Dorsch points out “Brazil’s economy stalled out in the past two quarters, showing near zero growth in Q’3 of 2011 and Q’4 of 2012. Factory output in February was -3.9% lower than a year ago.” The premier stock market index Bovespa is down 4.5% over the last one month.
On a totally different note the most popular television serial in Brazil is a soap opera called “A Passage to India” shot in Agra and Jodhpur and which has Brazilian actors playing Indian roles and as Sharma puts it, they could “pass easily for North Indians”.
India- Done and Dusted:
The economic problems of India deserve a separate article. But let me list a few. In the year 2007-2008 (i.e. between April 1, 2007 and March 31,2008) the fiscal deficit of the government of India stood at Rs 1,26,912 crore. Fiscal deficit is the difference between what the government earns and what it spends. For the year 2011-2012 (i.e. between April 1, 2011 and March 31, 2012) the fiscal deficit is expected to be Rs 5,21,980 crore.
Hence the fiscal deficit has increased by a whopping 312% between 2007 and 2012. During the same period the income earned by the government has gone up by only 36% to Rs 7,96,740 crore. The targeted fiscal deficit for 2012-2013 is Rs 5,13,590 crore. This is likely to go up given the fact that the rupee is depreciating against the dollar and thus our oil bill is likely to go up, pushing up our fiscal deficit. This would mean that higher interest rates will continue to prevail.
The stock market obviously realizes this and hence has fallen by 1.8% over the last one month, yesterday’s brief rally notwithstanding.
Over the last few years stock prices all across the world have moved in a synchronized fashion because the international investors like to move in a herd. Whenever there has been trouble in the United States or Europe it has led to emerging markets all across the world falling. Now we are in a situation where the emerging markets themselves are in a lot of trouble. So it is a no brainer to say there will be no rally in the stock market in the near future. Unless of course a certain Mr Ben Bernanke decides to open up the money tap again and go in for Quantitative Easing Round Three or to put it in simple English, print some more dollars. If that happens, then investors can get ready to have some fun.
(This article was originally published on May 8, 2012 at http://www.firstpost.com/economy/the-pain-in-spain-will-get-us-too-so-forget-market-rallies-302278.html. Vivek Kaul is a writer and can be reached at [email protected])