Vivek Kaul
The finance minister P Chidambaram hasn’t crossed the “red line” of achieving a fiscal deficit target of 4.8% of the gross domestic product (GDP), that he had set for the government when he presented the last budget in February 2013. In fact, he has done even better and achieved a fiscal deficit of 4.6% of the GDP.
Fiscal deficit is the difference between what a government earns and what it spends, expressed as a percentage of the GDP. There are essentially three variables that are involved in calculating the number. The amount the government earns. The amount the government spends. These two numbers form the numerator and their difference is then expressed as a percentage of the GDP.
Hence, in order to achieve a targeted fiscal deficit, any of these three numbers can be manipulated. Chidambaram has worked on two of these three fronts to arrive at a fiscal deficit target of 4.6% of the GDP.
Let’s start on the expenditure front. The government expenditure is categorised into two kinds—planned and non planned. Planned expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government. Non-plan expenditure is an outcome of planned expenditure. For example, the government constructs a highway using money categorised as a planned expenditure. But the money that goes towards the maintenance of that highway is non-planned expenditure. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure.
As is obvious a lot of non-plan expenditure is largely regular expenditure that cannot be done away with. The government can at best delay paying subsidies. Hence, when expenditure needs to be cut, it is the asset creating planned expenditure which typically faces the axe and that is not good for the overall economy. If one looks at the numbers that is the direction they point towards.
The planned expenditure target of the government was at Rs 5,55,322 crore. The actual planned expenditure has come in at Rs 4,75,532 crore, which is close to Rs 80,000 crore or 14.4% lower. This as mentioned earlier is not a good sign.
If the government had incurred this expenditure the actual fiscal deficit would have come in at close to 5.3% of the GDP.
When it comes to non planned expenditure the target was at Rs 1,109,975 crore. It came in around 0.44% higher at Rs 1,114,902 crore. Most of the non-planned expenditure is regular in nature and hence, like planned expenditure, cannot be done away with. But there is one accounting trick that the government can resort to even on this front.
It can postpone the payment of petroleum, food and fertilizer subsidies to the next financial year. Let’s take the case of petroleum subsidies for one. Rs 65,000 crore had been allocated on this front. The actual amount spent by the government has come in at Rs 85,480 crore. Of this amount a major chunk has gone towards payment of under-recoveries from the financial year 2012-2013 (i.e. the period between April 2012 and March 2013).
Hence, the amount allocated is clearly not enough for the payment of petroleum subsidies. In fact, data from the Ministry of Petroleum and Natural Gas suggests that the oil marketing companies have reported under-recoveries of a total of Rs 1,00,632 crore during the first nine month of 2013-14 (April-December) on the sale of diesel, PDS Kerosene and cooking gas.
So clearly the amount of Rs 85,480 crore earmarked in the budget is not enough. This means that the payments that need to be made on this front have been postponed to the next year. A recent article in the Business Standard estimates that subsidies of around Rs 1,23,000 crore will be postponed to the next financial year.
These are subsidies on petroleum, food and fertilizer which should have been paid up by the government in this financial year, but will be postponed to the next financial year. The article points out that the government will need Rs 1,45,000 crore to pay up all the subsidies but is likely to sanction only around Rs 22,000 crore. This leaves a gap of Rs 1,23,000 crore which will be postponed to the next financial year, and will become a huge headache for the next government.
This essentially means that the government will not recognise expenditure when it incurs it, but only when it pays for that expenditure. This goes against the basic accounting principles, where an expenditure needs to be recognised during the period it is incurred.
Lets now look at what Chidambaram and the government have done on the government earnings front to boost that number. The government has indulged in massive asset stripping to boost its earnings. A recent estimate in the Mint newspaper suggests that since January 2014, public sector banks have announced interim dividends of Rs 27,474.4 crore.
These are banks in which the government had put in fresh capital of Rs 14,000 crore earlier in the year. So the government gives from one hand and takes away as much twice as more from another. Also, it is worth noting here that the public sector banks are currently on a very weak wicket. As Shekhar Gupta wrote in a recent column in The Indian Express “You read any of the recent data from the RBI, reputed market analysts and brokerages, economists, even from Uday Kotak on CNBC-TV18 this Thursday. You will know that the current stressed, restructured or non-performing loans in the Indian banking system amount to nearly 25 per cent of their total assets. Kotak put the aggregate at Rs 10 lakh crore out of total advances of Rs 40 lakh crore. Scared yet? He says the banks’ total write-offs over the next couple of years could be Rs 3.5-4 lakh crore. The total net worth of all banks now is about Rs 8 lakh crore. In other words, half their net worth will be wiped out.”
In trying to meet the fiscal deficit target, Chidambaram has further weakened the Indian banking system. And then there is the case of moving money from government owned companies to the government. Take the case of the Oil India Ltd and ONGC buying shares in Indian Oil Corporation worth Rs 5,000 crore, a company which is expected to lose a lot of money during the course of this financial year. Hence, no investor other than the government owned companies would have bought IOC stock.
Continuing with asset stripping, the 90% government owned Coal India Ltd, recently declared a record dividend in January of Rs 18,317.5 crore. Of this, the government will get Rs 16,485 crore, given that it owns 90% of the company. The government will also get Rs 3,100 crore, which Coal India will have to pay as dividend distribution tax. This money should actually have been used by Coal India to develop more coal mines so that India does not have to import coal, like it currently does, despite having massive coal reserves. But that of course, hasn’t happened.
The icing on the cake was the sale of telecom spectrum which made the government richer by more than Rs 61,000 crore.
It isn’t a good idea to meet regular expenditure by selling assets. How many people you know survived for long by selling their home, their car and other assets that they owned, to meet their daily expenditure? Ultimately to meet regular expenditure, regular income is needed. The sale of assets to meet current expenditure is not a great practice to follow. This is because assets once sold, cannot be re-sold.
If all these factors highlighted above are taken into account, there is no way the fiscal deficit would have come in at 4.6% of the GDP. The number is at best a joke that Chidambaram and his UPA colleagues have played on the citizens of this country.
The article originally appeared on www.firstpost.com on February 17, 2014.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Under-recoveries
The Indian consumer does not get any subsidy on petroleum products
The Ministry of Petroleum and Natural Gas released the under-recovery numbers on the sale of diesel, cooking gas and kerosene, on February 3, 2014.
The under-recovery for cooking gas as on February 1, 2014, stood at Rs 655.96 per cylinder, whereas the under-recovery on diesel and kerosene stood at Rs 7.39 per litre and Rs 35.77 per litre.
The price that oil marketing companies 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).
These under-recoveries are typically referred to as subsidies (both in the media as well as by politicians) that the government is providing to the citizens of this country. But the question is it fair to call this a subsidy? 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 Securityin 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. 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 large portion of the price that consumers pay for buying petrol, cooking gas and diesel is passed onto the state governments and the central government in the form of various taxes. Excise duty collected by the central government and the sales tax collected by the state governments are the two major taxes. (In 2012-2013, the central government collected Rs 62,920 crore as excise duty. On the other hand state governments collected Rs 1,10,875 crore as sales tax.) Hence, the oil marketing companies (OMCs i.e. IOC, BP and HP) are not being adequately compensated for selling petroleum products (this does not include petrol), despite the high price. The government, in turn, compensates them for these under-recoveries.
Let’s throw in some numbers here. Data from the Petroleum Planning & Analysis Cell, a part of the Ministry of Petroleum and Natural Gas, shows that in 2012-2013 that the various state governments and the central government collected Rs 2,43,939 crore as taxes on the sale of various petroleum products. A small part of this income was also in the form of dividends.
Against this, the total under-recoveries on the sale of diesel, cooking gas and kerosene came in at Rs 1,61,029 crore. As is well known the central government did not pay this entire amount to the OMCs from its own pocket. It got the upstream oil companies like Oil India Ltd and ONGC to contribute towards the same as well.
The broader point is that the governments collected Rs 2,43,939 crore as taxes even though under-recoveries were at Rs 1,61,029 crore. This is a difference of more than Rs 80,000 crore here. In 2011-2012 this difference was more than Rs 90,000 crore. So the question is who is subsidising whom? It is clear that the end consumer is not being subsidised.
As the article titled The Political Economy of Oil Prices in India points out “The total contribution of the oil sector to the exchequer has been higher than the sum of under recoveries of the OMCs and direct subsidies on petroleum products for all the years since fiscal 2004…Even the sum of duties (customs and excise) and (sales) taxes on petroleum products, which is only a fraction of the total contribution of the oil sector to the exchequer, has exceeded the sum of under recoveries of the OMCs and direct subsidies in all the years since 2004-05. The inescapable conclusion…is that there is a negative net subsidy on petroleum products in India. Another way of saying the same thing is that the government extracts a net positive tax revenue from petroleum products in India. The oft-repeated assertion that petroleum products are subsidized in India is simply not true.”
Over the years, the governments in India, both at the state and the central level, have been spending more than they have been earning. Tax revenues from petroleum products remain a major source of income for the governments. While the expenditure of the governments has gone up dramatically, their income clearly hasn’t. And that is what they should be trying to address, instead of trying to tell us time and again that petroleum products are being subsidised. They clearly are not.
The article originally appeared on www.firstbiz.com on February 5, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)
More trouble for Chidu: Fiscal deficit hits 75% of target in first 5 months
Vivek Kaul
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
Vivek 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%).”
Multiple 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)
Only big-bang diesel hike can save India from a downgrade
Vivek Kaul
Around a month back the under-recovery on every litre of diesel being sold by the oil marketing companies(OMCs) was Rs 9.29.
For the fortnight starting September 1, 2013, this has shot up by 30.5% to Rs 12.12 per litre. The under-recovery on cooking gas has gone up by 14.2% to Rs 470.38 per cylinder. The under-recovery on kerosene has gone up by 9.8% to Rs 36.33 per litre.
The OMCs are facing a total daily under-recovery of Rs 470.38 crore on the sale of diesel, kerosene and cooking gas. This is up by nearly 24.5% from a month earlier. The monthly under-recovery for the OMCs at the current level works out to a little over Rs 14,100 crore (Rs 470.38 crore x 30 days in a month).
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.”
Realised price is essentially the price charged to the dealers by the OMCs. It is also referred to as the depot price. If the realised price 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 government has to compensate the OMCs for these under-recoveries. This is done in two ways. As A Citizen’s Guide to Energy Subsidies points out “a large part of these under-recoveries is compensated for by additional cash assistance from the government, while another portion is covered by financial assistance from upstream national oil companies.”
So oil producing companies like ONGC and Oil India Ltd compensate the OMCs like Indian Oil, Bharat Petroleum and Hindustan Petroleum, for a part of their under-recoveries. The government directly compensates the OMCs for a large part of their under-recoveries. This means a higher expenditure for the government.
The under-recoveries on diesel have gone by more than 30% in a period of one month. At the same time the under-recoveries on kerosene and cooking gas have also gone up significantly. This implies that the under-recoveries for the OMCs on the sale of diesel, cooking gas and kerosene, must have risen at a very fast pace.
Hence, the government will have to incur a higher expenditure to compensate the OMCs for the higher under-recoveries, in the months to come. A higher expenditure will lead to a higher fiscal deficit. Fiscal deficit is essentially the difference between what the government earns and what it spends.
If the government wants to avoid this it will have to increase at least the price of diesel, given that it makes for a significant portion of the under-recoveries. A few days back the government had increased the price of diesel by 50 paisa per litre.
This increase is too small to help the government control its fiscal deficit in any way. If the government wants to make a reasonable attempt at controlling the fiscal deficit, then the price of diesel needs to be raised by at least Rs 5 per litre.
It is important that the government does this to show the world at large that it is serious about controlling its fiscal deficit. The finance minister P Chidambaram and the prime minister Manmohan Singh have both recently said that whatever needs to be done to maintain the targeted fiscal deficit of 4.8% of the GDP (gross domestic product) will be done.
Just making such statements is not enough. These statements need to be backed by concrete action and raising the price of diesel by at least Rs 5 per litre would be one such action. 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. 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. As Swaminathan Aiyar put it in a recent column in The Times of India “People ask me, will the exchange rate go to Rs 70 to the dollar? I reply, why not Rs 80?”
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, palm oil, fertilizer etc. Hence, it is important that the government ensures that we do not end up in this situation. If it does allow the fiscal deficit to bloat and the rupee to depreciate, essential imports will get costlier, and that will lead to a higher inflation along with a slowdown in economic growth. It will also cause problems for corporate India, which has raised a lot of foreign currency loans over the last few years. If the rupee depreciates, companies will have to pay more rupees to buy dollars to repay their foreign currency loans.
On the flip side an increase in price of diesel will also create its share of problems. “Prices of diesel are controlled primarily to keep a check on the cascading inflationary impact of higher freight and transportation charges on the prices of essential commodities,” A Citizen’s Guide to Energy Subsidies points out. An increase in price of diesel will immediately translate into higher food prices, which is something that the government can ill-afford given that there are many state elections due over the next few months. Also food prices are not exactly low presently (This writer bought onions at Rs 50 a kg and tomatoes at Rs 40 a kg, yesterday). The government hence has to make a choice between the devil and the deep sea.
It is also important to explain here that the diesel prices in India are not low and the government is not offering any subsidies on it to the end consumer, as is often pointed out. As Surya P Sethi, a formerly Principal Adviser (Energy), Planning Commission, wrote in a 2010 article in the Economic and Political Weekly “This is yet another myth that permeates…most government discourse. Petrol and diesel prices are made up of the base price for the fuel and the taxes/levies imposed by the central and the state governments.”
Data from the Petroleum Planning and Analysis Cell shows that in 2012-2013, the petroleum sector contributed Rs 2,43,939 crore to the central government and the state governments. Of this a contribution of Rs 1,17,422 crore was at the central level and the remaining Rs 1,26,516 crore at the state level.
At the central level the money came in from the cess on crude oil, excise duty, corporate income tax, dividend income to central government etc. At the state level money primarily came in from sales tax/value added tax on petroleum products.
In comparison to the total income of Rs 2,43,939 crore made by the central and the state governments through the petroleum sector, the total under-recovery in 2012-2013, came in at Rs 1,61,029 crore. Given this, there was no real subsidy on offer to the end consumers, as is often made out to be. The consumers paid more than the cost price once the various taxes and duties are taken into account.
There are several problems here. One is that the OMCs were not able to recover enough money from the selling price of petroleum products ( except petrol), which makes them viable as a going concern. Hence, they need to be compensated for their under-recoveries.
Second, the entire Rs 2,43,939 crore, did not land up with the central government. And third, the Rs 1,17,422 crore that the central government earned from the petroleum sector in 2012-2013 wasn’t specifically earmarked to be adjusted against “under-recoveries” made by the OMCs. It was a part of the general revenues that the government earned during the course of the year and could be spent against any expenditure that the government had planned to incur during the course of the year.
Given this, any under-recovery leads to a higher expenditure for the central government and thus a higher fiscal deficit. A higher fiscal deficit needs to be controlled by increasing the price of diesel.
But that does not mean that the diesel that we have been buying is subsidised.
The article originally appeared on www.firstpost.com on September 3, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)