Is the government on a suicide mission? Its move to hike diesel prices by 12% is a very steep hike in a sensitive fuel item, one which directly affects farmers, and has a cascading effect on a number of goods and services such as public transport, and food items.
The government is hiking the price of diesel by Rs 5/litre, of which Rs 3.50 will go the oil marketing companies, and Rs 1.50 will go to the government as higher excise duty. But the government is keeping petrol prices steady, having increased it significantly in the past, while keeping diesel prices constant. But it is cutting the excise duty on petrol by Rs 5.30 per litre, which will subsidise the losses suffered by the oil marketing companies.
It is also limiting subsidised LPG cylinders to 6 per family, which means every family will get subsidised LPG cylinders at Rs 399 per family. While the government has left it to the oil marketing companies to fix the price of the non-subsidised cylinders, at current under-recovery levels, the cost per cylinder could increase to as much as Rs 750 per cylinder. That is a 44% increase for a family that uses 12 cylinders in a year.
The government’s decision will save the oil marketing companies under-recoveries of Rs 20,300 crore in the rest of the year. Still, under-recoveries incurred earlier will mean that the estimated under-recoveries in 2012-13 will be Rs 167,000 crore, 20.5% more than the previous year’s level.
That was the fiscal implication. But economics cannot be isolated from politics, especially when you are running a coalition government. This decision of the government is a move that none of its allies can support in open, irrespective of its fiscal merits. The opposition is already baying for the government’s blood for months now, the latest provocation being irregularities in coal block allotments.
This is a time that its needs all the friends it can find. It was also a time when nobody was expecting the government to hike diesel prices, leave alone attempt less provocative reform steps such as allowing FDI in multi-brand retail, push through the General Sales Tax Act, or increasing FDI caps in sectors such as insurance.
At a time such as this, the government went ahead and hiked diesel prices by Rs 5/litre, not even pushing through a calibrated hike. What gives? Here are some possible scenarios.
1. Bite the reform bullet, even if it means angering its allies
2. Hike by 5 times what you think is acceptable, ‘give in’ to pressure from allies and roll back
3. Put up a pro-reform face, putting pressure on the RBI governor to cut interest rates
4. Deflect attention from the coal block allotment scandal
5. Give a leg-up to the stock markets, helping the government’s disinvestment programme
6. Get ready for the 2014 elections
1. Bite the reform bullet, even if it means angering its allies
The UPA has got tired of its image as a weak party in power that cannot push through the mildest of reforms. The country’s economy is suffering and its image in the international investor community has been damaged. India’s shining growth story is now covered with the dust of bad decisions and indecision. Now is the time to pick up the reform gauntlet, and what better place to start than diesel prices. If it can succeed in hiking diesel prices, implementing other reforms will be a cakewalk.
This seems practical, courageous but may not play out its favour. All the key Congress allies in the UPA, including the Nationalist Congress Party (NCP), the Dravida Munnettra Kazhagam (DMK), the Trinamool Congress (TMC), and even parties such as the Samajwadi Party who give outside support, count the masses as their key support base. If the allies gang up against the decision, it will not only be embarrassing, but a roll-back will only reinforce the point that the UPA does not have the power to implement strong reforms.
2. Hike by 5 times what you think is acceptable, ‘give in’ to pressure from allies and roll back
This is the oldest trick in the book and has been used by many governments. Instead of the current hike of Rs 5/litre, the hike can be brought down to Rs 1/l or Rs 2/l. This appears a likely scenario, but if the UPA allies object to any increase, this too may potentially fail.
3. Put up a pro-reform face, putting pressure on the RBI governor to cut interest rates
The finance ministry has been batting for a cut in interest rates, as is seen in how it has put pressure on state-owned banks to cut interest rates on loans (and therefore deposits as well).
The RBI has been maintaining that it cannot cut interest rates because structural shifts have led to inflation remaining at high levels. Also, it believes the government has not done enough to address its growing fiscal deficit, which could have given the RBI room to lower interest rates.
By taking what seems like a very bold step, the government may be telling the RBI: look we have taken two steps, now why don’t you take at least one.
The mid-quarter review of the monetary policy by the RBI is due on September 17. The diesel price hike and limiting subsidised LPG cylinders appears to have been timed perfectly. The only question here is whether the RBI will act cautious, it will applaud the government move, say that it will now observe the situation even more closely, and in good time decide on the future course of action.
Or it may just cut the cash reserve ratio, releasing non-interest bearing funds back to banks. This will spur lending, and possibly lead to lower rates as well. The RBI can then wait for the level of subsidy cuts to become established, and then make its move on lowering benchmark interest rates.
4. Deflect attention from the coal block allotment scandal
The alleged irregularities in allotting coal blocks have been making headlines almost every other day. The government has been trying hard to contain the damage, but a flow of new revelations have been making life difficult. The move to cap subsidies may just create so much heat and dust, that people may forget about the coal issue and give the government an opportunity to gather its wits on how to tackle the coal allotment issue. This seems a rather weak scenario, as it can backfire on the government.
5. Give a leg-up to the stock markets, helping the government’s disinvestment programme
Irrespective of what UPA allies may think, both foreign and domestic investors are likely to be full of praise for the government’s decision, even if they may temper it with concerns of a roll-back. If the government is able to manage a slightly lower hike, markets will still be happy.
Healthy investor sentiment is very important for the government’s disinvestment programme to go through. The government has a target of Rs 30,000 crore to be raised through disinvestments, a very difficult target to achieve unless investor sentiment improves and there is some confidence in the government’s ability to take reform-oriented measures
6. Get ready for the 2014 elections
These reforms may be unpopular with the allies and voters, but they will help the government’s fiscal situation look better. That will allow them to support the various social welfare programmes being implemented by the government, such as guaranteed employment scheme, right to education, and right to food.
The government has about a year and a half to go before the next elections become due. The next Budget will most probably be its last full-scale one, as 2014 will perhaps only see a vote-on-account. If it can set its house in order in time for the next Budget, usually due in end-February, the government can then unleash what is known in India as an election budget. Either in the budget itself, or well before elections are announced, it will unveil a ‘package’ of measures which will be designed to please the main voting blocks. To do that, it needs to have some fiscal space left, and these reforms will give it that space.
These pre-election sops could range from cutting fuel prices, to giving sops to the farmers, tax breaks to the middle class, just to name a few. The fiscal will of course go over the brink, but the government really could not care, as it is election year. The opposition will cry foul, but will be unable to do much because it would be busy stitching up its own alliances, and trying to make their best shot at unseating the UPA from its post of the ruling party, a position it is holding for the second consecutive term.
Read the government’s press release here.