JOIN USThe priority should be to reduce unproductive and mis-targeted subsidies and to bring tax rates back to pre-stimulus levels.
Finance minister Pranab Mukherjee has recently said that he is losing sleep over the ballooning subsidy bill. The situation is getting worse as the international price of oil is steadily moving north with escalating Iran-US-Israel tension. Some fear that there could even be air strikes on Iran’s nuclear installations by Israel after the US presidential elections in November are over. In that event, the price of oil may go to any level. It is estimated that each dollar increase in the price of crude raises the implicit combined subsidy burden of the government and the oil companies by Rs 7,000 crore each year.
So, if the dollar price of oil goes up by, say, even $15 (a conservative estimate), it would add more than Rs 1 lakh crore to the subsidy bill. Further, it is introducing a huge uncertainty over the entire budget exercise since no expert can predict, with any degree of confidence, the average price of oil over the coming fiscal. Total government borrowing has already crossed Rs 5 lakh crore, as against Rs 4.17 lakh crore budget estimate for 2011-12.
Then there is the open-ended subsidy on urea (a major fertilizer) which depends on the difference between the administered domestic price and the import price of urea. If the import price of urea goes up and the domestic price cannot be raised (to keep farm lobbies in good humour), subsidy per tonne of urea automatically goes up, adding another element of uncertainty over the budget numbers.
Finally, the proposed Food Security Bill (likely to be introduced in the coming year) would expand the coverage and quantum of highly subsided food to the ‘poor.’ This would further add to the subsidy woes of the finance minister.
The FM has more reasons to lose sleep. His tax revenue collections are falling behind projections, mainly due to the economy growing at a rate (6.9 per cent) slower than expected (9 per cent). There is no sign of US, EU and Japan coming out of the recessionary mode anytime soon. The rising dollar price of oil would aggravate the global slowdown. As a result, the Indian economy would slowdown further, lowering tax revenues while adding to the inflationary pressure by raising the cost of energy.
Higher inflation, in turn, would push back the (expected) reduction in policy interest rates by RBI which is needed for boosting investment and consumption expenditures. The FM projected to raise Rs 40,000 crore through disinvestment of PSU shares in 2011-12. Due to depressed stock market he cannot hope to raise anything close to this figure through this route.
Recent attempt
The recent attempt to sell a 5 per cent share in ONGC flopped and the government had to cajole LIC to buy up more than 80 per cent of the shares on offer at a price 5 per cent higher than what the private investors were willing to pay. In the process, LIC lost some Rs 750 crore of investor money to ‘insure’ the government’s budget.
The sum total of all these implies that the projected fiscal deficit of 4.6 per cent for 2011-12 may well reach close to 6 per cent of GDP. That means less availability of funds or higher borrowing cost for private investors which is a negative for the private investment climate. The rising import bill of oil, slowing exports (due to depressed global market) and shrinking capital inflows (due to policy uncertainties in India) is worsening the balance of payments and weakening the rupee. This, in turn, is pushing up the price of oil and other imported inputs in rupees, adding to the oil and fertiliser subsidy bill and also the inflation rate in India.
There are some more worries of a structural nature. Our long-term projected 9 per cent growth is based on a savings rate of 36 per cent or above. But, the savings rate (as a percentage of GDP) has come down from 36.8 per cent in 2007-08 to 32.4 per cent in 2010-11. This is mainly due to a 3.3 percentage point fall in savings of the public sector.
All sensible economists (including the FM and the PM) know what needs to done. The priority should be to reduce unproductive and mis-targeted subsidies, bring excise and service tax rates back to pre-stimulus levels while expanding the service tax net, increase the share of capital expenditure, improve the performance of PSUs, SEBs and railways and cut leakages in the delivery mechanism of public services and subsidies. In addition, we need to improve the overall investment climate by reducing uncertainties relating to land acquisition and clearances of big projects, instead of more tax sops. The plethora of exemptions and allowances need to be minimised in the interest of better tax collection, more equity and less litigation costs.
But, then the results of recently held state elections in UP, Punjab and Goa, contrary to expectations, have been a disaster for the Congress party and will make the coalition partners in UPA (like the TMC and the DMK) more assertive.That will make it even more difficult to reverse the populist myopic policies over the remaining two years of the current UPA government. Perhaps, the FM will have to increase the dose of sleeping pills to fight insomnia.
(The writer is a former professor of economics at IIM, Calcutta)