It would be a major achievement, if the government does not roll back higher petroleum prices. An increase in petroleum prices would be less inflationary than a higher fiscal deficit as a result of under-recoveries.

Government economic policies have been in a bind over an extended period of time, essentially because of political economy problems.

In this context, the recent measures are indeed commendable. These measures predictably invite intense debate and dissent, but if the government is able to ride through the storm, there would be benefits to the economy over the medium-term.

Reduction of subsidies always invites loud protests and liberalising foreign investment raises emotional alarm bells. It would be a major achievement if a roll-back is avoided.

Overall Growth

The overall growth rate in 2012-13 would be around 5.5-6.0 per cent. Although this would be the lowest growth rate in a decade, it has to be viewed in the context of a difficult global situation.

The medium-term aspiration is a growth rate of around 8 per cent, which, itself, will be a Herculean task.

Petroleum Prices

Given our dependence on petroleum imports (about 70 per cent of consumption) ideally, a pass-through of the import price would be desirable, but political economy constraints result in the fuel subsidy going out of control, thereby adversely affecting the gross fiscal deficit.

The fuel subsidy bill, which was as low as Rs 2,900 crore in 2008-09, swelled to Rs 68,500 crore in 2011-12.

The gross under-recoveries for petroleum products are estimated at Rs 1,67,000 crore, of which over 60 per cent is accounted for by diesel.

The recent hike in diesel prices by 12 per cent is a salutary measure, notwithstanding the cascading effect on other prices.

In the debate on subsidies, two issues need to be borne in mind. First, India cannot defer paying the price for imported petroleum.

Secondly, an economy cannot subsidise itself and the overall burden has to be borne instantaneously. All that can be done is to shunt the burden from one segment to another.

It is erroneously argued that reduction of the petroleum subsidy results in inflation. When the petroleum price is not passed on, the fiscal deficit goes up and this results in generalised inflation.

Thus, there is merit in a pass-through, but the political economy resolution is easier said than done.

The reduction in the subsidy on Liquefied Petroleum Gas (LPG) is an appropriate measure. A lower price for the first six cylinders and a higher price for consumption of more cylinders is, however, administratively difficult to implement.

More importantly, the proposed system lacks distributive justice. First, nuclear families are more prevalent among the upper income groups and joint family living is more prevalent among the lower income groups.

Secondly, in practice, the better-off segments obtain supplies from more than one distribution agency. In fact, during periods of surfeit of cylinders, the distribution agencies were thrusting cylinders on consumers. Thirdly, an underground market in cylinders would develop.

The Nandan Nilekani Committee had rightly recommended a phased introduction of direct cash subsidies. This should be expeditiously implemented, so that there is a single price for LPG.

FDI Reform

The four bold measures on FDI are: (i) 51 per cent FDI in multi-brand retail (subject to individual states option), (ii) 49 per cent FDI in civil aviation, (iii) 74 per cent FDI in broadcast services and (iv) approved FDI in power exchanges.

These would raise loud protests of a massive FDI invasion. No such flooding is likely to take place in the immediate ensuing period. The overall policy was, all along, meant to favour FDI over portfolio investment, but in practice, portfolio investment has been significantly liberalised without a commensurate reduction in FDI red tape. As such, the slew of FDI measures merit support.

Public Sector Divestment

The announcement of public sector divestment to the tune of Rs 15,000 crore (total for the year budgeted at Rs 30,000 crore) is timely and preferable to crowding it towards the end of the financial year.

Ideally, the sale of family silver should be used to build up a Consolidated Sinking Fund (CSF) to repay public debt.

Finance Commissions in the late 1980s and early 1990s strongly recommended a CSF and the country will pay a high price for ignoring this advice.

Monetary Policy

The year-on-year inflation on the Wholesale Price Index (WPI) at 7.6 per cent and the Consumer Price Index (CPI) at 10 per cent, is well beyond the RBI’s comfort zone of 5.0-5.5 per cent; moreover, official indices always underestimate the actual inflation rate.

The RBI’s Mid-Quarter Review on September 17, 2012, correctly emphasises that in the recent period, growth risks have increased while inflation risks remain.

The reduction of the cash reserve ratio (CRR) from 4.75 per cent to 4.50 per cent, releasing Rs 17,000 crore, appears to be in the nature of support to the government’s recent measures, rather than responding to any need for increased liquidity.

The continuing inflationary pressures should be of overriding concern to the RBI, and any further policy relaxations should be rear-ended and not front-ended.

They should be undertaken only after there is a significant and enduring reduction in the consumer price index.

(The author is an economist.

(This article was published on September 20, 2012)
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