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The twin deficits and oil prices

, September 5, 2013, 0 Comments

The economic crisis in the country is largely associated with the fiscal and current account deficits. The fiscal deficit is primarily a domestic economic issue while the CAD is intertwined with international developments. The fiscal deficit is a budgetary phenomenon  while the CAD is a balance of payments phenomenon. The fiscal deficit relates to the gap between the revenue and expenditure of the government while the CAD relates to inflow and outflow of foreign exchange into the country. As we shall see increase in petroleum prices is closely associated with the twin deficits and control over them will be largely determined by whether we are able to increase petroleum prices in tune with international prices.

When P Chidambaram took over as Finance Minister he inherited a huge fiscal deficit. One of his main priorities after taking over as FM was to control the fiscal deficit. It goes to his credit that he was able to contain fiscal deficit within the target limit set by him for fiscal year 2013. Now for the current fiscal year he has set another target for fiscal deficit. This target is more difficult to attain primarily because we are expecting general elections soon and there will be pressures from within his party to increase expenditure on populist schemes. It remains to be seen how far the FM will be able to resist such demands from his party colleagues.

The revenue of the Central Government is more or less a given over which the FM cannot have much control once the budget has been formulated. As against this the FM has more flexibility over expenditure during the course of the fiscal year. One such item of expenditure over which he has control and which is subject to manipulation is the subsidy bill. In India today a major component of our subsidy bill constitutes the subsidy on petroleum products.

Under petroleum subsidies we have subsidy on petrol, diesel, cooking gas and kerosene. Petrol is a decontrolled item and the Oil Marketing Companies have the freedom to increase or decrease its price in tune with fluctuations in international price of crude oil. Kerosene is an item largely consumed by the poor and any increase in the price of this commodity is very politically sensitive. Cooking gas like kerosene is an item of consumption for the common man. But compared to kerosene this commodity is consumed more by relatively affluent sections rather than the very poor. It is unfortunate that government is not able to increase the price of gas in tune with actual costs involved. Politics in this country is so organized that it prevents rational economic decisions from being taken and we are burdened with huge subsidies on cooking gas – a subsidy whose benefit is largely derived by rich consumers.

Diesel prices are an item over which the government has been able to bring about some control. A decision has been taken to increase diesel prices by 45-50 paise per month until (hopefully) the entire diesel subsidy is wiped out and we are in a position to decontrol pricing of this commodity as has been achieved in the case of petrol. There is, however, no guarantee that this will happen. Elections are round the corner and after the elections a new government will come to power. There is no guarantee that the new government which comes to power will follow the same policies as is followed by the present government. The next government can reverse the decision to increase diesel prices every month and turn the clock back as far as reforming the subsidy regime is concerned.

Bringing CAD under control is also closely related to pricing of petroleum products. The CAD is largely a result of our trade deficit or the gap between exports and imports. Crude oil constitutes a major item in our import basket and control over this is crucial to bringing under control the CAD. Increasing petroleum prices is desirable not only to reduce subsidies but also to curb the galloping increase in our oil import bill. A higher level of petrol and diesel price will discourage domestic consumption of these commodities and will be conducive to reducing our oil import bill, the trade deficit and also the CAD.

As is now well known the high level of CAD has been a primary cause for the decline in the value of the Rupee. If the value of our currency has to be stabilized it will not be possible without bringing down the level of CAD. To bring down CAD, apart from reducing import of crude oil, we should also make efforts to bring down imports of coal and also gold. Coal is an item in which we have adequate domestic reserves but are not able to increase domestic production in tune with demand. If domestic production of coal is increased we will be able to reduce import of this commodity.

Gold imports are a special case in itself. This is largely an unproductive item whose consumption has gone up largely due to the enthusiasm of our people to invest in jewelry. Consumption of gold and jewelry is important for matrimonial purposes and also for investment in gold for its own purpose. Gold, in the recent past, has brought about substantial price appreciation to the people buying it and has become an avenue for safe investment. The recent crash in gold prices could have altered the situation to some extent but the Indian consumers’ demand for gold is un-satiable and cannot vanish overnight. Under these circumstances what the government can do is to regulate import of gold and let the consumers’ demand be met primarily by purchase from domestic stocks. The government and the RBI have taken many commendable steps in this regard and let us hope these measures will yield the expected results.

In the days ahead, it remains to be seen, whether the government is able to take bold decisions on pricing of petroleum products. Such bold decisions will be conducive to reducing our twin deficits which will be necessary if the country is to emerge successfully out of the current economic mess. These measures will also be necessary to check the present slide in the Rupee. Keeping the twin deficits under check is a requirement which the present government is well aware of. However, its success in achieving this goal is clouded under many uncertainties. As regards the next government is concerned the uncertainties are compounded since the realization of the need to take prudent decisions will itself be in doubt.






About author
P V Rajeev , former Economic Adviser of Government of India and worked as an Economist in Government of India for more than three decades. ...more