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Economy Sep 14, 2012

Why the diesel hike will not even dent the fiscal deficit

By Vivek Kaul

The Congress-led United Progressive Alliance (UPA) has the habit of shooting messengers who come in with bad news. So here is some more bad news.

Almost half way through the financial year 2012-2013, the fiscal deficit of the government is looking awful to say the least. Fiscal deficit is the difference between what the government earns and what it spends. The chances are this year it could be nearly as bad as it was in 1991, when the country was close to external bankruptcy.

The main villain of the piece is subsidies. Especially, subsidies for oil-diesel, kerosene, cooking gas-which will eat up nearly Rs 2,00,000 crore, not to speak of subsidies in fertiliser and food.

When the finance minister presented his budget in March, he made many assumptions that now look like fantasy. Reuters

But before you jump in and inform us that, hey, the government just raised diesel prices by Rs 5 a litre, and introduced dual pricing for cooking gas (families will get six cylinders at subsidised rates, and the rest at market rates), so won't the deficit come down?

It will, but the subsidy cut is a fleabite on a elephantine deficit.Fixing the hole in the budget will take a lot more effort than just one diesel hike. For the record, even after the diesel hike and the limits placed on subsidised cylinders, the oil subsidy bill will come down by just around 10 percent-from nearly Rs 2,00,000 crore to Rs 1,80,000 crore. Or thereabouts.

So let's take a close look at the numbers. When the finance minister presented his budget in March, he made many assumptions that now look like fantasy. The overall fiscal deficit-the gap between expenditures and revenues -was projected to be Rs 5,13,590 crore. The expenditure of the government for 2012-13 was expected to be Rs 14,90,925 crore. In comparison, the government expected to earn only Rs 9,77,335 crore during the course of the year.

The difference between the earnings and expenditure is Rs 5,13,590 crore, and this is the projected fiscal deficit. Put another way, the government had planned to spend 55 percent (Rs 5,13,590 crore expressed as a percentage of Rs 9,77,335 crore) more than it earned.

The expenditure part of the calculation includes subsidies on oil, fertiliser and food. The subsidy on oil was assumed to be at Rs 43,580 crore. This subsidy was to be used by the government to compensate oil marketing companies (OMCs) like Indian Oil, Bharat Petroleum and Hindustan Petroleum for selling diesel, kerosene and cooking gas, at a loss.

The government has more or less run out of the budgeted oil subsidies. It has already paid Rs 38,500 crore to OMCs for selling diesel, kerosene and LPG at a loss during the last financial year. It's like using this month's salary to pay last month's bills. This amount was reimbursed only in the current financial year and hence has had to be adjusted against the oil subsidies budgeted for this year. This leaves only around Rs 5,080 crore with the government for compensating the OMCs for the losses this year.

That's just loose change in comparison to the losses the OMCs are expected to face for selling diesel, kerosene and LPG. Oil Minister Jaipal Reddy recently said that if the current situation continues the OMCs will end up with losses amounting to Rs 2,00,000 crore during the course of the year.

As economist Shankar Acharya wrote in Business Standard on 13 September, "The real fiscal spoilsport is, of course, subsidies, especially those for diesel, LPG and kerosene, though those on fertiliser and foodgrain are also large. Data circulated by the petroleum ministry indicate under-recoveries by oil marketing companies (OMCs) of Rs 17/litre on diesel, Rs 33/litre on kerosene and Rs 347/cylinder on LPG."

The OMCs need to be compensated for these losses by the government because if they are not compensated then they will go bankrupt. And if they go bankrupt then you, I and everybody else, won't be able to buy petrol, diesel, kerosene and LPG, which would basically mean going back to the age of tongas and bullock carts. Clearly no one would want that.

So to deal with expected losses of Rs 2,00,000 crore the government has around Rs 5,080 crore of the budgeted amount remaining. This means that the government would have to come up with around Rs 1,95,000 crore from somewhere.

This is a very large amount of money. The government has tried to curtail these losses by increasing the price of diesel by Rs 5 per litre and thus bringing down the losses to Rs 12 per litre. This move is expected to save the government Rs 19,000 crore, which means losses will now amount to Rs 1,75,000crore (Rs 1,95,000crore - Rs 20,000 crore) in total.

Since 2003-2004, the government has had a formula for sharing these losses. The upstream oil companies like ONGC and Oil India Ltd, which produce oil, are forced to share one-third of the losses. But there have been instances when the formula has not been followed and the upstream companies have been forced to chip in with more than their fair share. In 2011-2012, the last financial year the government forced the upstream companies to compensate around 40 percent of the total losses.

If the government follows the same formula this year as well, it would mean that the upstream companies would have to compensate the OMCs to the tune of Rs 70,000 crore (40 percent of Rs 1,75,000 crore). Now that is a huge amount, whether the upstream companies have the capacity to come up with that kind of money remains to be seen.

But assuming that they do, it still means that the government would have to come up with Rs 1,05,000 crore (60 oercent of Rs 1,75,000 crore) from somewhere. This would mean that the fiscal deficit would be pushed up to Rs 6,18,190 crore (Rs 5,13,590 crore + Rs 1,05,000 crore). If the upstream companies cannot bear 40 percent of the total loses the government will have to bear a greater proportion of the total losses, pushing the fiscal deficit up further.

Oil subsidies are not the only subsidies going around. The government is expected to overshoot its food subsidy target of Rs 75,000 crore as well. The Economic Times had quoted a food ministry official on 15 June 2012, confirming that the food subsidy target will be overshot after the government had approved the minimum support price (MSP) of rice to be increased by 16 percent to Rs 1,250 per quintal. "The under-provisioning of food subsidy in the current year is at Rs 31,750 crore. Now, with increased MSP on paddy (i.e. rice), the total food subsidy deficit at the end of the current year will be about Rs 40,000 crore, putting immense pressure on the food subsidy burden of the government," said The Economic Times, quoting a food ministry official.

If we add this Rs 40,000 crore to Rs 6,18,190 crore, the deficit shoots up to Rs 6,58,190 crore.

Some of this is already showing up. In the first four months of the year, the government's fiscal deficit was greater than half of the budgeted fiscal deficit for the year. The targeted fiscal deficit for the year was Rs 5,13,590crore. Half of it would equal to Rs 2,56,795 crore.

The government has already crossed this in the first four months. Going forward at the same rate, it would end up with a fiscal deficit of Rs 7,70,385 crore (Rs 2,56,795 crore x 3) by the end of the year. This would work out to 50 percent more than the projected fiscal deficit of Rs 5,13,590 crore.

It would be preposterous on my part to project a fiscal deficit which is 50 percent more than the projected deficit. But as I had shown a little earlier, a deficit of around Rs 6,60,000 crore is pretty much on the cards.

What does not help is the fact that things aren't looking too good on the revenue side for the government. As Acharya puts it in his Business Standard article, "More recently, there are ominous, if unsurprising, indications of a significant deceleration in direct tax collections up through August, especially from companies, with gross corporate tax revenues stagnant compared to April-August of the previous financial year. Despite finance ministry reassurances, tax collections for the year could fall significantly below budget targets because of sluggish economic activity."

So the government is not going to earn as much as it had expected to through taxes. The government also has set a disinvestment target of Rs 30,000 crore. It hopes to earn this money by selling shares of public sector companies. But six months into the financial year there has been no activity on this front.

Taking these factors into account, a fiscal deficit of Rs 7,00,000 crore cannot be ruled out. The fiscal deficit, as we all know, is expressed as a proportion of the gross domestic product (GDP). The projected fiscal deficit of Rs 5,13,590 crore works out to 5.1 percent of the projected GDP. The GDP in this case is assumed to be at Rs 1,01,59,884 crore.

With a fiscal deficit of Rs 7,00,000 crore, the deficit as a proportion of GDP works out to 6.9 percent (Rs 7,00,000 crore expressed as a percentage of Rs 101,59,884 crore).

The GDP number of Rs 101,59,884 crore may also go awry. The assumption is that the GDP will grow by a nominal rate of 14 percent over the last financial year's advance estimate of GDP at Rs 89,121,79 crore. The trouble is that the economy is slowing down and it is highly unlikely to grow at a nominal rate of 14 percent.

The current wholesale price inflation is around 7 percent. The real rate of growth for the first six months of the calendar year (i.e. the period between 1 January 2012 and 30 June 2012) has been around 5.4 percent. If we add that to the inflation, we are talking of a nominal growth of around 12.5 percent. At that rate the expected GDP for the year is likely to be around Rs 1,00,26,201 crore (1.125 x Rs 89,121,79 crore).

Hence the fiscal deficit as a percentage of GDP will be around 7 percent (Rs 700,000 crore expressed as a percentage of Rs 100,26,201crore). A 7 percent fiscal deficit would give the Prime Minister Manmohan Singh a sense of dj vu. In his speech as the Finance Minister of India in 1991 he had said "The crisis of the fiscal system is a cause for serious concern. The fiscal deficit of the Central Government...is estimated at more than 8 per cent of GDP in 1990-91, as compared with 6 per cent at the beginning of the 1980s and 4 per cent in the mid-1970s."

One way out of this mess is to cut the losses due to the subsidies on diesel, kerosene and LPG. But that would mean a price increase of Rs 12/litre on diesel, Rs 33/litre on kerosene and Rs 347/cylinder on LPG. That, of course, is not going to happen. Also with the government having to borrow more to meet the increased fiscal deficit, the interest rates will continue to remain high.

Despite the diesel price hike, India is staring at a huge economic problem. The question is whether the government is ready to recognise it. As Pratap Bhanu Mehta writes in The Indian Express "The central driver of good economics is recognising the problem." The good news is that the government's actions yesterday indicate it is at least beginning to recognise the problem. Whether it will be enough is another question.

Vivek Kaul is a writer. He can be reached at vivek.kaul@gmail.com

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by Vivek Kaul

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