Economics vs politics PDF Print E-mail
Saturday, 08 September 2012 00:00
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Diesel hikes, downgrades and development-spend

While petroleum minister Jaipal Reddy has been constrained to say the political opposition to hiking prices of fuels like LPG and diesel was a classic case of “politics defeating economics”, it may not remain that way for long. With the fiscal deficit for just the first four months of the year already equalling 51.5% of the year’s target, it is likely to overshoot significantly, more so since global crude oil prices have risen even more after the ECB bond-buying announcement. In which case, India’s credit ratings are under grave threat, and global credit rating agencies have made it clear they are looking for credible signs of policy action. While the finance minister has announced a slew of measures, including putting GAAR on hold and possibly even rolling back the retrospective tax amendment, this is nowhere near enough. If rating agencies are not convinced there is a credible plan to fix the fisc, a rating downgrade taking India to junk level looks likely.

Though the RBI Governor has said India will be able to manage, this seems more like wishful thinking. With the current account deficit projected to be 3.5-3.6% of GDP, foreign flows are critical, and these are going to be negatively affected by a downgrade. Inward FDI has already halved to $5.6 billion in Q1FY13 from $12.2 billion in Q1FY12, net FII flows have fallen to just $728 million in April-August FY13 from $2.2 billion in the same period in FY12, and ECB inflows were minus $409 million (India’s ECB repayments exceeded inflows) in April to July FY13 as compared to plus $5.4 billion in April to July FY12. Though NRI deposits are up nearly six-fold, this still leaves a deficit that is uncovered.

In other words, a ratings downgrade can very quickly translate bad economics into bad politics as well. While the doubling of per capita incomes in the last five years as compared to diesel prices going up by just a third means there is considerable scope for hiking diesel prices while leaving the common man no worse off, the larger point is that development-spend also rises only with GDP growth. With GDP growth rising from an average of 3% in the FY95 to FY03 period to a whopping 7% in the FY04 to FY10 period, development expenditure growth rose from around 8.9% per annum to 17%. That’s pretty simple economics. And even simpler politics.


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