Energy subsidies and BoP

Complacency on fiscal policy can trigger external crisis

Prime Minister Manmohan Singh did well to reiterate his government’s commitment to a rational energy pricing policy by categorically stating that the government would do with diesel what it has already done with petrol. Deregulate them as well. For too long has the United Progressive Alliance government — and the Congress party — dithered on the issue. Even when the government was willing to take some difficult decisions, the party would subvert these politically. Consequently, despite staring a mounting crisis in the face, the government has dragged its feet in dealing with the challenge of high oil prices, rising losses of oil companies, growing burden of oil bonds and the high fiscal deficit. This combination of factors was the focus of the Kirit Parikh committee which recommended the dismantling of the administered price mechanism for energy prices and a return to the path of deregulation. In reiterating his government’s intention to stay the course, the prime minister has underlined the seriousness of the situation. For nearly a year now, analysts have been raising questions about the fiscal sustainability of India’s energy and other subsidies. In the run up to the general elections of 2009, and in the context of the global economic slowdown and the fiscal stimulus packages put in place, few were willing to upbraid India. But with a renewed focus on the fiscal sustainability of growth, there is once again a closer scrutiny of India’s “subsidy Raj”.

An International Energy Agency (IEA) study on “petroleum prices, taxation and subsidies in India”, done in June 2009, (available at: www.iea.org/papers/2009/petroleum_pricing.pdf), concluded that if India did not reduce its energy and related subsidies, and continued to rely on oil bonds for financing the losses of oil companies, it could well face a “1991 type” crisis of external confidence. According to the IEA study, “Current energy policy in India has contributed tangibly to increased fragility and instability in India’s central government finances. This illustrates the huge impact of petroleum product pricing on the health of India’s national Budget and on India’s macroeconomic stability as a whole. With India being the world’s fourth-largest economy (in purchasing power parity terms), macroeconomic instability of this kind is of global concern. With the onset of global recession, local economists have begun to worry about India’s emerging ‘twin deficits’ (i.e., simultaneous structural budget and current account deficits) — a domestic situation which last culminated in India’s ‘Gulf War’ balance-of-payments (BoP) crisis in the early 1990s.” Surely, it is too alarmist for anyone to suggest that India is quite near any such external payments or fiscal crisis. On the contrary, it is the overall robustness of the extant macroeconomic situation that has largely induced complacency in the management of external and internal deficits. However, the fact remains that a stable economic situation can easily get destabilised if structural weaknesses on account of mounting subsidies and unrealistic pricing of scarce resources is allowed to persist without end.