Policy prescription: MoF's economic review presents a realistic assessment

The latest monthly Economic Review, by the Department of Economic Affairs under the Ministry of Finance, released this week, has done well to present a realistic assessment of the current macroeconomic situation, along with a policy path. It’s been over two months since the beginning of the conflict in West Asia, with no resolution in sight. The Strait of Hormuz, through which about one-fifth of global crude oil passes, has been blocked by both the United States and Iran. Amid continued uncertainty, prices of crude oil rose again on Thursday, with benchmark Brent crude trading above $125 per barrel, compared with about $70 before the start of the conflict. While the global economy is suffering because of the conflict, countries like India are particularly exposed because of their considerable dependence on the region for imports of crude oil.

 

The review is spot on in saying that several international agencies seem “guilty” of assuming a quick restoration of energy supplies. However, it’s worth noting that many governments, including those starting the conflict, also seem to have assumed that it would end quickly with minimal disruption. However, Iran’s resistance and resolve have altered the conflict’s nature. Therefore, it is unclear how long the impasse will persist or how a durable resolution will be achieved. One clear message from the West Asia conflict is the need to build buffers of key inputs, and this should not be limited to oil and gas. It has been witnessed that countries can weaponise their dominance in the production of critical inputs and commodities. Coming back to oil, some countries have passed on the increase in prices, and some have not. India is in the latter category.  The government reduced special excise duty on petrol and diesel to protect the oil-marketing companies (OMCs) to some extent. However, reports suggest the OMCs may see under-recoveries of about ₹80,000 crore just on the sale of liquefied petroleum gas this financial year if present level of losses persists. They are also estimated to be facing large losses on the sale of petrol and diesel. This is not a sustainable position, and prices have to be adjusted. This will have implications for growth and inflation outcomes. Projections of a deficient monsoon would only complicate matters for Indian macroeconomic managers.

 

In the given context, the review notes that many countries may be tempted to shore up near-term growth and protect employment. However, the need to maintain macroeconomic stability must also be kept in mind. The review recommends pushing the reforms agenda. For instance, the decriminalisation and deregulation process must continue. Simplifying processes, which helps lower the cost of imports and exports, can be extremely useful in the present circumstances. Taxation policies need to be made more certain and predictable. The review has also emphasised attracting capital flows and noted that all agencies need to come together in this regard. India runs a current-account deficit and is also facing capital outflows. In unfavourable circumstances, India needs to do much more to encourage foreign investors to invest. Thus far, the government has managed the situation reasonably well, possibly assuming that the crisis would be resolved quickly. However, with continued uncertainty, it will have to make adjustments. The objective should be to preserve macroeconomic stability and boost medium-term growth prospects.