In the aftermath of the crisis of 2008-09 the government of India boosted fiscal spending in order to counteract the sharp slowdown in demand. To a large extent its measures succeeded in preventing a steep decline in GDP growth. But there were two flaws in the government’s policies. One, it continued with its expansionary fiscal policy for far too long. And two, its spending was aimed at boosting household expenditure rather than at augmenting the economy’s productive capacity.
The consequences of these policies are before us now. Global growth is slowing once again. But with fiscal deficit already high the government cannot repeat its expansionary fiscal spending of the last crisis. Having boosted consumption in rural areas through employment guarantee programmes such as MNREGA without enhancing agricultural productivity, we now face high food inflation. And owing to persistently high WPI inflation (owing to, among other factors, the lack of capacity augmentation in manufacturing), the central bank can’t begin to cut policy rates until inflation moderates decisively, despite widespread signs of slowing global and domestic demand. At this juncture, the only option left before the government is to try and boost private investment in infrastructure. This will not be easy. Corporate confidence is at a low in an environment where demand is declining while high input costs and high interest rates are squeezing their profitability.
Another obstacle arises from the nation’s state of politics. Since November 2010 (when the 2G scam broke), the government has been so engrossed in fighting corruption-related charges that policymaking and implementation have taken a backseat.
After the licence raj ended, corruption within the government took a new form — that of payoffs by industrialists to politicians for the transfer of national assets (telecom spectrum, land, mining rights and so on) at low prices. After the 2G scam, this cosy compact between industrialists and politicians has broken down. So great is the fear of being embroiled in a corruption scandal that politicians and bureaucrats are afraid to sanction projects, lest they be accused of favouring a particular private party. This has led to complete implementation paralysis within the government. Now a new mode of operation, wherein resources are transferred to corporates on the basis of transparent norms, needs to evolve. New legislation, such as a draft land acquisition act and a draft mining act, is in the works. But it will be a while (the Winter Session or later) before they are approved by Parliament.
But if economic growth is not to falter, the government needs to urgently get a few infrastructure projects moving ahead. One way out would be to fast-track those projects that are already underway (but have got stuck for some reason) or have already achieved financial closure. The government could also undertake urban development projects in PPP (public-private partnership) mode.
Once a start is made, sentiment could improve and we could well see private investment reviving. After all India is one of the few countries in the world whose structural growth prospects remain intact. If the Indian government can design projects properly and provide the right policy environment, private investment (including overseas) will flow into its infrastructure sector. The big question is, will this government find the energy and focus to make a beginning, or will it choose to merely blunder along on the economic front for the rest of its term, especially given a loaded electoral calendar ahead?
Era of cheap oil is over
India needs to both curtail its dependence on oil and diversify the energy sources that it depends on
In November the price of petrol was first hiked and subsequently rolled back. The rollback was a case of bad economics. Though the price of crude is not on the upswing currently, there remains a yawning gap between the international price of crude and the price of petrol in the domestic market. The hike would have lowered the under-recoveries of oil marketing companies and reduced the government’s oil subsidy burden (estimated to be in the range of Rs 505-598 billion this year, according to estimates by Citi, which assumes an average crude price of $102 per barrel for FY12).
Even though global growth is slowing down, crude prices have not moderated as much as would be expected in the circumstances. One reason, as is well known, is the financialisation of all commodities, including crude. Nowadays prices of commodities are determined not just by the fundamentals of demand and supply but also by fund flows into and out of these asset classes. Moreover, depreciation of the rupee has negated to some extent the benefit of whatever price softening that has taken place internationally.
But above all, a more fundamental factor is at play that is responsible for high oil prices: supply has grown at a meagre rate of 1 per cent annually over the last decade. Currently global production capacity stands at 91-92 million barrels per day while demand is pegged at 88-89 million barrels per day.
This poor supply response is the result of lack of discovery of large oil fields. About 1 per cent of the world’s largest oil fields (numbering 798) account for 50 per cent of production. Of these, 20 supergiant oilfields account for 25 per cent of total global production. Now no new giant and supergiant oilfields are being discovered. Recent oil discoveries have all been confined to small oilfields with rapid decline rates (i.e., their production capacity gets depleted very fast).
Most of the recent increase in production has also come from more unconventional sources, such as deep-sea oil and tar sand oil. Such sources are more expensive to tap. Their high cost of production sets a floor below which the price of oil can’t decline.
A tight demand-supply equation also has the potential to cause sudden flare-ups in the price of oil. Under normal circumstances, a buffer of 3-4 million barrels per day between supply and demand is considered safe. When this buffer shrinks, a spike occurs. In 2008, for instance, high demand from emerging markets caused the buffer to shrink. Prices then soared to $150 per barrel. With the Chinese and Indian economies now becoming more energy-intensive, the scope for much of a slack between demand and supply is unlikely.
A disruption in supply also has the potential to send crude prices soaring. In the first part of 2011 the price of Brent crude soared to $120 per barrel when supply from Libya got curtailed due to the political upheaval in that country. With the Middle East still in a state of political ferment, a recurrence of supply disruption from another country cannot be ruled out. Natural phenomena such as a hurricane in the Gulf of Mexico could also disrupt supply.
What needs to be done?
Over the long term, India needs a policy that, one, reduces its dependence on oil, and two, leads to usage of a more diversified range of energy sources.
To begin with, the government needs to impose stricter fuel-efficiency standards on vehicles. Two, it needs to develop quality public transport systems in all the major urban centres so that people have to depend less on private vehicles.
The level of subsidy on oil products also needs to be reduced gradually. It is only when consumers feel the heat of high prices that they will adopt fuel-conservation practices, including buying fuel-efficient cars instead of gas guzzling SUVs.
To induce more people to shift to gas-based vehicles, gas pipeline networks and CNG fuelling stations need to be set up even in state capitals and smaller towns. Corporates need to encourage greater use of video conferencing to replace travel by executives. A more widespread and better enforced ban on plastics will also reduce crude consumption for production of plastics.
If we don’t make these changes now, India will always be hamstrung by an egregiously high fuel subsidy bill, which will in turn make it difficult for the country to rein in its fiscal deficit.