Paying the price of oil

There was a time when the Indian economy — and, in fact, its political climate — was dependent completely upon the monsoon. If you had a bad monsoon, you had a bad year and a troubled government. If you had a good monsoon, you had a bit of growth and a government that felt secure. This is no longer strictly true. Yes, droughts are still dangerous, but the impact of a bad monsoon on the entire economy is no longer catastrophic. Over decades, successive policymakers have worked hard to drought-proof large parts of the country. Prime Minister Narendra Modi has survived two bad monsoons of the sort that badly hurt Atal Bihari Vajpayee; the days when Rajiv Gandhi saw an inversion in popularity thanks to a bad monsoon are long gone. 

Yet the tyranny of the monsoon has been replaced by another, very similar in effect. Once Indian policymakers perhaps wished they could control El Nino; today, their successors have to accept they cannot control OPEC. The global price of crude oil makes or breaks fiscal years and politicians’ reputations. High crude oil prices, as the UPA-II suffered through, provide a cost push to the economy that leads directly to popular unrest about inflation, accusations of corruption, and stumbling growth that dents the government credibility. Declining oil prices, as has been the case for much of Mr Modi’s term, instead provide a nice bump to revenue — Rs 2.5 trillion a year, according to some estimates — and keep prices down, leading to a satisfied middle class and a quiescent corporate world. 

It appears, however, that conditions are once again turning adverse. The global price of a barrel of crude oil is now up around $80 a barrel. India is far from running short of reserves, but there are signs of weakness on the external account — the exchange rate has climbed to close to Rs 70 to the dollar. There is some sign that macro-financial flows have reversed of late, responding to greater uncertainty about the Indian economy and the expectation that interest rates in the developed world are shortly going to rise. So it isn’t just oil: Mr Modi has also benefited from ultra-low interest rates globally that make growth-seeking investment in India look more attractive than the state of structural reform strictly justifies. 

Illustration by Binay Sinha
The government has, sadly, misused the good years. It should have reduced the deficit more sharply than it has, given it got such a windfall from crude oil prices. Instead it has massively increased the wage and pension entitlements of the Centre. State and quasi-state borrowing has increased, meaning that bond yields have spiked sharply, now heading dangerously close to 8 per cent. 

More generally, the troubled years of high costs under the UPA-II should have served as a call to arms, in the way that the disastrous years of famine in the mid-1960s did. Just as the political response to those years was decades of attempting to drought-proof India, the response to the revelation that India’s fate is tied to crude oil prices should have focused the mind on minimising their effect on our external balances and on our politics. This has not been done. 

If India is dependent on the world for its energy, it must make itself useful to the world. It has come to believe instead that it can throw up walls and seek to profit off its own domestic demand. This is in any case a bad strategy, but it is downright laughable given the simple fact that we have no oil. We will never be able to isolate ourselves from the world; we will always need to be globally competitive, if just to pay for our energy needs. Increasing our competitiveness and thus our exports to the rest of the world is not necessary for “simple” reasons like creating jobs and prosperity. Integrating with the world is needed because, without that, we will never be independent of the world. When crude oil prices go up, the relative competitiveness of our exports should act as an automatic stabiliser, moderating the effect on our economy of the price increase. Instead, we have been complacent: The economic affairs secretary said recently that, while the current account deficit might increase by $50 billion as a result of higher prices, the overall macro picture would not change, and that growth would remain strong. But how can growth remain strong if costs go up, without an automatic stabiliser in place?

As importantly, perhaps, the political impact of crude oil prices should have been reduced by policy changes and government rhetoric. Those aspects of spending — and thus the fiscal deficit — that are tied to the price of oil should have been minimised or eliminated. Sadly, we have not done so. In spite of the supposed deregulation of retail fuel prices, they have not been depoliticised. The fact that the normal operation of pump pricing was suspended leading up to the Karnataka election belies the claims about deregulation. The cost to the deficit of this delay is yet to be accurately tallied, but it will be substantial — and, furthermore, it is a harbinger of things to come. Transparent pricing is essential — which perhaps will never be possible completely until the big oil companies are removed from under the government’s thumb. Fuel taxes, meanwhile, need to be brought under a clear and predictable structure and not become subject to political arbitrariness — a system which is sure to cause increases in the deficit when governments come under popular pressure. Already the Opposition seeks to corner the government on the retail price of fuel. It was short-sighted indeed to not take this weapon away from this and future oppositions. 

The fertiliser sector is the source of similar danger. Output prices are largely controlled by the government; but costs are dependent on the price of hydrocarbons. The government, far from freeing fertiliser prices when the going was good, has instead upped its own investment in the sector, promising to build five new plants. This increases the possibility of crisis. We should remember that high fertiliser subsidies were one of the major pressures on the fiscal deficit in the years leading up to 1991. 

A great opportunity has been missed to oil-proof the Indian political economy, in the way it has largely been drought-proofed. Mr Modi does not have long left in office before he faces elections. If the economic narrative turns against him now, then he will perhaps blame global trends — but, in fact, he has only himself to blame.
Twitter: @mihirssharma

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