Writing on the wall

Rising fuel prices, stagnation in industry, agrarian crisis, growing unemployment. In the last lap of its tenure, the Narendra Modi government is sinking into a crisis that is mostly of its own making.

Finance Minister Arun Jaitley and Prime Minister Narendra Modi.

AS the rupee plumbs newer depths and petroleum prices, unshackled by the Narendra Modi-led National Democratic Alliance (NDA) government’s love for the free market, rise on a daily basis, there is no knowing where the Indian economy is heading. The rise in prices; the depreciation of the rupee against global currencies, particularly the dollar; the stagnation of industry; job losses; deflated bank credit; the collapse of agricultural commodity prices—all these weigh heavily on the Modi government as it enters the last lap of a tenure premised on the promise of “achhe din” (better days). But like Nero who fiddled when Rome burned, Modi merrily continues to roll out old schemes cloaked in new vocabulary.

The excessive centralisation of power in the Prime Minister’s Office, demonstrated by one of Modi’s first actions on assuming office—dismantling the inter-ministerial groups that were meant to ensure better coordination within the government—was always going to be a double-edged sword. While it ensured his authority as the Supreme Leader, it also ensured that if things went wrong, he would be the target of all the flak that came to the Bharatiya Janata Party (BJP).

Heaping burden

The slide in the rupee and the fuel price rise are connected in the bitter logic of the market. As the rupee weakens against the dollar, the value of dollar-denominated crude oil imports, which account for about three-fourths of the crude oil used by Indian petroleum refineries, translates into higher petroleum prices. It does not take rocket science to figure out that the rupee’s slide is directly and immediately responsible for importing inflation into the country. Nor does one require the services of a pundit in economics to understand that this also immediately translates into a squeeze on the incomes of especially those whose wages are stuck at low levels. Thus, Indians are paying for higher and rising international crude oil prices set in dollar terms, which the Modi government presents as something it can do little about. This is accentuated by the fact that the Modi regime is unwilling to consider options that would provide a measure of protection because this is combined with the relentless slide of the rupee, which worsens the inflationary impact.

Instead, Finance Ministry mandarins have a simple explanation for the crisis: the Current Account Deficit (CAD) has worsened because of higher oil imports, which is responsible for the slide in the rupee, and if this is arrested, all will be well with the economy.

Finance Minister Arun Jaitley’s recent announcement of measures to contain the trade deficit fits well this diagnosis (see story on page 14). In fact, the world is a different place than the one Jaitley imagines it to be. Capital flows, happening at the flick of a switch and which move faster and far more currency than trade can ever hope to achieve, drive international currency rates. In any case, with trade wars unleashed by the United States President Donald Trump—including on imports of aluminium and copper from India to which India has not even responded—looming, there is no guarantee that trade will be India’s path to salvation. It is not a coincidence that in a world inspired by the talk of protectionism, discussion on the World Trade Organisation has disappeared from the radars of the media. In fact, it appears rather odd for a government that claims to be nationalist to walk into a storm that every other country is running away from.

To add insult to injury, Indians hurt by rising prices are being told by these same mandarins that a depreciation of the rupee is just the medicine the economy needs in order to maintain its exports at competitive levels. This is not just absurd, it is downright risible if not for the grave crisis the economy is in. These experts argue that soon, very soon, the rupee will settle down at an appropriate “equilibrium”, if only it is allowed to happen naturally. The logic, repeated ad nauseam , without an iota of evidence, asserts vacuously that the trade deficit would adjust automatically because the slide of the rupee would make imports costlier and exports cheaper. The train of the logic continues through the assertion that once this happens, capital would again flow back. However, both inflation and depreciation can continue together, significantly aggravated by the speculative influence that the rupee would further plunge. Meanwhile, the significantly higher inflation level prevailing in India would at some time hurt even the export competitiveness of Indian entities.

Abiding faith in markets

Thus, the pretension that the government must stay off the market and let the market find its “equilibrium” is not what governments the world over do. It is downright irresponsible to expect people to undergo severe hardship for a whim based on a facile expectation. The expectation of capital inflows, based on the hope of a return to the earlier situation (especially after the Great Crash of 2008) of cheap money seeking higher returns in India, is a pipe dream. Capital is flowing back to the U.S. not just because of the higher interests on offer now, but because of the uncertainty caused by Trumpism. To expect that this could be reversed by tinkering with a few policy measures reflects a vainglorious mindset that is unable to comprehend the complexities of the world of modern finance.

Logically, arresting the alarming increase in petroleum prices would have been one measure that would have not only kept inflation under control but also provided a measure of relief to the people at large. Unlike other imports, these are universal inputs in the sense that they are commodities that enable the economy and its people to remain on the move. Moreover, since they are essentials used across the economy, the increase in prices would have a far quicker impact on the general level of prices. The Modi government has signalled this as a strict no-no, obviously fearing that this would be seen by financial interests (global as well as Indian) as being less than stringent with its fiscal deficit targets.

One of the obvious avenues open to the Modi government would have been to reduce the taxes it levies on petroleum products. Instead, it has asked the States to reduce their taxes on petroleum products. This is not only fallacious but irresponsible from a perspective that reflects a commitment to federalism. In June 2014, a month after Modi assumed office, the price of the Indian basket of imported crude was about $109 a barrel. For three years the Modi government basked in the comfort of lower oil prices (in June 2017, the price of the Indian basket of imported crude was about $47 a barrel—56 per cent lower since it assumed office). Figures for August 2018 (the latest) provided by the Petroleum Planning and Analysis Cell reveal that the average weighted price of imported crude was $72.53—still 33 per cent lower than the price prevailing when Modi took office. These figures reveal that the government did little to use the fortuitous circumstances to provide succour to the people.

There is more in this grim tale of singularly focussing on maximising the Centre’s own tax take. The Central taxes on petroleum, notably the excise duty and the special excise duty, have increased from Rs.1.22 lakh crore in 2014-15 to Rs.2.80 lakh crore in 2017-18—a whopping 130 per cent in a span of three years. If States are being asked to shed some of their taxes, by how much has their tax take on petroleum products increased? Data released by the Petroleum Planning and Analysis Cell reveal that the tax collections on petroleum products by all the States combined increased during this time frame from Rs.1.41 lakh crore to Rs.1.86 lakh crore—an increase of 32 per cent in three years.

States under pressure

Kerala Finance Minister T.M. Thomas Isaac says States bear the immediate burden of an increase in petroleum product prices (see interview on page 18). This is because they bear the burden of running the transport services. When fuel prices rise, it has an immediate impact on a State’s exchequer. Moreover, since fuel and liquor are the mainstay of States’ budgets, it is difficult for States to cut their taxes on petroleum products. Taxes on petroleum products contribute to about one-fourth of the revenues of most State governments. A cut in tax rates on these commodities will jeopardise the delivery of their services. For example, notwithstanding the Modi government’s grand promises of a universal health insurance scheme, much of these services in several States are already being implemented by State governments. A revenue shortfall will hit such services. As Isaac points out, no State government has, unlike the Centre, increased taxes (the Centre levies the excise duty) on petroleum products. So, he is in a position to say: Unlike the Centre, the States have not increased taxes that they should now lower. Significantly, for a party that is ruling 21 States, it has announced a cut in State taxes only in Rajasthan. This was the least that the government could do as it has to face a disgruntled electorate in the Assembly elections later in the year.

The industry’s clamour to bring petroleum products within the ambit of goods and services tax (GST) is not only irresponsible but suggests an amazing degree of ignorance of State finances and the nature of Indian federalism. If these products are brought under GST, it will require a significant reduction in the VAT (value added tax) levied by States on these products. This would require that the States are compensated for the loss arising from a lower GST rate, for which a mechanism does not exist. Isaac said working out such a mechanism would take time, but the prices were rising on a here-and-now basis, daily.

In fact, there was one recourse open to the Modi government. For a government that swears by nationalism—while using it to bear down heavily on any form of dissent or to attack the minority community—it has shown little spine to defend the national interest. It could have dealt with the crisis caused by the surge in global petroleum prices by entering into negotiations with Iran to supply crude on favourable terms. But the Modi government buckled under pressure from the Trump administration, which set a November 4 deadline for the world to stop buying crude oil from Iran.

Chennai Petroleum, a subsidiary of India’s biggest refiner Indian Oil Corporation, has decided to stop processing Iranian crude from October. This despite the fact Naftiran Intertrade Co Ltd., a subsidiary of the state-owned National Iranian Oil Co., has a 15.4 per cent stake in Chennai Petroleum. This unprecedented action of an Indian company in enforcing sanctions on a long-standing equity partner is a clear indication of additional pressure being mounted by the U.S.

Faced with a crisis on multiple fronts, the Modi government pretends that liberal terms to invite investments would have the magical effect of attracting capital flows. In 1991, India initiated economic reforms in the hope that they would enable it to overcome the severe balance of payments crisis. Three decades later, these external imbalances remain and the economy is as fragile as it was then. Indian agriculture continues to be in a crisis and despite all the loud talk, manufacturing activity remains exactly where it was in 1991. A significant change since then is that there is a flood of imports. Although Indian foreign exchange reserves amount to more than $400 billion, foreign entities (foreign direct investment and foreign institutional investors) now own about 56 per cent of all outstanding shares in Indian entities. Effectively, this means that more than half of all profits in Indian companies flow out to foreigners. This highlights the fact that there is less surplus available to invest within the Indian economy. As someone said, we are now, more than ever before, dependent on the kindness of strangers.

For a party that came to power on the tidal wave of anger against corruption, the BJP has come a full circle. The controversy over the Rafale aircraft deal is just one. The contours of a widening scam in the Indian banking sector is another. There is a growing perception that no government in recent times has been as blatantly pro-big business as the Modi government.

As a banking scam of unprecedented proportion, which seeks to dwarf the 2G scam during the UPA’s tenure, looms it is evident that the Modi government is entering its last lap in a state that is a pale shadow of its triumphant entry four years ago. Arrogance and ignorance are bad enough separately, but when these qualities combine to be present in a public authority, it can be disastrous.