A suitable strategy

Print edition : July 04, 2008

Murli Deora, Petroleum Minister, and P. Chidambaram, Finance Minister, at a function in New Delhi.-SUBHAV SHUKLA/PTI

As the neoliberal edifice crumbles in the face of rising prices, a rationing regime becomes the only way of protecting the poor from their impact.

THE basic problem for India with the rise in world oil prices is that an additional levy is being imposed upon it by foreigners outside its tax jurisdiction. Had they been within its tax jurisdiction, then this additional levy could have been taxed away from them, which would have been akin to oil prices not rising. But now this levy has to be paid on existing crude imports. Those who get this levy are unlikely, in the short run, to be demanding Indian goods with it; we cannot, therefore, pay this sum through additional exports. If we cannot curtail imports, then we just have to borrow this sum, that is, pay for it through a rise in our net external indebtedness. This, prima facie, is not difficult at present since we have huge foreign exchange reserves, which are nothing else but IOUs of other countries held by us, running down reserves amounts to the same thing as an increase in our net indebtedness, and can pay this additional levy.

But this is an unwise move, for two reasons. First, the reserves are a stock while the additional levy is a flow. Unless the reserves are expected to increase each year by at least as much as this levy, we will run out of reserves in following this course. Secondly, unlike in the case of China, our foreign exchange reserves are based largely on short-term financial inflows, which are like borrowings that are currently hoarded but could be taken away at any time. Hence, we cannot afford to dip into them without risking a liquidity crisis. If the rise in world oil prices were a temporary one, then perhaps we could, with impunity, use up the reserves to finance this additional levy.

But it may not be temporary, in which case we have to cut our import bill in the face of this rise.

Of course when the countrys net external indebtedness increases, that greater debt is incurred by some entity within the country. This entity, in the present case, is the government. Corresponding to the increase in net indebtedness, therefore, there has been a rise in fiscal deficit (which has been camouflaged through oil bond issues that are not counted as fiscal deficit). But the problem lies not with the rise in fiscal deficit, that is, not with which entity in the country is incurring the debt, but with whether the country can sustain a rise in its net external indebtedness. If it cannot, then a shift of the borrowing burden from the government to the non-government sector for financing a given quantum of imports, does not help; and if it can, then the higher fiscal deficit per se does not matter.

To see this latter point, let us imagine that our foreign exchange reserves are, like Chinas, built out of our own current account surpluses and not out of debt-creating inflows. In such a case, even if the government does not raise petro-product prices and pays the entire additional amount due to foreigners, arising out of the world oil price rise, through a fiscal deficit, that is, through borrowing from the Reserve Bank of India (RBI), then all that happens is that the RBI simply substitutes government IOUs for foreign exchange reserves in its assets. There is no increase in reserve money in the economy, no increase in money supply, no inflationary overhang, no excess demand for goods and services, and no acceleration of inflation.

The problem, therefore, arises not because a fiscal deficit per se is bad, but because we cannot with impunity run down reserves which are, unlike Chinas, built out of speculative financial inflows. And yet it is surprising to see not only the Prime Minister but the entire community of economic commentators subscribing to this fiscal-deficit-must-be-avoided-at-all-costs argument, which Joan Robinson, the renowned economist, had called the humbug of finance. This humbug has, alas, been sold to India by international finance capital.

If the country cannot afford to raise its net external indebtedness, then there is no alternative to cutting imports. And the hike in petro prices, though decreed in the name of reducing fiscal deficit, which is a red herring, is a measure for curbing our import bill. Indeed that is its rational kernel. But to achieve a cut in imports, a petro price hike is both an extremely costly measure for the economy and an ineffective one to boot.

Its modus operandi is bizarre. First, petro-product prices are raised; where petro-products enter as inputs into production by oligopoly-dominated industries, the prices of these latter industries outputs, which are usually a mark-up over their unit variable costs, are also raised; where these latter industries outputs enter as inputs into other oligopoly-dominated industries, then their prices too are raised, and so on. Hence petro-product price increases give rise to a cost-push inflation in the economy relative to money wages.

Even if some employees get protection against this price increase through increases in their incomes, the vast majority of workers do not. The objective in short is to usher in an administered inflation in prices relative to money wages. This gives rise to a reduction in the overall demand for real goods and services in the economy, and hence to a contraction in output, employment, and, it is presumed, imports.

This complex modus operandi is not often recognised. Instead, it is simply presumed that a rise in petro-product prices will reduce the demand for petro-products, in accordance with textbook economics. But the demand for petro-products is not particularly price-elastic, at least in the short-run, which is why in the world market as a whole even a doubling of oil prices over the last 12 months has led to no perceptible reduction in the demand for oil. What buyers of petro-products with fixed incomes typically do in the face of price hikes is to curtail their demand for other goods, to be able to pay the higher prices on an unchanged quantity of petro-product purchases. But this too causes a contraction in output; and it may cut imports, both of petro-products and of other goods (hence avoiding a depletion of exchange reserves). Thus, the cut in imports here can come, if at all, through the recessionary impact of the petro-product price hike, that is, of the administered inflation.

Interestingly, the main argument advanced against the price hike has suggested instead a cut in excise and import duties, which, if the fiscal deficit remains unchanged, must entail a cut in government expenditure, and hence also a recession.

The argument against the governments position on the petro-product price hike, in other words, has rightly emphasised that an administered inflation, at the expense of the working class and other fixed-income earners, is a repugnant way of inducing a recession; but it has not emphasised that a recession itself is a repugnant way of cutting the import bill. This is because the critics of the price hike too are distracted by the fiscal red herring introduced by the government into the discussion. Not only is a recession a repugnant way of cutting the import bill; it is typically ineffective as well. Whether the recessionary impact follows an administered inflation or whether it is induced by cuts in government expenditure, the sectors most affected are not the modern sectors, which are directly and indirectly highly import-intensive, but the other sectors that are not.

Rural development expenditure, welfare expenditure for the poor and social expenditure are typically where the cuts take place when the government cuts back its expenditure. These are precisely the expenditures whose direct import content is small. What is more, the incomes generated by government expenditure in these sectors are also typically spent on commodities that have low import content.

Hence, the entire implicit government strategy of curbing imports by engendering a recession through an administered inflation is objectionable, for at least three reasons. First, its modus operandi for inducing a recession is by squeezing the working population, even though the same end can be achieved without such a squeeze. Second, its modus operandi for curbing imports is by inducing a recession, even though the same end can be achieved without the pain of a recession. Third, a recession may not even achieve this end at all, in which case an inflationary recession would have been unleashed to no purpose, that is, would not even have reduced the rise in net external indebtedness caused by the crude price increase.

In this last case, which is the most likely fallout of the petro-product price increase, we would have had a double squeeze on the people, through a reduction of the real incomes of the employed, and through a rise in unemployment, and yet no amelioration of the basic problem of increased net external indebtedness.

Of course, it may be argued that since the Indian economy is currently experiencing high inflation caused by excess demand pressures, especially in the market for food articles, introducing a recessionary impulse, even if through an administered inflation, may be desirable. But since the objection to inflation arises from its being against the poor and working people, any so-called solution to inflation that works by squeezing these very segments is no solution at all.

What then should be our response to the crude price increase? If the price increase is considered to be non-transient, if the foreign beneficiaries of this price increase are unlikely in the near future to stimulate through their demand an Indian export splurge (as had happened in the mid-1970s), that is, if the assumptions behind a sit tight strategy are invalid, as they appear to be, then there is no alternative to the introduction of petro-product rationing, at prices that are kept steady. If the current crude prices persist, then, compared to the situation a year ago, nearly 4 per cent of the gross domestic product (GDP) will be getting additionally drained away each year at current levels of imports. This is unsustainable and clearly calls for drastic import cuts.

No doubt the term rationing conjures up unpleasant images of long queues, but the intensity of rationing can be calibrated, and the mode of rationing can be made relatively painless. For instance, since the government itself is a major consumer of petro-products, a simple directive to effect cuts in consumption can be a starting point. But just as in the current era of high food prices there is no alternative to a revamped ration-system, likewise in the current era of high oil prices (which underlie high food prices because of the substitutability between food and biofuels) there seems to be no alternative to the introduction of a ration system for petro-products.

There are three obvious advantages of rationing: first, it ensures that the import cut, required for negating the increase in net external indebtedness, actually happens; secondly, by ensuring the curtailment of imports for final, as opposed to intermediate, demand, it can prevent output contraction and hence increased unemployment; and thirdly, it can ensure that the incidence of the curtailment of final demand is distributed equitably among social groups and classes, certainly more equitably than with an administered inflation. In short, between rationing, on the one hand, and inflation-induced recession, on the other, as weapons for offsetting the increase in net external indebtedness, rationing is indubitably superior.

The introduction of petro-product rationing at fixed prices, however, will release purchasing power for other uses. To prevent this released purchasing power from exacerbating excess demand pressures, it must be mopped up through higher taxation of incomes. The alternative means of countering the impact of such released purchasing power, viz. through cuts on government expenditures, is inadvisable, since it may hit pro-poor schemes such as the National Rural Employment Guarantee Scheme (NREGS).

Such mopping up will entail a reduction in the fiscal deficit. But to ask for such a reduction in fiscal deficit as a complement to rationing, in order to avoid any addition to excess demand pressures, is different from the humbug of finance.

A reduction in fiscal deficit under the latter perception, through a rise in petro-product prices, as the government has done, lowers effective demand and is recessionary; but a reduction in fiscal deficit along with petro-product rationing at fixed prices, is not. It is meant to prevent excess demand pressures at existing levels of activity.

The regime of rationing-cum-taxation protects the working class against possible inflation, defends real wages to the extent feasible within an overall reduction in domestic absorption, prevents recessionary and unemployment-generating tendencies, and is a surer means of reducing net external indebtedness. As the neoliberal edifice crumbles in the face of skyrocketing food and oil prices in the world economy, a rationing regime becomes the only way of protecting the poor and the vulnerable from their impact.

A letter from the Editor


Dear reader,

The COVID-19-induced lockdown and the absolute necessity for human beings to maintain a physical distance from one another in order to contain the pandemic has changed our lives in unimaginable ways. The print medium all over the world is no exception.

As the distribution of printed copies is unlikely to resume any time soon, Frontline will come to you only through the digital platform until the return of normality. The resources needed to keep up the good work that Frontline has been doing for the past 35 years and more are immense. It is a long journey indeed. Readers who have been part of this journey are our source of strength.

Subscribing to the online edition, I am confident, will make it mutually beneficial.

Sincerely,

R. Vijaya Sankar

Editor, Frontline

Support Quality Journalism
This article is closed for comments.
Please Email the Editor
×