During the first 2 years of its stint, Modi – government did a splendid job sticking to its fiscal consolidation road-map. It achieved fiscal deficit target for both 2014-15 and 2015-16. This was despite a substantial step up in the planned expenditure [a major chunk of this going into roads including rural roads, highways, irrigation, agriculture and railways] besides meeting social welfare commitments etc.
This was the outcome of reforms in the area of FDI [foreign direct investment], ease of doing business and fast track approvals of stuck projects [leading to acceleration in GDP growth and buoyancy in tax receipts] on one hand and rationalization of subsidies on the other. The latter focused mainly on plugging leakages and efficient delivery of subsidy on LPG, food, kerosene etc. Yet, there was an ‘X’ factor.
In June, 2014, when Team Modi took charge, the international price of crude oil was at its peak of over US$ 110 per barrel. Since then, it has been on a downward trajectory plummeting to a low of US$ 30 per barrel as of January, 2016. The gas price too moved in tandem from a high of US$ 14 per mBtu [million British thermal unit] to a low of US$ 6.5-7 per mBtu during the same period.
Considering that India meets 80% of its oil requirement from imports, during 2015-16, it saved a mammoth US$ 50 billion due to decline in oil price. As a result, subsidy on petroleum products [POL] [the excess of cost of import/refining plus marketing and distribution cost over their retail price (controlled by the government)] was only Rs 40,000 crores during 2015-16 down from around Rs 60,000 crores during 2014-15 and 130,000 crores during 2013-14.
In fertilizers wherein feed-stock for making urea is gas, steep reduction in price of imported LNG offered huge saving in subsidy. But, India could not tap it till December 31, 2015, due to a flawed long-term supply agreement with RasGas [Qatar] under which price was pegged at over US$ 13 per mBtu. Yet, in a rare display of economic diplomacy, Modi re-negotiated terms of the agreement to reflect prevailing price thereby reaping this benefit from January 1, 2016.
In this backdrop, a predominant slice of the credit for maintaining fiscal discipline goes to oil bonanza [and to some extent in gas] which not only enabled a massive reduction in subsidy but also helped the government garner extra revenue from increase in excise duty [ED] on POL products [ED was revised half-a-dozen times during last 20 months]. But, this bonanza won’t be available eternally.
Already, oil price has increased from US$ 30 per barrel as of January, 2016 to around US$ 50 per barrel currently. Further increase is not ruled out in view of demand growth [especially from India] on one hand and reduction in supply from non-OPEC [Organization of Petroleum Exporting Countries] countries on the other. Though, for now, the surge may get attenuated by huge pile up of global oil stock [as per assessment by International Energy Agency (IEA)].
Even if oil shoots up to US$ 75-80 per barrel say, from 2017-18, this could lead to surge in subsidies on POL and fertilizers too [as price of gas and other raw materials/intermediates used in its production move in tandem]. This could get out of control especially keeping in mind the massive increase in coverage of the poor [e.g. Modi plans to extend LPG subsidy to 50 million more poor in next 3 years on top of 30 million already added during 2015-16].
To cope up with this scenario, continued focus only on ‘incremental’ reforms will not work. Modi will have to demonstrate appetite for big bang reforms. He should gear up for urea decontrol and direct subsidy transfer to poor farmers [this has been pending for long; in fact, as per road-map recommended by Expenditure Reforms Commission (ERC) in 2000, this should have been done 10 years back].
The government should get ready for direct benefit transfer [DBT] of all fertilizer subsidies [including decontrolled P&K fertilizers which currently get subsidy under Nutrient Based Scheme (NBS)]. Already, a committee under Shanta Kumar has recommended a flat subsidy to be given to farmer on per hectare basis which will also empower him to use nutrients the way he wants keeping in mind the soil needs. This recommendation should be implemented promptly.
In the LPG segment, Modi should not hang on to his current approach of requesting people to give up voluntarily. Till 2014-15, almost all of this subsidy was cornered by better-offs including the very rich. Under the “GiveUp” campaign, only 10 million have surrendered which is not even 5% in a total of 180 million beneficiaries. The government should knock-off all the better-off and restrict subsidy only to the poor. This brooks no delay.
Likewise, in kerosene, the current gradual approach [only some pilot projects are being run in some districts] should give way to a major over-haul. There is no rationale for continuing with the present scheme when, almost the entire subsidized kerosene is siphoned off for adulteration of diesel benefiting dubious traders and those sitting in the establishment who let this happen for a price.
The food subsidy is another area where transition to DBT is happening at tortoise speed. At present, this is being tried on a pilot basis in 3 union territories. At this pace, meaningful reform in this segment cannot happen even in a decade. The government should break-away from this inertia sooner than later. It will also have to get cracking on other subsidies such as power, irrigation, seeds etc.
Apart from aforementioned surgical reforms in subsidies, it should also implement measures to bring in competition, efficiency improvements and cost reduction in POL products, fertilizers and food via de-regulation and free imports thereby breaking the monopoly of public sector undertakings [PSUs] especially in POL and food.
All of this needs to be done within 2 years or else the monster of oil price as and when it surges will terribly upset the fiscal consolidation apple cart which may even impede investment by the government in turn, jeopardizing growth.