How Mamata is denting the rupee and bloating the oil bill
Why the next elections will be a referendum on reforms. Post-Mamata, Mulayam to bail out UPA 'for secularism's sake'
Post-Mamata, Mulayam to bail out UPA 'for secularism's sake'
Tigress, tigress, burning bright, in the forest of the night,
what immortal hand or eye, could frame thy fearful symmetry
- With due apologies to William Blake
Mamata Banerjee‘s pro-people revolt against the UPA is going to make the rupee fall and oil costlier — calling for even greater price increases to fix the hole in the budget. By opposing a price hike in diesel and the six cylinder limit on subsidised cooking gas, she is in fact going to make oil even costlier for India.
This is how it works. A major reason for announcing the so-called economic reforms last week was to get India’s burgeoning oil subsidy bill, which was expected to cross Rs 1,90,000 crore during the course of the year, under some control.
One move was the increase in diesel price by Rs 5 per litre and limiting the number of cooking gas cylinders that one could get at the subsidised price. This was a direct step to reduce the losses that the oil marketing companies (OMCs) face every time they sell diesel and cooking gas to the end-consumer.
The other part of the reform game was about expectations management. The announcement of reforms, like allowing foreign direct investment in multi-brand retailing or the airline sector, was not expected to have any direct impact any time soon. But what it was expected to do was shore up the image of the government and tell the world at large that this government is committed to economic reform.
Mamata’s revolt is single-handedly worsening the oil bill, thanks, in part, to the rupee’s worsening fortunes. AFP
Now how does that help in controlling the burgeoning oil bill? Oil is sold internationally in dollars. The price of the Indian basket of crude oil is currently quoting at around $115.3 per barrel of oil (one barrel equals around 159 litres).
Before the reforms were announced, one dollar was worth around Rs 55.4 (on 13 September 2012). So if an Indian OMC wanted to buy one barrel of oil it had to convert Rs 6,387.2 into $115.3, and pay for the oil.
After the reforms were announced the rupee started increasing in value against the dollar. By 17 September, one dollar was worth around Rs 53.7. Now if an Indian OMC wanted to buy one barrel of oil it had to convert Rs 6,191.6 into $115.3 to pay for the oil.
Hence, as the rupee increases in value against the dollar, the Indian OMCs pay less for the oil the buy internationally. A major reason for the increase in the value of the rupee was that on 14 September and 17 September, the foreign institutional investors (FIIs) poured money into the stock market. They bought stocks worth Rs 5,086 crore over the two-day period. This meant dollars had to be sold and rupee had to be bought, thus increasing the demand for the rupee and helping it gain in value against the dollar.
But this rupee rally was short-lived and the dollar has gained some value against the rupee and is currently worth around Rs 54.27.
The question is why did this happen? Initially the market and the foreign investors bought the idea that the government was committed to ending the policy logjam and initiating various economic reforms. Hence the foreign investors invested money into the stock market, shares rallied and so did the rupee against the dollar.
But now the realisation is setting in that the reform process might be derailed even before it has been earnestly started. This was reflected in the amount of money foreign investors brought to the stock market on 18 September. The number was down to around Rs 1,049.2 crore. In comparison they had invested more than Rs 5,080 crore over the last two trading sessions.
Mamata Banerjee’s Trinamool Congress, a key constituent of the UPA government, has decided to withdraw support to the government. At the same time it has asked the government to withdraw a major part of the reforms it has already initiated by Friday. If the government does that the Trinamool Congress will reconsider its decision.
How the political scenario plays out remains to be seen. But if the government does bow to Mamata’s diktat – which seems unlikely now - then the economic repercussions of that decision will be huge. The government had hoped that the losses on account of selling diesel, kerosene and cooking gas could have been brought down to Rs 1,67,000 crore, from the earlier Rs 1,92,000 crore by increasing the price of diesel and limiting the consumption of subsidised cooking gas.
If the government goes back on these moves, or even stop going further down that road in the months ahead, the oil subsidy bill will go back to attaining a monstrous size. Also, what the calculation of Rs 1,67,000 crore did not take into account was the fact that rupee would gain in value against the dollar. And that would have further brought down the oil subsidy bill. In fact, HSBC, which had earlier forecast Rs 57 to a dollar by December 2012, revised its forecast to Rs 52 to a dollar on Monday. But by then the Mamata factor hadn’t come into play.
Even if the government does not bow to Mamata – there are the Mulayams and Mayawatis to think about and they are not talking any different – the rupee will definitely start losing value against the dollar again. This will happen because some foreign investors may opt to stay away from both the stock market as well as direct investment. In fact, foreign direct investment during the period of April to June 2012 has been disastrous. It has fallen by 67 percent to $4.41billion in comparison to $13.44 billion during the same period in 2011. If the government goes back on the few reforms that it unleashed over the last weekend, foreign direct investment is likely to remain low.
One factor that can change things for India is the if the price of crude oil were to fall. But that looks unlikely. The immediate reason is the tension in the Middle East and the threat of war between Iran and Israel. Hillary Clinton, the US Secretary of State, recently said that the United States would not set any deadline for the ongoing negotiations with Iran. This hasn’t gone down terribly well with Israel. Reacting to this, Benjamin Netanyahu, the Prime Minister of Israel said “the world tells Israel, wait, there’s still time, and I say, ‘Wait for what, wait until when? Those in the international community who refuse to put a red line before Iran don’t have the moral right to place a red light before Israel.” (Source: www.oilprice.com)
Iran does not recognise Israel as a nation. This has led to countries buying up more oil than they need and building stocks to take care of this geopolitical risk. “In the recent period, since the start of 2012, the increase in stocks has been substantial, i.e. 2 to 3 million barrels per day. These are probably precautionary stocks linked to geopolitical risks,” writes Patrick Artus of Flash Economics in a recent report titled Why is the oil price not falling?
At the same time, the United States is pushing nations across the world to not source their oil from Iran, which is the second largest producer of oil within the Organisation of Petroleum Exporting Countries (Opec). This includes India as well.
With the rupee losing value against the dollar and the oil price remaining high the oil subsidy bill is likely to continue to remain high. And this means the trade deficit (the difference between exports and imports) is likely to remain high. Exports for the period between April and July 2012 stood at $97.64billion. Imports, on the other hand, were at $153.2 billion. Of this, $53.81 billion was spent on oil imports. If we take oil imports out of the equation the difference between India’s exports and imports is very low.
Now how does this impact the value of the rupee against the dollar? An exporter gets paid in dollars. When he brings those dollars back into the country he has to convert them into rupees. This means he has to buy rupees and sell dollars. This helps shore up the value of the rupee as the demand for rupee goes up.
In case of an importer, the things work exactly the opposite way. An importer has to pay for the imports in dollars. To do this, he has to buy dollars by paying in rupees. This increases the demand for dollar and pushes up its value against the rupee. As we see, the difference between imports and exports for the first four months of the year has been around $55 billion. This means that the demand for the dollar has been greater than the demand for the rupee.
One way to fill this gap would be if foreign investors bring in money to the stock market as well as for direct investment. They would have had to convert the dollars they want to invest into rupees and that would have increased the demand for the rupee.
The FIIs have brought in around $3.86 billion (at the current rate of $1 equals Rs 54) since the beginning of the year. The foreign direct investment for the first three months of the year has been at $4.41 billion.
So what this tells us that there is a huge gap between the demand for and supply of dollars. And precisely because of this the dollar has gained in value against the rupee. On 2 April 2012, at the beginning of the financial year, one dollar was worth around Rs 50.8. Now it’s worth Rs 54-plus.
This situation is likely to continue. And I wouldn’t be surprised if rupee goes back to its earlier levels of Rs 56 to a dollar in the days to come. It might even cross those levels, if the government does bow to the diktats of Mamata or gets into election mode, where nothing sensible will be done on passing on oil price hike to the consumer.
Since the government forces the OMCs to sell diesel, kerosene and cooking gas much below their cost to consumers, the losses will continue to mount. The current losses have been projected to be at Rs 1,67,000 crore. I won’t be surprised if they cross Rs 2,00,000 crore. The government has to compensate the OMCs for these losses in order to ensure that they don’t go bankrupt.
This also means that the government will cross its fiscal deficit target of Rs 5,13,590 crore. The fiscal deficit might well be on its way to touch Rs 7,00,000 crore, or 7 percent of GDP. (For a detailed exposition of this argument click here). And that will be a disastrous situation to be in. Interest rates will continue to remain high. And so will inflation.
To conclude, consider what happens to the traffic in Mumbai during Ganesh Chaturthi and upto immersion days. Any five people can get together while taking their Ganesh idol to their homes, put on a loudspeaker, start dancing on the road and thus delay the entire traffic on the road for hours. Indian politics post-Mamata is getting to be more and more like that.
Reforms, like the traffic, may have to wait. Mamata’s revolt is single-handedly worsening the oil bill, thanks, in part, to the rupee’s worsening fortunes. By not raising prices now, the subsidy bill bloat further, and in due course we will be truly in the soup.
by Vivek Kaul
MORE from News Updates
- Education Franchisee opportunity
- NCERT Solution
- CBSE Class 9 Mathematics
- NCERT Solutions for class 10 Science
- Sample Papers
- CBSE Class 9 Science
- NCERT Solutions for class 10 Maths
- Revision Notes
- CBSE Class 10 Hindi
- CBSE Class 10 English
- CBSE Class 10 English
- CBSE Class 10 Social Studies
- CBSE Class 10 Science
- CBSE Class 10 Mathematics
- Career In Science After 10
- Career In Commerce After 10
- Career In Humanities/Arts After 10
- Ncert Solutions for Class 10
- Ncert Solutions for Class 11
- Business Studies Class 12 CBSE project