Subsidies dilemma: sound economics or political survival

NEW DELHI Mon Mar 19, 2012 6:51pm IST

Prime Minister Manmohan Singh (C) addresses the media on the first day of the budget session in New Delhi March 12, 2012. REUTERS/Stringer

Prime Minister Manmohan Singh (C) addresses the media on the first day of the budget session in New Delhi March 12, 2012.

Credit: Reuters/Stringer

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NEW DELHI (Reuters) - For India to reach its target for cutting the budget deficit, Prime Minister Manmohan Singh would almost certainly have to raise prices for subsidised fuel products.

For Singh, it is an unhappy choice between sound economics and political survival. Since the former risks bringing down the government, he is likely to sacrifice budget discipline to hang on to power.

The annual budget unveiled on Friday set a goal of easing what has become a crippling subsidy burden, largely due to rising global oil prices, but it gave few details on how to get there.

Singh himself conceded that he will have to "bite the bullet" on subsidies after a budget presentation that aims to push the subsidy burden below 2 percent of GDP - from 2.4 percent now - and get the fiscal deficit down to its targeted 5.1 percent of GDP in the year starting April 1.

It is a tall order for a coalition government of peevish allies that seems to weaken by the day. Cheap diesel and cooking fuel, as well as food and fertiliser subsidies, are vote-winners in a country where vast numbers of the population are poor.

Railway minister Dinesh Trivedi quit on Sunday under pressure from his own party, a partner in the coalition, less than a week after proposing an increase in passenger fares for the first time in eight years. His exit underscored just how hard it is for Singh's government to make prudent but unpopular decisions.

Sanjaya Baru, a former media adviser to the prime minister, said that to meet its fiscal targets, Singh has no choice but to ruffle feathers of his already fractious coalition partners.

"The era of reform by stealth is over: unless you create a consensus this is not going to be easy," Baru said, predicting that the government would not have the stomach for a step that could bring its own downfall.

Raising fuel prices could destabilise the ruling coalition to the point that it breaks, leading to elections in a matter of months, two years ahead of schedule.

Not doing so risks further eroding New Delhi's already dismal fiscal credibility, further driving up borrowing costs and crowding out desperately needed investment. Including shortfalls at the state level, India's fiscal deficit is the highest among big emerging economies.

Bond yields shot up to their highest in 10 weeks after the budget's target for market borrowing by the government topped expectations.

Sluggish investment, in turn, means India's capacity for non-inflationary growth has shrunk to about 7 percent, from 8.5 percent before the global financial crisis.

For Budget graphics package, click link.reuters.com/cyt96s

The only real hope of hitting the budget target relies on circumstances beyond the government's control, including a prolonged drop in world oil prices, a dramatic upturn in the economy and unexpectedly strong returns on the sale of state assets. All are unlikely.

SLIPPERY OIL TARGETS

Singh's government has freed the price of petrol, viewed as a rich person's fuel, but has not mustered the courage to do so on diesel, which is more widely used, including for farming.

India last raised diesel prices in July 2011. Since then, global oil prices have risen about 13 percent, which partly explains why India's fiscal deficit will hit 5.9 percent of GDP in the year ending this month, far above the 4.6 percent goal, as oil subsidies were nearly triple the target.

Absent prompt and dramatic fuel price increases, the new year's deficit target also looks out of reach. India has budgeted just 436 billion rupees for oil subsidies, roughly two-thirds its bill for the current year.

Critics say India's targets for food subsidies and proceeds from the sales of state assets also look ambitious.

The budget assumes an oil price averaging $115 per barrel, which is less than the current price of nearly $126.

Morgan Stanley expects India to miss its fiscal deficit target in the new year by half a percentage point, predicting a gap of 5.6 percent of GDP.

Jahangir Aziz, chief India economist at JPMorgan, said that if oil averages $125 a barrel in the coming fiscal year and LPG and kerosene prices are not raised, diesel prices would need to rise more than 10 rupees a litre -- nearly a quarter -- to meet the budget target.

"In light of the furore that has accompanied the recent modest increase in railway prices, an increase of this magnitude would appear challenging to say the least in the current political environment," he said.

FRENEMIES

The biggest threat to the survival of the ruling coalition comes from firebrand leader Mamata Banerjee whose Trinamool Congress party brings a crucial 19 seats to the government in parliament.

In December she forced the government to roll back plans to allow foreign supermarkets, thwarting a signature reform and dealing a humiliating blow to Singh's Congress party. It was she who forced the resignation of the railway minister, a member of her own party, for his proposed rise in fares.

Raising diesel prices could be the last straw that sees her withdraw from the government. In anticipation of that, Singh's party is courting another regional grouping, the Samajwadi Party (SP), which has 22 lawmakers, as a potential replacement partner to preserve its parliamentary majority.

However, it is far from certain that the Samajwadi Party or other coalition allies would support unpopular policy moves that could cost them votes in the general elections due by 2014.

Singh may in the end decide not to risk the survival of a government that is already at its weakest since coming to power eight years ago.

For more than a year it has been hammered by a string of corruption scandals, it is stuck in a policy paralysis and a flop in recent state elections has further undermined the Congress party's political strength, making it all the more vulnerable to the demands of mercurial coalition allies.

"The crisis will intensify and their ability to cope with it will diminish. The government is being buffeted on all sides and it will have to give way at some point," said political analyst Swapan Dasgupta.

He said that if the government did raise fuel prices it would wait until the parliament session ends in May to avoid a confidence motion that could topple it. However, he said it was not clear that Singh had the nerve for such a step.

"I believe they will just blunder on until 2014, and to hell with the deficit," he said.

(Editing by Neil Fullick)

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