Union Budget 2012-13: Reform or head-back to a 1991 type crisis

Written by: Sunil Fernandes

Union Budget 2012-13: Reform or headback to 1991 type crisis
In 1991, India averted a major economic debacle, when the current account deficit, fiscal deficit and falling rupee all led to an economic crisis, with the nation having foreign exchange reserves to meet just a few weeks of imports.

All of the three are rearing their ugly head once again. The situation is not as grim as it was then, but the sharp rise in fiscal deficit, which is now projected to be more than 5.6% of GDP (as against 8.4% in
1990-1991) suggests that we need to be cautious.

The current account deficit on the other hand is way above the 1991 level. In fact, in 1991 the current account deficit was near 3%, while currently it is way beyond 3%. Though one must admit that the foreign exchange reserves currently are far superior and enough to meet at least six to seven months of imports. However, with the fast depreciating rupee and global economy still in doldrums, the current account deficit may widen, unless caution is exercised.

The rupee has compounded the problems further by making imports costlier and widening the fiscal and current account deficit. Of course it recently touched historic lows in December of Rs 54 and has recovered to Rs 50 per dollar since.

Subsidies need to be handled and handled really fast

The major problem for the country continues to be crude. Crude oil has put a strain on the fiscal deficit, and also on the current account deficit and the currency as well. Petroleum products (apart from petrol) are subsidised by the government, which means that the government bears enormous subsidy burden for domestic LPG, kerosene and diesel. Now the government has been hit by a double whammy. On the one hand, crude prices globally are hitting fresh highs, while on the other a fast depreciating rupee is making cost of oil even dearer.

Apart from the crude problem the government has food and fertilizer subsidies. Rough estimates suggest that all subsidies put together would cost the government more than Rs 220,000 crore. Should the government stop subsidising, India’s twin deficits would drop alarmingly, making India’s economic fundamentals quite robust.

Biting the bullet

Clearly, the government faces a huge predicament. Should it take a re-look at subsidies to contain the fiscal deficit, there would be a huge political uproar, with its own allies even withdrawing support from the government. Apart from that, the government has already faced a debacle in the just concluded state elections and any deregulation of subsidised products, especially diesel may see its popularity plunging to abysmal depths, as deregulation, would lead to severe price rise for the common man.. On the other hand if it does not do so, it leaves the economy in shambles.

It's a case of getting stuck between the devil and the deep blue sea.

What the government needs to do?

The government must bite the bullet and take a hard look at subsidies. It must simultaneously liberalise and push through the reforms agenda. This would be the last budget in which it can do so, as the Budget for 2013-2014 is expected to be a populist budget given that the subsequent year would be an election year.

It's not going to be easy for Finance Minister, Pranab Mukherjee, given his political compulsions. However, he's known to be a smooth operator when it comes to politics and he now needs to apply it to economics.


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