September 2012 has been quite an eventful month for India. In the past two weeks there have been tremendous amount of discussions and debates on the recent reform process that the current government UPA-II had proposed and is now implementing. There have been a lot of speculations and conflicting opinions on what the outcome of these policies will be.
Basically there are two things that the government decided to alter this month- FDI in retail and fuel price hike. There have been other reforms as well like allowing foreign investments in the aviation sector (which is very much needed), but retail revolution and the diesel price hike are the two policy changes that are in the limelight due to their pervasive effects for both the economic and political sphere and the population as a whole.
It all started with the Diesel price hike by Rs. 5 on 14th September 2012 along with a subsidy cap on LPG cylinders. It is has been seen that international oil prices have been pretty high the past few years with the entire world economy struggling with the gloomy conditions. While in other countries like the US, fuel prices fluctuate daily corresponding to the world prices- it is not the same in India. The Indian government has always protected the people by providing huge subsidies to prevent prices from escalating. But since world prices have been rising (ranging from around $80 per barrel to $170 per barrel) and since India imports over 80% of the fuel consumed, the subsidy gap has been becoming increasingly onerous for the government.
To protect the common from the high prices and to prevent the cascading effect a hike in Diesel prices will lead to- the government refrained from increasing the price for as long as it could. In return, the oil subsidy expenditure for year 2011-12 alone was about one lakh forty thousand crores which would have reached two lakh crores if the prices wouldn’t have been hiked. Even with the five rupee hike, the government will incur a subsidy expenditure of around one lakh sixty thousand crores for 2012-13.
A country, when it starts to develop, provides subsidies to give an incentive to the industrial sector to develop and for consumers to consume and induce growth. But gradually, as growth takes place, it is economically sensible for these subsidies to be withdrawn as these subsidies are a massive expenditure for the government. But the same hasn’t been the case in India. Withdrawing subsidies will lead to strong political implications which is why all political parties refrain from doing so; they rather provide more subsidies to strengthen their vote bank.
It has been noted that countries like India, China and Indonesia provide massive subsidies on oil to keep their domestic prices low. Consequentially, the world demand for oil isn’t falling and henceforth world prices are not falling either. Countries like US and UK, which have no subsidies, have seen their demand for oil fall as the prices have risen. That’s how it is supposed to work- Efficient Market Mechanisms.
On the other hand comes the major policy change that has been undertaken- Foreign Direct Investment in Retail. Two years ago, Congress had put forward the proposal for allowing foreign direct investment in the retail sector. In colloquial terms, that means letting Walmart and the likes to set up in India. But if was rejected in the Parliament as it was felt that it would be a very anti populist decision. Where India as a democracy won then, the people as a whole lost out on something very essential.
Once again this has been put forward by the government. While the government is going forward with this decision (which seems to have been taken quite positively by both the Sensex and the CII), it has faced strong opposition from various political parties.
What does allowing FDI in Retail basically mean?
It means that foreign companies will be allowed to set multi brand retail stores in India provided they partner with an Indian company and that they can hold a share of 51%. Also, the cabinet has given an OK to 100% FDI in single brand retail. They can directly procure goods from the farmers (the primary producer) and the system of intermediaries and middlemen can be abolished that drive up the prices.
What are the concerns?
Very briefly, there are three major concerns:
- One of the concerns is that it will lead unemployment as small stores and middlemen will not be able to sustain themselves.
- Secondly, it is also felt that prevailing supply chains will break down and the farmers will be exploited by these foreign companies as they will be dependent on them, especially for technology improvements.
- Thirdly, Indian retail sector will face international competition and the international prices will drive up the domestic prices. And we can't afford that as inflation is already a long prevailing, important concern.
Therefore, it is felt that opening up this sector to foreign investment can have catastrophic effects for the people.
As always, there is flip side to these concerns.
It is expected that employment will not fall; rather it is expected to create over 1.5 million jobs in the next five years. The average size of a Walmart store is about 85,000 sq. ft and the average turnover per store is about US$ 51 million. It has been growing annually at an average rate of 12%. In contrast, in India, only 4% of total retailers have above 500 sq. ft. and the average turnover of a retailer is approximately Rs. 186,075. Clearly, with such a high growth rate and turnover, foreign investment in retail will create jobs.
Also, India's infrastructure is severely lacking. That is fact that we have to accept. We complain about food prices rising when there are tonnes of food crops and vegetables that rot as we do not have the necessary storage capacity and the desired level of transportation system. Tonnes of perishable goods, well, perish due to the lack timely transport. To counter this, it has been said that all foreign multinationals that invest in India in retail will have to investment 30% of the revenue in building infrastructure. This is a very significant condition.
Bringing these two major decisions together, the fact is that the government expenditure far exceeds its revenue. India’s fiscal deficit stands at 5.7% of the GDP. Its current account deficit had hit a record of 4.1% of the GDP for 2011-12 and increased to 4.5% of GDP for the period January to March 2012. This data is quite alarming, and quite like what the situation was in 1991. But the present solution is not to curb imports and subsidise exports because our focus is also to bring back India’s growth to 8-9% from the 5.5% level.
To curb its expenditures is the main reason for the government to raise diesel prices and put a cap on LPG subsidy. Where Mamata Banerjee’s claims of increasing the LPG subsidy cap to 12 to 24 cylinders per year may appeal to the population on the whole; the claim is economically disastrous. About 50% of the population still survives with less than 6 cylinders a year. Therefore, this subsidy cap should not really hit the poor.
As Swaminathan Aiyar says, “the idea that the government can make the common man or the middle class happy by providing an additional subsidy is the most bankrupt politics.” Growth provides incomes, growth provides employment, and that is what people need. Not subsidies. Reviving back growth will generate incomes and create jobs. Economy has to grow faster to absorb the new labor force. Hence, that should be the focus.
And to revive back this growth it is extremely essential to bring down the CAD. To do this, government expenditure needs to be curtailed i.e. subsidies need to be done away with, well, at least reduced. Secondly, growth will take place when we are able to increase foreign reserves without cutting down on imports and subsidising exports. And to do this, foreign direct investment is being opened up in sectors like that of retail. When foreign multinationals invest in India, they bring with them jobs, new value chains and processes, and most importantly information and technology that they have spent years in developing and patenting them. A technology transfer takes places in India.
Why now and why not in 1991? This is because India today has the consuming power to take advantage of it which probably it didn’t have ten years ago. There are economies of scale. Agricultural productivity will improve, transportation will improve, and finally the consumer will also benefit.
When a policy change happens, it happens across all sections of the economy. It is not that these policies will benefit only some sections of the economy. Economic growth affects each section.
Strong opposition, organising protests and 'Bharat Bandh' is no solution. According to the Confederation of Indian Industry, the bharat bandh or the strike on 20th September 2012 opposing FDI in Retail and Diesel price hike let to a loss of Rs.12,500 crore to the Indian economy in terms of trade; ;et alone other damages!
To conclude, I would say that in my opinion these two changes have been very much needed. While on the above a hike in diesel price is not favourable, things can get much worse if it isn’t done. Goods will get expensive, but we probably live in difficult times. And protecting consumers by subsidies is only temporary protection for the people. When policy changes took place in 1991, the Narsimha Rao government also faced strong opposition. But the fact is when other parties took over the country; none of them reversed these policy changes. And that is something that needs to be thought about.
Economics always gets diluted by politics. But every time, everything should not be politicized. Subsidies and protection from foreign companies does not guarantee election and votes. Growth of the economy as a whole does, or should!
