Oil pricing 'bungled' by Govt in last few yrs: ICRIER

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Shankar Acharya, Member of the Board of Governors at Indian Council for Research on International Economic Relations, or ICRIER, said oil pricing has been 'seriously bungled' by the government in the last few years. Government should raise fuel prices gradually and more frequently, he said. He also said Indian growth will slacken in the near and medium-term. India's medium-term prospects are poor if oil stays over USD 100 per barrel.

Excerpts from CNBC-TV18's exclusive interview with Shankar Acharya:

Q: Give us your thoughts on this oil situation that we are faced with and what is the way for India to deal with this problem, which is affecting all our macros so adversely?

A: The oil situation is central to the weakness in our overall economic situation particularly the macro and there is no easy quick fix to it. The government in the last three-four years has seriously bungled the whole oil pricing matter. The prices have been going up for the last three-four years, it did not happen yesterday.

Adjustment of our own retail prices, which are unfortunately controlled, has taken place very hesitantly and with great infrequency. In fact, there has been very little adjustment even after the most recent hike. You have a situation where there are large subsidies, which are being disguised by the oil bonds. These are not really disguised, people have seen through them now. In effect what is happening is the fiscal deficit, instead of being 2.5% for the Central government as the minister said it would be, it is more likely to be 6-7% or at least 5% for the year. That together with the state�s deficit will come to about 8%-10% fiscal deficit, which certainly spooks a lot of investors.

Q: As you said there is no easy way out of this but what is the lesser devil in your eyes?

A: What we do is what we should have done, which is gradually increasing the fuel prices petrol, diesel, kerosene and LPG. So, that will reduce the level of under recoveries and deficits that go with it. At the same time, we should give up on this oil bonds business, make it a clean subsidy from the government to the oil marketing companies. By going the oil bond route, what you are doing is essentially giving bits of paper to these oil marketing companies which they find hard to use to purchase inputs or maintain their operations or even buy oil from abroad.

The limits of the Fiscal Responsibility and Budget Management (FRBM) act will be breached but from an economic point of view that has already been breached. So, all that you will be doing is making transparent what is going on in a opaque way.

Q: What I also meant by the lesser devil is the trade off between a fiscal deficit problem, inflation and a growth problem on the other hand, if these prices were to percolate down. What is the right balance between the two in your eyes?

A: That is the argument for adjusting oil prices slowly and not doing it overnight, which is the way to handle it. This sort of thing has happened five-six years ago, when the oil went from about USD 10 per barrel to USD 30 per barrel; it is a 300% increase and was handled by 3-4 adjustments of oil prices and followed by a system, where by you did every month a small adjustment. That system went on till about 2003 after which, for some political reasons it broke down and that�s been unfortunate. Something like that has to be resurrected.

On the issue of trade off between inflation and growth, the way it is going to strike, as deficits have already mounted and as their implications rollout during the year you are going to see relatively higher interest rate scenario. That has all the consequences it had in the past, which means that cost of funds will go up, availability of the funds will go down. Therefore, the ability of the financial system to support high levels of investment will be constrained, not to mention margins being also lower of all the companies concerned. So, you will see slackening in growth during this year. I am more worried about the medium-term beyond this year.

Q: A lot of global analysts seem to think that even if crude oil prices were to cool down once in the near-term, it could remain in the more than USD 100 per barrel kind of zone for the next many months and years. If that be the case, is it inevitable that it has a huge debilitating impact on our economy or are there any longer term fixes around this central macro problem?

A: If oil remains at more than USD 100 per barrel than India�s medium-term growth prospects have to be shaved down because it is just an unfortunate fact of life that we have to import something like 70-75% of our oil needs and with oil at that price we have to take a hit.

Those countries which are closer to self-sufficiency or are our net oil exporters including Asian countries like Malaysia, China to some extent, they are not net exporters but their self-sufficiency ratio is higher, Indonesia. The prospects of all these countries, relative to ours are less hit by high oil prices. We certainly don�t solve the problem by reducing the profitability of our oil companies because that just means their ability to go out and do new finds to make the right commercial decisions is weakened.

Q: Just to scratch your argument further that growth has to be shave down if oil indeed were to remain at high levels, if indeed we have more than USD 100 per barrel oil for the next many years, do you think India can still grow at more than 7.5%; I am not even talking about 9% on a sustainable basis?

A: Somewhere between 6.5% and 7.5% should be possible in a medium-term sense. This year you will get 7.5%-8% anyway, as the momentum is there. But, beyond that if oil remains high, a lot depends on the measures you take. If the adjustment of these prices are done over time, the firms and individuals will adjust to these prices and will find their way to doing the right thing. If we do some of the reforms, which for a long time have been on hold whether they are in the labour market, in various other fields, or financial sector and so forth then you improve the chances of higher productivity. For those reasons, they can compensate for the lower productivity because of high-energy price.

Q: Do you expect to see a radical change in economic policy and its approach towards the crude and the inflation situation after the current elections are over because the whole policy framework has been totally focused on ensuing political elections at the center? Do you see a radical change, which maybe for the better after the elections are done this time?

A: I do not see a radical change coming. It will be more of muddling through by weak coalition governments and that is perhaps not strong enough to meet the challenge. It is a very serious challenge that we are facing from this, essentially something like quadrupling of international oil prices over a period of four years and a doubling in the last year alone.

So, it is a big challenge and not enough attention is being paid to it in our political economic decision-making. I do not see that the future political consolation that will emerge after the next election will do a better job.

Q: Having observed our economy for many decades, would it be fair to say that India�s macros look the weakest that you have seen in the last five years? When was the last time you saw so many headwinds facing the economy and how we dealt with that experience?

A: Last time, the fiscal front was weak around 2001 or thereabouts, even 2002, when the combine fiscal deficit was in the order of 9%-10% of GDP. Growth during that period was quite slow at 5.5% or so. If you look at the pattern of our economic growth, it tends to slowdown when fiscal deficit is on an upswing, which was happening between 1997 and 2002. It tends to improve when the fiscal deficit is coming down, which was the case between 2003 and 2007.

It is not a one-to-one mechanistic thing but the tendency to my mind is clear enough and there are reasons for it. Essentially interest rates go up, availability of funds goes down and all those reasons. So, there is weakness. The very strong thing is that there are some differences now, which are of course the high levels of savings and investments, which today are driving the economy. Whether they can be sustained is an open question but we are in a better shape on that score today than we were in 2001-2002.

Q: What about interest rates so far the bankers seem a little reluctant to say that they will pass down the repo rate and interest rates. They do not say very convincingly that rates are headed up in the system, what is your sense of how much interest rates could rise from here in the current environment?

A: It is pretty much a mug�s game to give actual numbers but the direction is very clear that the rates are going to continue to harden. You only need to look at the ten-year government securities (G-Sec) to see that they have hardened as well as some of the short-term rates. Exactly how much they will harden is very hard to predict. It depends on what will be the trajectory of international oil prices and therefore the extent of under recoveries by the marketing companies, the level of petro bonds and things like that will play out during the year. Overall, if oil prices remain anywhere near where they are and even if they are above USD 100 per barrel then I would expect to see continuing hardening of interest rates in the coming months.

Q: What�s your take on this whole Mean Reversion theory, which some people seem to like in our economy that every four or five years, if we get above trend growth then inevitably after four-five years you tend to drop back for a couple of years into that 6.5-7% zone for economic growth. In 2007 everybody was talking about the fact that the Mean Reversion does not hold India can grow on sustainably at 9-10% over the next five-seven-eight years but now things look a bit different?

A: I am not particularly sympathetic to the Mean Reversion theory or any theory of that mechanistic kind. Growth is a product of a number of factors, which have their interplay but it is not all that mysterious. So, all this business and if you are well above average it will come down, it depends on policies. If we do take the right policies then we are more likely to sustain a period of high growth, if we don�t take the right policies, which manifestly we have not done in the last three-four years, then the high growth that we have experienced in the last four-five years is a subject to risk, which is what we are seeing today.