Need to raise petrol prices urgently, says Rangarajan

Moneycontrol Bureau

The government needs to raise petrol prices urgently to address the twin problems of fiscal deficit and current account deficit, C Rangarajan, Chairman of Prime Minister's Economic Advisory Council told CNBC-TV18 in an exclusive interview today.
"There will be a temporary impact on WPI (wholesale price index) inflation when petrol prices are raised, but the impact on fiscal deficit will be much more if (petrol) prices are not raised," Rangarajan told CNBC-TV18.
Cutting fuel subsidy, or in other words, hiking retail fuel prices is the key to the government lowering its fiscal deficit as well as trimming its import bill as crude accounts for roughly a third of the total bill.
Rangarajan said the slide in the rupee was much more than anticipated, and that the problem was being aggravated by lack of foreign capital flows into the country. The rupee today touched a fresh record low of 55.82 to the dollar today even as the Reserve Bank of India is using every weapon in its arsenal to support the currency.
"What is really needed is to revive sentiment to enable large capital flows," he said, adding that the RBI should use forex reserves to prevent abrupt swings in the rupee, and the government should use broader macro economic policy as a tool to encourage capital flows.
Rangarajan supported the RBI's decision to directly intervene in the forex market to support the rupee as it was necessary to indicate the central bank's ability to intervene.
Lack of policy reforms has been a key dampener for foreign investors, and the government's decision to amend tax laws retrospectively has further alienated global investors.
Rangarajan dismissed some foreign brokerages projections of 6.3% GDP growth forecast this fiscal, and said growth would be closer to 7%. He expected strong growth in agriculture on the back of good monsoon, services to sustain last year's growth momentum, and manufacturing too to grow well on last year's small base.
He disagreed that inflation was a structural problem, but said that the increase in farm minimum support price (MSP) every year was one of the biggest contributors to inflation.
He was hopeful that the government would take some strong action shortly, and that both inflation and current account deficit for FY13 would be lower than that last year. Rangarajan saw productivity increases as one of the key to moderating inflation. Below is the edited transcript of the interview on CNBC-TV18. Also watch the accompanying videos. Q: Are you personally a bit surprised at the pace of the decline in the rupee versus the dollar because it seems to have taken most economic participants. The direction may not have been in question but the pace seems to have surprised everybody?
A: I think the fall has been much more than what was expected. But, the underlying factors pointed towards decline in the value of the rupee. The current account deficit has been high, on the rise and the capital flows have not been buoyant. Therefore, the result in pressure on the rupee was evident.
It all depends upon how the capital flows play out. If the capital does not flow in then automatically with a high level of current account deficit the currency begins to depreciate, sometimes fast and sometimes slow.
_PAGEBREAK_ Q: What is the principle reason for this very sharp decline? Is it our weakening macro, the twin deficits etc or is it sentiment led by the weakening global situation and the fear of a euro crisis which is looming? The global or the local factor, what could you give more weightage?
A: It is just the position of two factors. First is the high level of current account deficit. Even though I do expect the current account deficit in the current fiscal to be somewhat lower than last year, certainly 3% plus of the GDP of the current account deficit is a very high level.
Earlier also we have had a current account deficit of 2.8% of the GDP. But, that did not cause any problem because the capital flows were adequate but what is happening now is that the capital flows are not adequate. In fact, they seem to have slowed down very considerably and therefore, against the background of a high current account deficit if the capital flows do not happen, then automatically it has a pressure on the rupee.
To some extent, the decline in the capital flows or the drying up of capital flows is also due to what is happening in the international situation. The Greek episode, the Greek crisis, the inability of the European countries to come to some decision as to how to resolve the problem- all of this is raising the risk perception in these countries.
Therefore, capital flows have become extremely shy. I think that is one of the major reasons for the sudden fall in the value of the rupee. Q: I want to come to your statement. You used the phrase to a certain extent the global problem is the reason why capital flows have slowed down. Is it also to do with how Indian macro and policies have shaped up? Would you concede that’s one important reason why flows have been lacking over the last many weeks and months?
A: No, I was saying that the sudden drop in the value of the rupee is due to the fact that the capital flows have dried up due to the external factors. But, there is an underlying trend about the slowdown of the capital flows.
That is because of certain perceptions regarding the growth rate of the economy, the high level of current account deficit and the high level of fiscal deficit. These factors do play on the minds of the investors and that is why the earlier we take action to correct inflation, to correct fiscal deficit, the better off we will be. Q: So far the Reserve Bank's direct intervention in the market by supplying dollars has been very limited. Apparently they came in this morning but only to a small extent and they stepped back – would you be an advocate of them being more aggressive with direct interventions to pull the rupee back using our forex reserves?
A: The forex reserves are there to be used. I think the very purpose of the foreign exchange reserves is to enable the central monetary authority to intervene in the market. But a view has to be taken whether what is being seen is the result of fundamental factors or is it because of the temporary set back in capital flows.
If the perception is that it is because of the set back in the capital flows for a short period, then intervention is most effective because it is filling a gap for the time being. But, if on the other hand the perception is that the capital flows are not going to be adequate and so long as the current account deficit remains high, it will have an effect on the rupee then perhaps the intervention may not be justified.
I think it is important for the central bank to come into the market from time to time in order to stem the steep fall in the value of the rupee because sometimes the markets over shoot. The markets always have a tendency to take it beyond what is justified by the circumstances. Under those situations, I would still think that the central bank has a role to play by intervening in the market. Q: Which of the two scenarios are we in now according to you? Is it a temporary capital mismatch that we are dealing with? In that case, would you advocate a far more aggressive deployment of reserves to protect the rupee?
A: I think it's both. As I said, the temporary slowdown in the capital flows is due to what is happening in the European situation. But the underlying facts about the capital flows are also there. Therefore, I think more or less the line that has been adopted by the Reserve Bank seems to be appropriate. Q: You have been a central banker in the past. In this situation, would you have protected the rupee from going down to this 56 kind of level that we find it this morning by supplying more dollars in the market directly?
A: No, I think this is a decision that only people who are managing the affairs can decide. It is very difficult for people from outside to make the judgement. Certainly, intervention on the part of the Reserve Bank should not be ruled out.
If the impression goes that it will not intervene at all, it will have an adverse impact. Therefore, I would advocate the Reserve Bank to follow the policy it has been following. Q: Let me ask your views about one issue which is, the fact that the oil companies are significant buyers of dollars and whether it's prudent to take their demand out of the market at a time when supply is not there by the Reserve Bank directly dealing with that. Are you a votary of that?
A: Well, it has been done in the past. If I may say so, it has been done in my time. But things have changed quite a lot since then. While oil marketing companies demand can be met, there maybe other bulk users of foreign exchange who may also want to come and claim that kind of a privilege.
It is also somewhat difficult to decide at what rate the dollar should be released to the oil marketing companies or anybody to whom bulk foreign exchange is being released. But, that's an option which should not be ruled out, one that has to be weighed carefully.
_PAGEBREAK_ Q: You used it in your time as you said. Is the time ripe for such an intervention? I am not saying you should tell the RBI what to do but in your personal assessments as things stand today, is the time right to revisit such a strategy?
A: I agree with you on revisiting the strategy. But, the other complications in the light of changing circumstances will also have to be looked into by the RBI. All that I can stay at this stage is that it is an option that should not be ruled out. Q: I will ask about yet another tool which has been employed in the past, which is millennium deposits from the SBI, which can at least in the moment tide over the temporary mismatch of supply of dollars that we are seeing in the market. Is it a good route to go down?
A; It is a route to follow but the timing has to be appropriate. When the rupee is falling fairly steeply that may not be the right time to do it because the perception about the rupee also enters into the calculation of the people.
Therefore, the millennium development bonds or something similar to it is not really an option to cover temporary shortfalls. It is essentially is a measure to overcome the fundamental shortfall in the capital flows. I think it's an option that we should explore but the timing will have to be decided carefully. Q: Are you saying that done at this point, it would smack of desperation on the part of the government and may even lead people to get even more bearish on the currency?
A: I think the perception regarding the rupee has to change slightly before we can introduce that. Q: Then what kind of ammunition does the RBI have? If you are saying dealing directly with oil companies is something which should be contemplated, not rushed into and the timing for millennium deposits is not right. What ammunition does the RBI have at this point, besides forex reserves to deal sharply with the depreciating currency?
A: The important thing is to make the investors aware and conscious that the growth story of India remains intact and there is potential for the economy to grow at 7%, even in the most difficult times.
What is really needed is used to revive the sentiment and enable larger capital flows to come on their own. Use the foreign exchange reserves to prevent abrupt falls, abrupt dislocation in the market. But use the broader macro economic policy stance in order to attract more investible funds into the market. Q: You are speaking about reviving sentiments at a time when two of the most influential investment banks- Morgan Stanley and CLSA have downgraded their GDP growth targets for this year to 6.3%, a number that we were not hearing earlier. Do you think things could get as dire as that and this must be weighing on the minds of people who are looking at the currency today?
A: I do not think that estimate is a justifiable one. I still think that the Indian economy will grow close to 7% in the current fiscal. Agriculture will do well. The prospects for the monsoon are reasonable. The service sector did well last year too.
The manufacturing sector will do better, partly for the reason we are staring with a low base. But, I also expect some action to be taken by the government and therefore, taking all the factors together, the Indian economy will grow close to 7% in the current fiscal. I do think a growth rate of 6.2 or 6.3% as a forecast is pessimistic. Q: This despite the kind of IIP numbers and general industrial feedback that you are seeing from the manufacturing sector because that seems to be disappointing a lot of people including you on the way down?
A: Yes. I know. But remember, the 6.9% rate of growth estimate for last year takes only 3.9% as the growth rate for manufacturing. The growth rate or the growth was contributed more by services and agriculture. Looking into the current fiscal I think the agricultural growth rate will be as much as last year.
The services sector growth rate will also be reasonable and the manufacturing growth will be higher, will certainly be higher than 3.9%. The sentiment may be low but I do think that will be the action on the part of the government.
For example, the inflation rate in the current fiscal will be definitely lower than last year. This itself has led to a situation in which there is some easing of the interest rate situation. I also think that the public sector will make a significant contribution in terms of the output of the key infrastructure sectors like coal, power and roads. This itself will act as a big stimulant, as far as private investment and private production is concerned. Q: What is the possibility of a big pass down in fuel prices since you brought up the issue of inflation as early as this week? Do you think there will be significant pass through which has not happened since late last year, since the month of January?
A: I think the need to raise the petroleum prices is very urgent. I think we have a double whammy with international crude prices remaining high, the rupee has depreciated. All of this clearly indicates that we need to take action in order to compensate for the high international crude prices.
Therefore, the earlier the action is taken the better because as you know, the budget has provided only Rs 45,000 crore (forty-five thousand crore rupees) as subsidy for petroleum products. That will not be adequate if we do not take action.
I know that temporarily when petroleum prices are raised, it has an impact on wholesale price index as well as the consumer price index. But that is something that we have to take in our stride because the impact of higher fiscal deficit on inflation will be even more severe.
_PAGEBREAK_ Q: If that temporary spike in inflation does happen over the next few weeks, the last inflation reading was not great, do you think the Reserve Bank can follow up its 50 bps cut in the next few months or is it unlikely too as many market participants feel?
A: I think the Reserve Bank will look at the price situation and therefore, the dominant factor influencing Reserve Bank’s policy will be the behavior of inflation. The impact of any increase in the administered prices will be properly discounted by the Reserve Bank.
What the Reserve Bank will be looking for is outside of the impact of the increase in the petroleum prices, what is happening to the price index. Unless that happens to be showing significant downward direction, it will be difficult for the Reserve Bank to alternate its policy.
But certainly, I think what the Reserve Bank will be looking for will be a decline in the non-food manufacturing prices after taking into account the impact of the petroleum price increases. Q: I know inflation will come down because of the high base of last year, at least temporarily. But with Consumer Price Inflation, the CPI Index is consistently showing 10% plus, inflationary expectations are going up and getting so deeply entrenched that we may have a structural inflation problem, not just a cyclical one. Which is about to end sometimes soon?
A: No, I think the word structural inflation is not a very clearly defined parameter. Certainly there are in-built factors which contribute to higher level of inflation. In the case of food articles, we have the Minimum Support Price for cereals and certain other commodities. If year-after-year we keep increasing the minimum support prices for these commodities at about 10% then certainly it will have an effect upon inflation permanently.
This apart, I do not think that there are other factors in the economy which will always result in a higher inflation. I think productivity increases are possible even in agriculture. Certainly, it is possible in the other sectors of the economy.
To come back to the point, yes the crude oil prices for example are again supply side phenomenon. If the international crude prices start rising then they have an impact upon the prices within the country as well.
Therefore, I would say there are two factors, if you want to call it the structural factors contributing to inflation. One, the continuous increase in the Minimum Support Price of cereals and the impact of the increase in price of international crude.
That apart, there are other factors which must be contributing to moderate inflation. Productivity increase is the important factor here. Therefore, to come back to the point that you raised earlier, I believe it's a temporary factor.
The rise in the petroleum prices will have some upward impact on inflation, but we have to take it in our stride and see whether outside of that we can bring down the inflation. Q: This is something which is being spoken about by a lot of people that maybe, India is in an economic situation today which is probably the worst since we saw the crisis of the early 90s, the twin deficits, faltering growth, very weak sentiment both for businessmen and consumers on policy front. Do you recall in the last 20 years a situation where India’s economics have looked more fragile than they look today?
A: No, I think there are several ways of looking at the economy. One way of looking at the economy is that we came out of the impact of the international price rises very quickly. We had two continuous years with 8.4% growth rate and even last year, the growth rate of 7% or close to 7% is a good growth rate considering the international economic situation.
These are factors that are in a sense comforting and they are different from what we saw in 1991 or 1990. Also while the foreign exchange situation is tight, we do have reserves which can be utilized. This is also a situation which is very radically different from 1991.
Having said that, I accept the fact that inflation remains high, the current account deficit is also high and the fiscal deficit is also high. That is why I say that we need to address these three factors immediately. Term inflation, ensure that the fiscal deficit remains through the budgeted level and work towards a lower level of current account deficit.
If we do that, I think the sentiment will reverse. The sentiment will order for a change and it will attract investment. But let me in conclusion say that I still expect the growth rate in the current fiscal to be close to 7%.