Economy and Public Policy | There are no stones to feel while crossing the river

Representational image.

In the noticeably short term, say less than five years, decision paths and trade-offs are clearer than in the long term, say more than 10 years. This is why governments make sensible short-term bets but like most individuals, it flounders while taking decisions from the long-term perspective.

Consider the case of the COVID-19 pandemic — a short-term disruption lasting for around half of a year more than the previous major global financial crisis in 2008-2009 lasted. The Union government did well to step up welfare spending to replace lost income by shifting the implicit additional tax burden of indirect taxes to the relatively better off via higher domestic petroleum prices (at a time when global prices and inflation were low), and borrowing more than usual to fund the outlay when interest rates were low.

Now the objective conditions have changed. Inflation is high and likely to persist over the next two years. The economy and the employment rate are recovering slowly. But both the interest rates and the public debt burden are increasing. It makes sense to cut back on borrowing, and reel back the enhanced welfare expenditure.

But this is more easily said than done in an economy like India where the bottom quintile lives on the knife’s edge, and when the national elections are less than two years away. A fly in the ointment is also the continuing supply and commodity price disruptions unleashed by the Ukraine crisis.

Global petroleum prices remain on fire with oil at around $100 a barrel, driving global inflation along with elevated food prices. Neither can be ignored by a welfare-oriented lower-middle-income economy like India. Directly subsidising citizens for the combined inflation impact of both, as is happening in the United Kingdom, is beyond the fiscal capacity of the government.

Yet, sensible short-term measures were taken. Excise tax (cess) on petroleum products, which increases retail prices, was cut back in May by the Union government. Additional reductions could help improve the financials of refiners who have maintained the retail price line since May. The more recent ‘windfall gains tax’ on oil production and the export of petrol, diesel, and ATF (other than by 100 percent export-oriented refiners) is a brilliant move which insulates the domestic retail price from change, and yet enhances government revenue.

Compulsory domestic sales of 30 and 50 percent of the volume of petrol and diesel sold this fiscal year by refiners limits the temptation to neglect the domestic market and instead sell abroad, where the sale price is higher. Domestic retail prices are capped by publicly-owned oil companies aligned with the Union government’s objectives of containing inflation.

Could not a stiffer export tax on petrol and diesel have been a better alternative? Not really. Oil prices remain volatile. To hit the sweet spot would have required frequent changes to the tax rate, and courted the possibility that either exports are rendered uncompetitive or alternatively the domestic market is starved. Arbitrary taxes on export (earlier wheat exports were banned) could possibly send negative signals to potential investors. The only mitigating circumstance is that the uncertain global outlook demands unorthodox solutions.

As in a war, where survival itself is at stake, timely short-term decisions ensure survival. It is also simplistic to assume that short-term, practical decisions at a time of great uncertainty, necessarily compromise the future predictability of policy. Nimble, strategic decision-making is at a premium globally, not just in India.

How does the short-term strategy of the Western alliance measure up to its long-term goals? Near-term actions towards long-term carbon commitments were the first to be shelved, in the light of the Ukraine crisis. Plans to phase out coal and petroleum fossil fuels have been mothballed, coal plants are being revived, and pressure is mounting in the United States to explore for new oil reserves.

The crisis in Ukraine has become longer than was originally expected by all participants. Russia is the implacable perpetrator. But the support of China to further their common objective of muzzling the Western alliance has muted the blowback as has the dependence of Europe on Russian gas and oil.

The world does not think less of the Western alliance in letting practicality which is usually a short-term concept — adjust the trajectory of long-term objectives. It is similarly blinkered to believe that the short-term steps were taken by India to deal with the fiscal stress from the Ukraine crisis on top of the cumulative burden of dealing with two years of COVID-19-induced stress would be taken as anything other than hard-headed, just-in-time, nimble policy decisions.

When the facts change, the policy must adapt or be rendered obsolete. This is exactly the way India has played it.

The Union government played it too safe by waiting till May to slash the high excise tax on the sale of petroleum products. Inflation had already reached 6.01 percent in January, nearly 2 percentage points higher than 4.07 percent in the same month in 2021. Excise tax rates should have been reduced well before the 2022-23 budget presentation knowing that it was conservatively constructed to de-risk tax revenue uncertainty. Tax revenues have met budgetary expectations in April and May 2022.

By April, inflation was 7.8 percent with expectations of remaining above the normative outer bound of 6 percent till December 2022 after which a decline to 5.8 percent in Q4 2022-23 is expected, assuming the price of oil at $105 per barrel. Thus far oil (Indian basket) remained at $109.51 in May, $116.61 in June and $110.08 per barrel in July.

The RBI is likely to increase the repo rate to between 5.50 to 5.65 percent, where it was in August 2019, in tandem with the 0.50 to 0.75 percent hike in the US Federal Reserve rate this month. This helps in stemming the outflow of hot money and stabilising the rupee. But insulating the economy from inflation needs a direct deflation of price levels via lower indirect taxes on production inputs and consumables.

To make do with lower resources, the government should review its strategy of high public investment as a normative target. In a COVID-19-afflicted world, enhancing public capital outlays made sense as no other investment was forthcoming. In a post-COVID-19 world, where private investment is reviving, creating demand by putting income in people’s hands can kick start private investments.

Even if the investment outlay is retained at high levels above 4 percent of GDP, the infrastructure policy should distinguish between productive and non-productive capital investment. Excluding ‘bridges to nowhere’, roads, for which the dimensions are far in advance of current traffic needs or dis-incentivising more empty apartments and office buildings is crucial.

Our infrastructure policy should not replicate how the average Indian farmer ‘broadcasts’ seed or applies expensive urea fertiliser given to them at less than 10 percent of the current market cost — by hand sprinkling rather than drip-feeding them. India lacks the financial resources to cover the empty swathes of the country with concrete-like China. Ours must remain a boutique model of surgically untangling the most pressing logistical knots by spending the least amount of public funds.

The most neglected area in public finance is at the intersection of education, social support, and health provisioning. Once the Omicron blues depart, the Ukraine crisis is resolved, and Russia returns to the fold of progressive nations, we will still be struggling with low levels of job creation and growth if we do not take early steps to create a workforce which is educated to work with robots, which is productive enough to earn a living wage by servicing export markets, a health system which provides decent care to all and a social security system (stacked on top of the food security system) which sustains the aged underprivileged, the specially-abled, and the jobless.
Individual policies and programmes address parts of these long-dormant ulcers. The advances in sanitation, affordable homes, and the Ayushman Bharat health initiative are three such. But aggregated results are in short supply.

The Ukraine crisis has reiterated all the wrong lessons from realpolitik — that democracies are not immune to sacrificing the defining principle of sovereignty in self-interest; that friendly, third-party nuclear capability, such as NATO, is of little consequence in protecting non-nuclear countries like Ukraine; that the glue of international trade is powerless to contain geopolitical ambition; and that global supply chains might already be past their ‘sell-by date’ with autarchy and self-reliance being fashionable again, within just four decades of their demise, in the 1980s.

Exploring global waters is tricky. There are no pebbles to feel as you cross the river — only wide known unknowns.

(This article first appeared in the ORF.)

Sanjeev S. Ahluwalia is Advisor, Observer Research Foundation. Views are personal, and do not represent the stand of this publication.