Budget 2011 in a new light

Pranab, Prince of Serendip

Posted on March 2, 2011 | Author: Swaminathan S Anklesaria Aiyar |

India is in surprisingly good fiscal shape despite populist spending, venal politics and misgovernance.

In ordinary English, a budget lays down what you earn and spend. A government budget determines how much money each department gets, with a clear understanding that nothing more will be given save in exceptional circumstances.

Budget discipline for each department is supposed to ensure that the government overall does not overspend, and that spending priorities are not distorted by excessive demands from this department or that. Departments with lowered allocations are supposed to sack consultants and even staff if salaries cannot be financed from their allocations.

In India, however, budgetary allocations have long ceased to be sacrosanct. Cynics say that the Budget is now simply the starting point for finance ministry negotiations with every department for additional funding. Supplementary demands for grants grow year after year.

This year’s Budget sets a new benchmark in allocations that defy credibility. In one area after another, spending in 20011-12 is budgeted to be less or only marginally more than actual spending in 2010-11.

Sonia Gandhi is a dedicated populist who swears by subsidies, and her National Advisory Council constantly produces new ideas for evermore subsidies. Yet the Budget says subsidies will fall from Rs 1,64,153 crore this year to Rs 1,43,570 crore next year.

The oil subsidy looks like ballooning after the recent surge prices in global prices, yet is projected to fall from Rs. 38,386 crore to Rs. 23,640 crore. Global fertiliser prices are skyrocketing, yet the fertiliser subsidy is projected to fall from Rs. 54,977 crore this year to Rs. 49,998 crore next year. Non-Plan capital outlays (excluding defence) are to be more than halved, from Rs. 27,696 crore to Rs. 13,212 crore.

The food subsidy is to remain virtually unchanged at around .60,000 crore, although procurement prices have gone up and carrying costs for the huge government food stock are high. Something as innocent sounding as “other non-Plan expenditure” is to be slashed from .1,45,884 crore to .1,28,859 crore. Pranab Mukherjee claims in his Budget speech that social spending will rise 17%.

Yet the Budget papers show non-Plan expenditure on social services plummeting from Rs. 35,085 crore this year to Rs. 20,862 crore next year. A small part of this may be explained by the reclassification of some revenue spending as capital spending. Yet look at the bottom line, which is total government spending. This is budgeted to rise just a smidgeon from Rs. 12,16,576 crore to Rs. 12,57,729 crore. Is this possible at a time of high inflation and raging political populism?

Optimists like economist Surjit Bhalla interpret the Budget figures as Mukherjee’s determination to get spending under control. Cynics like me will say the spending targets are no more than the start of negotiations with each department on how much more it will get.

Optimists may think Mukherjee is going to be the toughest finance minister in history, wielding a fearsome budgetary axe. Cynics like me see this Budget as simply the preface to the real spending figures that will show up in supplementary demands for grants in autumn.

Having said that, let me add that the recent era of highly elastic Budget estimates has not been a fiscal disaster. On the contrary, Mukherjee was able to say with pride in his Budget speech that the ratio of central government debt-to-GDP for 2011-12 is now estimated at just 44.2 % of GDP, against the Finance Commission’s recommendation of 52.5%.

This looks very impressive at a time when the same ratio looks like crossing 100% in the US and 200% in Japan. We need to add state government debt of around 24% of GDP, but the resultant consolidated government debt of around 69% of GDP does not look unreasonably high.

The credit goes not to budgetary stringency, but to two other factors: revision of GDP data and buoyant revenue. Based on new GDP deflators, it turns out that we have understated GDP for years, which in turn means we have overstated our fiscal problems for years. Besides, revenue buoyancy has consistently surprised us on the upside, and is doing so again this year. Revenues look like rising 25% this year against the budgeted 19%.

Conclusion: populism in India has not wrecked government finances, as widely feared. India does not require a painful fiscal squeeze that would be politically difficult. Fairly modest steps in the direction of fiscal virtue are enough.

The revenue gains of rapid growth have consistently been underestimated by financial analysts. Fiscal prudence is the last thing on the minds of our venal politicians, who are always looking for ways to buy off voters disgusted by political venality. Yet, without intending it, the populist giveaways of politicians have been well within the limits of fiscal prudence.

This is called serendipity. The word is derived from an Arabian tale of Three Princes of Serendip (a mispronunciation of Swarna-dwip or Ceylon), who had the happy ability to constantly make fruitful and productive discoveries without intending to.

Our politicians too have discovered without intending to that they can boast of fiscal virtue even while indulging in farm loan waivers, enormous oil and food subsidies, and other giveaways. Their aim is to buy popularity, not stimulate GDP, but they have achieved both through serendipity.

This may not continue forever. But as of now, India looks in surprisingly decent fiscal shape. This is not because of good governance but in spite of terrible governance. So, even slightly improved governance — like waste reduction by using cash transfers instead of subsidies — can improve fiscal fundamentals faster than venal politicians can erode them.

Shale gas transforms geopolitics, energy

Swaminathan S Anklesaria Aiyar
The Indian government remains asleep to the revolutionary potential of shale gas, which promises to revolutionise both the world energy scene and global geopolitics. Russia, Iran and Opec are going to be greatly weakened, while the US, Europe and China will be greatly strengthened. India can be a major beneficiary. First, shale is a common sedimentary rock found in most countries, so shale gas can hugely reduce the dependence of most countries (including India) on imported energy. Second, the geopolitical clout of major gas exporters — Russia , Iran, Algeria, Bolivia — will fall dramatically . Third, some countries may start converting their transport fleets into gas-based ones, hitting the demand for and prices of petrol and diesel. Fourth, converting gas into oil will become economic. Shale has long been known to contain natural gas, but this was not worth extracting with conventional technology. Now a new technology, ‘fracking' , plus horizontal drilling, have greatly increased shale gas productivity, so extraction is now viable at $3-4 /mmbtu. The new technology has been pioneered in the US so successfully that the US has overtaken Russia as the world's biggest gas producer. US gas reserves have increased from 30 years consumption to 100 years consumption. Port terminals to import LNG (liquefied natural gas) into the US will instead export LNG to Japan. The US dream of energy independence remains fanciful, but its dependence can indeed fall dramatically. Historically , the price of gas was linked to that of oil: gas cost one-sixth to oneseventh the price of oil. That equation has been smashed in the US, where oil costs $72/barrel but gas costs one-eighteenth as much ($4/mmbtu). Poland and Ukraine, totally dependent on Russian gas, are rushing to find shale gas and free themselves from Moscow. Georgia, another Russian dependent , also seeks energy freedom. Russia has an iron grip on its ‘near abroad' , countries that used to be part of the USSR. But that grip will loosen dramatically if shale gas is found in large quantities in Eastern Europe. Many Western European countries are rushing to acquire shale gas technology . Exxon Mobil is the front-runner in European exploration, but Shell is following suit. This dismays Algeria, a major supplier to Western Europe, which wants to create a gas cartel like Opec. The chances of this are zero. Indeed , LNG facilities created in the Persian Gulf to supply the US are becoming redundant, so supplies will have to be dumped on Europe and Asia. India must take advantage of this. Gazprom, the Russian gas monopolist , admits that it has been forced to delink 15% of its supplies from the price of oil, and instead accept links
to spot gas prices at trading hubs like Louisiana's Henry Hub, which sets the US benchmark price. Holland has a gas hub at Zeebrugge and Britain at National Balancing Point, and a new hub is coming up in Germany. At these hubs the spot price is determined by the interaction of multiple buyers and sellers, replacing the old prices linked to oil. The Financial Timesreports that half the gas contracts in Western Europe are now linked to spot prices. Petrochina estimates that China may have 45,000 billion cubic metres of shale gas, more than Russia's proven conventional gas reserves. China used to be an oil exporter but in recent decades has become a major importer of oil and LNG. Chinese demand helped push oil to $150/barrel in 2008. In the next 10 years, shale gas may significantly reduce China's import demand. World oil prices may keep rising for another five years, but could plateau or fall after that. China is also exploiting its coal-bed methane reserves of 170 billion cubic metres. Gas can readily substitute fuel oil in industry and power generation, and kerosene in cooking. But the bulk of oil consumption is in transport. Compressed natural gas (CNG) is powering buses and three-wheelers in Delhi and other cities. However, setting up CNG facilities across countries and converting vehicles to run on CNG remains a major challenge. It may never happen in the US. Authoritarian China, however , will surely push through such a change. This may be phased over a decade or more, but the price impact will start showing up earlier. India has large shale deposits, with good prospects in the Gangetic plain, Punjab, Rajasthan, Gujarat. Tamil Nadu , Andhra and the north-east . India must get cracking on seismic surveys followed by allotment of exploratory blocks. Companies should be able to acquire blocks any time based on a predetermined revenue-sharing formula. Mukesh Ambani will probably be the first to start exploration, but others will follow quickly, including Anil Ambani (who is already in unconventional gas through coal-bed methane). Large shale gas discoveries should embolden India to convert transport fleets in all cities from petrol and diesel to CNG. That will reduce not only energy dependence but pollution too. Reliance has considered converting some KG gas into oil. Now that gas has become cheap relative to oil, it should go ahead. Other refiners — Essar, IOC, BPCL and HPCL — should consider this option too. For decades India has kowtowed to Gulf countries, notably Iran. It can now afford to act much tougher. Iran supported Pakistan in Indo-Pak wars, and blasted India for Pokharan-II , and demanded that India sign the NPT. Iran nationalised the Rostam and Raksh oilfields in which the ONGC had a stake. It reneged on a contract to supply cheap LNG top India after Ahmedinejad came to power. Despite this India has been deferential to this potentially powerful energy supplier. That must now change. India must tell all Gulf producers that it will pay gas prices linked not to oil but to the Henry Hub price. The best starting point is not Iran but Qatar, which has just completed a gigantic expansion to become the world's largest LNG supplier. This is now in surplus. Qatar wants $10/ mmbtu. India must offer just $4. Once Qatar gives way, so will other LNG exporters, including Australia.