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Strategies & Market Trends : India Coffee House -- Ignore unavailable to you. Want to Upgrade?

To: Mohan Marette who wrote (3700)	2/10/1999 1:20:00 PM
From: Mohan Marette	Respond to of 12475

India: Reducing Subsidies -- A Good First Cut (Source:Morgan Stanley Dean Witter) Vikram Goyal (Hong Kong) Key Points: Despite political constraints, India's BJP-led coalition government last week cut subsidies on several items. The action could be viewed as a sign of the government's commitment to economic management although impending fiscal difficulties suggest that there are few alternatives. Irrespective of the motivation, the important point for investors to note, in our view, is that politically contentious but key policy actions to contain fiscal deterioration have begun to be implemented. This is a good start. However, political pressures limit the extent to which the government can continue to push such politically sensitive policies. Consolidation of the government's reform credentials will be tested during the forthcoming parliamentary session when important reforms are slated for legislation and the new budget is to be presented. Details: Last week the BJP-led coalition government cut subsidies on several items. Reducing subsidies is politically contentious the world over. India is no different. In fact, given the coalition pressures on the current government, it is particularly difficult. BJP-enthusiasts are hailing the move as a signal of the government's pro-reform credentials, suggesting that this is only the beginning, with further reforms to come. Cynics, on the other hand, claim that the subsidy cuts have come amidst desperation and there are few viable alternatives to stem widening fiscal imbalances. Both camps are right to some degree. However, irrespective of the difference in views, the important point for investors to note is that the outcome is positive. Politically difficult but important policy actions to contain fiscal deterioration have begun to be implemented. Explicit subsidies account for Rs220 billion or 1.4% of GDP in the 1998/99 central government budget (implicit subsidies -- on power and irrigation, for example -- are higher). Of these, food is the largest category, accounting for 0.6% of GDP. The food subsidy is the differential between the procurement price paid by the government to farmers and the issue price to end-consumers under the Public Distribution System (PDS). It is well documented that the PDS, aimed at poverty alleviation, is associated with substantial spillover and has not been a cost-effective policy tool. The second largest category under subsidies is fertilizers, which account for 0.4% of GDP. The fertilizer subsidy is paid to producers, and in its current form subsidizes both fertilizer producers and end-user farmers. Other subsidies, including for exports, make up 0.4% of GDP. In recent years, as a percentage of GDP, fertilizer and other subsidies have been lowered but food subsidies have stayed about the same (Table 1), reflecting the political intransigence in paring food subsidies. The reduction in subsidies in the Other Category reflects the cuts in export subsidies following the 1991 currency devaluation. Table 1 Central Government Finance (% of GDP) 91/92 92/93 93/94 94/95 95/96 96/97 97/98 98/99B Subsidies 2.0 1.7 1.6 1.3 1.2 1.3 1.4 1.4 Food 0.5 0.4 0.7 0.5 0.5 0.5 0.5 0.6 Fertilizer 0.8 0.9 0.6 0.6 0.6 0.5 0.5 0.4 Other 0.7 0.4 0.3 0.2 0.1 0.3 0.3 0.4 Source: The World Bank Last week the government cut subsidies on wheat, rice, sugar and urea, raising prices for these items. Subsidies on domestic gas (LPG) were also cut, and prices raised, as part of the phased dismantling of the administered price mechanism in the petroleum sector. Authorities estimate that the combined cuts could generate savings of around Rs28 billion in the budget for fiscal 1999/00. With less than two months to go in fiscal 1998/99, the savings for the current fiscal year will be modest. In a bid to improve transparency, finance authorities have recently made fiscal data available on the Internet. The numbers reveal that the primary deficit of the central government (fiscal deficit less interest expenditures) climbed to Rs288 billion in April-December against the budgeted target for the entire fiscal year of Rs160 billion. The fiscal deficit itself has already reached Rs734 billion or 80.7% of the budgeted deficit. This is significantly higher than the 63.3% of the budgeted deficit reached during the corresponding period in 1997/98, a year when the total fiscal deficit rose to 6.1% of GDP. The authorities are clearly under pressure in managing the fiscal accounts and reaching the fiscal deficit target of 5.6% of GDP. Deficit-financing market borrowings in April-December already exceeded the borrowing target for the entire fiscal year. Pressures on interest rates have remained modest owing to subdued private sector credit demand and unabated deficit monetization by the Reserve Bank of India. With limited scope for enhancing excise and customs revenues (whose prospects are linked with the moribund state of the economy), and the disappointing progress on disinvestment, controlling current expenditures appear to be a viable option to stem the ballooning deficit. The Rs28 billion saving from the cut in subsidies is a fraction of the amount needed to narrow the fiscal deficit. Yet it provides the authorities with some buffer in managing expenditures in the upcoming budget. The more important outcome, in our view, is the signal that the government is willing to move forward on politically difficult decisions, albeit when faced with impending difficulties. The action should go some way in alleviating the damage to sentiment from the previous initiative to consolidate fiscal accounts through cross-ownership in the public enterprise sector. However, sustained political pressures limit the extent to which the government can continue pursuing politically sensitive policies. Yesterday, in protest against the subsidies cut, the Haryana Lok Dal (HLD), one of the BJP's coalition allies, threatened to withdraw government support -- an action that could bring down the BJP government and force new general elections. The BJP may succeed in persuading the HLD to do otherwise. However, memories of the trade-off between good economics and bad politics are likely to remain fresh. The forthcoming parliamentary session, during which important reforms are slated for legislation and the new budget will be presented, will test the consolidation of the government's reform credentials...