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IASbaba’s Daily Current Affairs – 7th March, 2016
Published on March 8, 2016, 11:15 a.m.

### ECONOMICS

TOPIC

General studies 3:

• Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.
• Government Budgeting.

General studies 2:

• Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

Budget 2016 fails to lay out a clear roadmap for the petroleum industry

• Energy has been an important part of the present Prime Minister’s agenda.
• However the 2016 budget lacked clarity on certain principles affecting the petroleum industry because of which the stock prices of oil companies fell (ONGC stock prices fell by around 10%).

Fundamental outlook:

Three fundamental questions that arises at the backdrop of the announcement of budget 2016 wrt the petroleum industry are

• Does the government appreciate the severity of the crisis facing the petroleum industry?
• Is it serious about reviving domestic oil and gas exploration.
• Is its emphasis on clean energy substantive?

A critical evaluation of the Policy announcements in the budget 2016:

The Finance Minister(FM) made three policy announcements

1. The first was that the price of gas from newly discovered fields would be determined through the market and linked to the price of alternative fuels.
• It was not clear, at least initially, whether “newly discovered” meant discoveries yet to be made or those already made but not monetised.
• It was also not clear whether the price would be linked to low-priced coal, the higher-priced imported liquefied natural gas or to a fuel between these two price points.
1. The second was to switch the calculation of cess on oil production from a specific rate (fixed rupees per barrel produced) to ad valorem (percentage of value).
• This is what the companies had lobbied for and it was a sensible move.
• The fixed charge of $9.1 per barrel produced was affordable when prices were hovering around$100 per barrel but a crushing burden in the current low price regime of around $35 per barrel. • What took the wind out of this proposal was the ad valorem rate of 20 per cent. • For, at that rate, the tax burden came down by only$2 per barrel from $9 to$7 and for so long as the price of oil remained in the current range.
• In the event prices rise to the average level predicted by analysts of $45 per barrel in 2016, this benefit will be wiped out and companies will find themselves in the same financial straits they are in today. 1. The third one was to double the cess on coal production from Rs 200 to Rs 400 per tonne, and to direct that this money be used for financing clean energy. • Again, like the switch to ad valorem, this was a positive. • However there was a lingering concern, that this money would be diverted for other purposes. • So far, the clean energy fund has been managed by the finance ministry. • The money has not always gone towards clean energy research but for financing unrelated activities like cleaning the Ganges. • This concern might have been allayed somewhat had the FM assured listeners that the money would be managed by people with domain expertise and not subject to political or financial exigency. Hard truths that the government should digest: The government must internalise three hard truths: 1. India’s dependence on oil and gas imports will increase in the short to medium term. • We currently import around 75 per cent of our requirements. • This will go up to near 90 per cent by the end of this decade. • We are and will remain hugely vulnerable to the vicissitudes of the international market. 1. The petroleum industry is in terrible shape. • According to consultants Wood Mackenzie, every private oil company loses cash at$30 per barrel.
• All are now on a massive cost-cutting exercise.
• They estimate that over the period 2015-2017, the companies will take out $200 billion of expenditure and that exploration investment will drop from around$95 billion in 2015 to less than \$40 billion in 2016.
• Cost-cutting will not save the highly leveraged companies from bankruptcy and there will be a plethora of stranded assets available for sale at a discount.
1. Our environment is under stress.
• Our cities are amongst the most polluted in the world, our forest cover is denuding; the water tables are receding — the list is long.
• Clean energy is the sine qua non for breaking the currently unhealthy linkage between growth, energy demand and environmental degradation.

These three hard truths present the government with three clear choices.

1. If it wishes to accelerate exploration, it will have to stop milking the ONGC cow.
• Private investors will not step into the breach.
• A downward recalibration of the ad valorem tax rate would be a positive first step.
1. If it wishes to increase domestic production, it should do what many oil-producing countries, including China, the US, the UK and Malaysia, have done in response to the current low oil price regime and offer tax credits and exemptions for incremental production from marginal fields and enhanced oil recovery.
1. If it wishes to give a fillip to clean energy, it should put together a more robust package of subsidies and concessions, promote electric vehicles and cement R&D partnerships between government entities, private corporations, universities and research laboratories.

Connecting the dots:

• Critically examine the problems faced by petroleum industry in India along with measures taken by the government to overcome them.
• What do you understand by clean energy? Explain various sources of clean energy in India along with measures taken by the government to promote them.

### ECONOMICS

TOPIC

General studies 3:

• Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.
• Government Budgeting.

General studies 2:

• Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

FRBM act: Reality check and to review the fiscal consolidation path

Background:

• Recently there was a suggestion that fiscal expansion or contraction should be aligned with credit contraction or expansion respectively, in the economy indicating a paradigm shift in how to determine fiscal deficit.
• Currently, the Fiscal Responsibility and Budget Management (FRBM) Act insists on a blanket 3 per cent arithmetical limit on fiscal deficit.
• Idea is to recognize the possibility of an inverse correlation between fiscal deficit (fiscal expansion) and bank credit (monetary expansion) i.e If credit growth falls, fiscal deficit may need to rise and if credit rises, fiscal deficit ought to fall — to ensure adequate money supply to the economy.
• As the FRBM Act ignores the possible inverse link between monetary and fiscal economies, time is ripe for an objective basis for fiscal deficit and to recheck FRBM act to review the Act, and if necessary, amend it significantly.

What is FRBM act all about?

The Fiscal Responsibility and Budget Management (FRBM) Act was legislated by the Parliament in the year 2003.

Its objectives can be identified as:

• To institutionalize fiscal discipline
• Reduce Fiscal Deficit
• Improve Macroeconomic Management.
• The law aims at promoting Fiscal Stability for the country on a long-term basis.
• It emphasizes a Transparent Fiscal Management System and a more equitable distribution of debts over the years.
• This law also gives flexibility to the Reserve Bank of India to undertake monetary policy to tackle inflation and take corrective measures in order to give an impetus to the economic environment.
• FRBM Act was notified in response to the need felt to curb broadening Fiscal Deficit.
• The FRBM rules specify annual reduction targets for fiscal indicators.
• Originally, the act envisaged Revenue Deficit to be reduced to nil in five years beginning 2004-05 and fiscal deficit was required to be reduced to 3 percent of GDP by 2008-09.
• The Act also provides exception to the government in case of Natural Calamity and whenever there is a threat to National Security.

As Government is in need of resources for funding various kinds of developmental schemes and routine expenditures, resources are raised through taxes and borrowing. The government can raise funds by borrowing from the Reserve Bank of India, financial institutions or from the public by floating bonds.

What does fiscal deficit mean?

• The difference between total revenue and total expenditure of the government is termed as fiscal deficit. It is an indication of the total borrowings needed by the government. While calculating the total revenue, borrowings are not included.
• However, uncontrolled Fiscal Deficit is harmful not only for the health of economy but also for the Growth of the economic indicators and finally the development prospects in the road towards Inclusive Growth.

What was the need which compelled FRBM act to be introduced?

• In 1980s, India saw a sharp deterioration of the fiscal situation, which ultimately culminated in the balance of payments crisis of 1991.
• Within a decade of economic liberalization, the fiscal deficit and debt situation again seemed to head towards unsustainable levels around 2000. At that time, a need to institutionalize a new fiscal discipline framework.
• FRBM Bill was introduced to institutionalize the fiscal discipline at both the centre and state level.
• Under the Fiscal Responsibility and Budget Management Act (FRBMA) 2003, both the Centre and States were supposed to wipe out revenue deficit and cut fiscal deficit to 3% of GDP by 2008-09, thus bringing much needed fiscal discipline.

How rational is fixation of fiscal deficit with 3 per cent limit?

• The magic number made its debut in the famous Maastricht Treaty to form the European Union (EU) in 1992.
• The treaty prescribed four criteria which EU members had to comply to be eligible to adopt the Euro as the common currency. One criterion was the 3 per cent fiscal deficit limit — the others being limits on inflation, long-term interest rates and public debt.
• It was an open secret that the FRBM Act enacted in 2003 and implemented from 2004, had adopted the ready-made EU limit of 3 per cent.

What is the logic behind the correlation between credit expansion and fiscal deficit?

The economic debate on the money-growth link dates back to the Great Depression of the 1930s. While the celebrated Nobel laureate, Milton Friedman, talked about inadequate money supply as the cause of the Great Depression.

The logic of correlation between credit expansion and fiscal deficit has five sequential limbs explaining inverse relation:

1. Money is the blood of economic growth.
2. Most money that fuels the economy is created by banks, not by government.
3. Banks and financial institutions fund business and it is that credit money which drives the economy.
4. If there is lack of business confidence in the economy then bank credit will not grow too and growth will also suffer due to lack of adequate money.
5. This is the situation budget needs to step in, to pump money into the economy by incurring deficit (spending more than the income). For this money need to be borrowed lying with the bank or print more money.

The fifth limb ensures that growth does not decelerate for want of enough money circulating in the economy. The FRBM law has ignored the fourth and fifth limbs of the logic and fixed the 3 per cent fiscal deficit as inviolable.

Working of FRBM act and its reality check:

• The combined fiscal deficit (fiscal expansion) and credit growth (monetary expansion) as a percentage of GDP has halved from 17.4 per cent in 2009-10 to 8.8 per cent, which is less than nominal GDP growth.
• Three things are obvious. Money supply growth has reduced. Credit expansion has fallen. And even fiscal deficit and credit growth put together have declined, all pointing to the growing economy being starved of the needed money needed, in which the FRBM Act has also lent its hand.
• If bank credit growth falls, fiscal deficit may need to go up. If bank credit growth rises, fiscal deficit should reduce. This is particularly true for a growing economy like India.
• Had the fiscal deficit not been above the FRBM ideal limit of 3 per cent in the last four years, the growth would have suffered even more. It does not need a seer to say that the FRBM law as it stands harms the economy. Thus need of the hour is to review FRBM act, and if necessary, amend it significantly.

Way ahead: Review the fiscal consolidation path

• Possibility of adopting a target range rather than a specific number (3 percent)
• The suggestion that fiscal expansion or contraction should be aligned with credit contraction or expansion, as mentioned in the Budget speech, is worth exploring.

Connecting the dots:

• Recently there was a suggestion to amend FRBM act and to review the fiscal consolidation path. Throw light on the short fall of the current FRBM act and what needs to done to bring more fiscal discipline?

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