Scalding oil, sliding rupee

Mains Paper: 3 | Economy
Prelims level: current-account deficit 
Mains level: Improvement in CAD

Introduction 

• Except for the US, most economies of the world are in crisis mode.
• We live in a highly globalised and an instantaneous transmission world.
• We live in a world where politics and economics inter-mingle and each component accuses the other for causing a mishap, or a crisis.

Important highlights about the CAD crisis 

• Today, the crisis in question is a rupee current-account deficit (CAD) crisis.
• An improvement in CAD can either occur through an improvement in exports or a reduction in imports.
• Exports is money coming in, and that is “good”. Import is money going out, and that is “bad”.
• Exchange rate is a price — a cheaper rupee helps exports, and hurts imports.
• A cheaper currency, especially a fast depreciating one, hurts confidence, sentiment, and investment flows (both domestic and international) and is not much of a good.
• This is all basic macro, and well known.
• Good policy is the art of balancing the various currents to achieve a harmonious balance.
• Economists and analysts are also human. They make genuine and honest mistakes.
• As humans, they also possess ideologies and are prisoners of their “political” outlook.

Examine some recent policy measures in India

• Emerging economies, especially fast-growing ones like India, need capital inflows to finance their investments.
• The CAD is also equal to the gap in savings and investment.
• The “high” GDP growth over the years helps pay for the borrowing of savings from abroad.
• We will look at measures from the angle of money in (good) and money out (bad).
• This list of economic mishaps for 2018 starts with the imposition of a 20 per cent long-term capital gains tax in the 2018/19 Budget.
• This increase was a reversal of longstanding 14-year policy.
• As is obvious, if you do not have capital gains, you will not obtain capital gains tax revenue.
• For the present fiscal year, capital gains have been zilch.
• In late August, the Ministry of Finance (MoF) announced measures to arrest import growth.
• The 19 items for which import duties were hiked included items such as air conditioners, refrigerators and washing machines and the total value of these imports in 2017/18 was about Rs 86,000 crore.

Effects on the price of oil

• The international price of oil declined from $ 110 a barrel in May 2014 to an average of $50 to $60 in each of the last three fiscal years.
• Despite large international price fluctuations, the government kept the domestic oil price broadly constant.
• On a base of 100 in 2012, the CPI for petrol averaged the following in the last four years — 108 in 2014/15, and 99, 103, 108, and 119 in the present fiscal year (April through September).
• So at the time of the election in May 2014, CPI for petrol was 115.
• The CPI for petrol is estimated to have averaged 126 in September 2018 or a mere 10 per cent above the 2014 election price.
• Oil price control, again:
• On September 4, the government announced an excise tax reduction of Rs 1.5 per litre.
• An additional Rs 1/litre reduction in the price of oil is to be contributed by oil companies.
• This loss to the oil companies is expected to yield Rs 9,000 crore.
• In less than 24 hours since the policy was announced, the market cap of oil companies was reduced by Rs 1.26 trillion.
• It is sound fiscal fundamentals to keep the domestic oil price relatively constant amidst international turbulence.
• The original sin was likely committed by the RBI in keeping real interest rates very high in 2017.
• The GDP is estimated to be 2,900 billion in 2018. Each additional 1 per cent of CAD is $ 29 billion.

Where will this money come from?

• Foreign inflows into the domestic debt market was $20 billion in 2017; this year the flow is a negative $7 billion.
• Oil companies and other investors want predictable, reality-based policies, not inducements to volunteerism.
• The Swiss-based Bank of International Settlements publishes, for more than 60 countries, a monthly estimate of the real exchange rate (REER).

Way forward 

• In India, REER averaged around 92 in crisis year 2013 and exports (manufacturing and services) increased at a 6 per cent rate.
• • In 2018 (to date) the REER has averaged 103 and exports have increased at a near 20 per cent rate.
• Two simple facts emerge from these “simple” data.
• REER levels do not seem to be associated with either exports or the desirability of exchange rate change.

Online Coaching for UPSC PRE Exam

General Studies Pre. Cum Mains Study Materials

UPSC Prelims Questions: 

Q.1) Which one of the following is the largest contributor to India‟s current account deficit in 2017-18?
(a) Manufacturing trade deficit
(b) Gold imports
(c) Remittances deficit
(d) Oil imports
Answer:  D

UPSC Mains Questions:
Q.1) What are the Effects on the rising of oil price in Indian market?