Bad Move. NDA-2’s biggest achievement was oil and fiscal reforms
The big achievement of Modi govt was oil and fiscal reforms. Yesterday's price cut was a bad move.
Now, the bad news. The financials of oil companies have been improving dramatically since 2014 after the NDA-2 government freed them from price control. Oil subsidies have reduced and oil companies’ balance sheet has improved due as their borrowings came down and profits went up. An indication of their success can be seen in share price performance since this government came to power in 2014. BPCL has climbed 188 per cent, HPCL, 315 per cent while IndianOil Corporation has risen 170 per cent.
This is set to change as they now have to absorb one rupee of petrol/ diesel hike. What the Street also doesn’t know is whether this will be the last price hike that would need to absorb given that international prices may still go up and the rupee could weaken further. This kind of uncertainty is built into decisions like this which is why the government should have refrained from taking such a call. Every one rupee reduction in marketing margin will lead to a 17-22 per cent cut in FY19 earnings and the pain for investors would be exacerbated by the fact that neither the company nor the investors know whether they would have to absorb more hikes also. Shares of three oil companies fell sharply on Thursday and analysts are forecasting an at least 25 per cent fall in profits for FY19.
The second major piece of bad news is about the fiscal deficit. The government may be confident of meeting the target but this cut in duties comes at a time when GST revenues are already soft with little prospect of getting better. Against expectations of Rs 1.05-1.10 lakh crore of monthly GST collections, the government has managed to secure an average of about Rs 90,000 to Rs 95,000 crore so far this year. Direct tax collections, especially on the personal income tax front, have been robust and a lot of credit for this should be given the much-derided demonetisation and the implementation of GST.
But now, the projected dip in excise collections is likely to be accompanied by fall in non-tax revenue, especially disinvestment and the fiscal picture is not looking healthy at all for the government. This is likely to impact markets and investor sentiment like it happened in 2015-16.
States’ revenue collection is also going to fall though they have the cushion of have collected major sum of money given that VAT on petrol and diesel is ad valorem and linked to market prices.
Uncertainty is a bad thing but this uncertainty is also heightened by the fact that most investors would find it difficult to believe the government’s word on reforms. Among the NDA-2’s biggest achievement is oil price reforms and tight fiscal policy. It has given freedom to oil companies on pricing and markets and rating agencies have reacted positively to it. The government has also not been afraid of hiking LPG prices and its programme of weaning away wealthy customers off subsidised LPG has been quite successful.
Some of the good work is now threatening to get undone. The fiscal deficit has been brought down to 3.5 per cent of GDP from over 4.5 per cent of GDP in the last year of the UPA and though the government may meet this year’s target, it will be disappointing if it comes at the cost of cutting capital expenditure.
Prime Minister Narendra Modi’s hand was probably forced by political compulsions but the problem with this kind of thinking is that you are fighting against uncontrollable market forces with both hands tied to your back. You can try to outrun an oncoming tsunami only to find that it has become bigger the moment you reach higher ground. There is no way to stop oil prices from climbing. You just have to wait for market forces to play our and for sanity to prevail.
What will be the government’s response if crude continues to rise and the rupee continues to fall? They can't keep tinkering with duties forever. How much additional burden will they continue to put on oil companies? Stop-gap, cosmetic solutions have a short shelf life and markets and investors and almost everybody is able to see through this.
What this episode shows is that neither politicians, bureaucrats or the outrage-spewing middle-class is able to live with slings and arrows of a true market economy. It is one thing to ask for greater deregulation and revel in the consumerism that free markets bring, but it is equally important to not run away and ask for protection the moment these forces turn against you. Free markets are free markets. State intervention in prices of ordinary goods is always, always a bad idea!