The reaction to the Rs 5 diesel price increase has been predictable. Financial markets have embraced the much needed hike with gains of more than 2 percent in the Sensex and Nifty, six basis points fall in 10-year government bond yields and a 1.5 percent gain in the rupee against the US dollar.
Markets are cheering the hike, though it is not going to do anything great for the fiscal deficit as the gross under-recovery in selling fuel at below costs is estimated at Rs 1,75,000 crore (after the diesel price increase) in 2012-13 against Rs 1,38,500 crores in 2011-12.
The reason the market is cheering the price hike is that it is seen as the first step of tough economic decisions that is required to pull the economy back from the dumps. GDP growth for 2012-13 is expected to fall sharply from levels of 6.5 percent growth seen in 2011-12. The growth was an even higher 8.4 percent in 2010-11.
The fuel price hike will also give the RBI room to cut interest rates as it sees the government recognizing the fact that it needs to set its fiscal deficit in order.
Fiscal deficit, budgeted at 5.1 percent of GDP for 2012-13 was expected to go up to over 5.5 percent of GDP before the fuel price hike.
Government bond yields that set the barometer for interest rates in the economy has been hovering at levels of 8.20 percent to 8.30 percent on worries of higher government borrowing.
Government bond yields will fall on the fact that the government may not have to increase its borrowing for this fiscal and on the fact that the RBI will cut policy rates in its policy review on the 17 September 2012.
The RBI will cut rates by at least 50 bps as there are enough indications of economic weakness, with the index of industrial production (IIP) growth at -0.1 percent for Apr-July 2012. Exports were also in the negative during April-August.
The reaction to the diesel price hike from the political class is also predictable. The hike will hurt the common man and it will add to inflation and it will hurt votes. Protests are being organized, with key government allies strongly voicing their anger at the hike. Media is also playing its part in getting quotes from housewives and commuters.
The ordinary person is immediately affected by the hike but the fact is that, without the hike the ordinary person will be more affected down the line as the economy goes down in the dumps as inflation rears its head due to high fiscal deficit and a weak rupee and politicians count money all the way to their Swiss bank accounts.
Leaving aside the reaction of the average Indian to the fuel price hike, any opposition by the political class to subsidy reduction by passing on rising commodity prices to the end-user should be termed as anti-poor and anti-national. Opposition to subsidy reduction is anti-poor as the high fiscal deficit hits them the most, in terms of jobs, inflation and lack of basic infrastructure.
Opposition to subsidy reduction is anti-national as weak finances makes a country vulnerable to strong arm tactics of richer and stronger countries. Weak finances also affect the country’s defence as it cannot spend enough on its forces to counter the spending by more powerful countries such as China.
It is also true that many members of the ruling party will also be against the fuel price hike and will demand concessions for their own state or territory to agree to the fuel price hike. The government will have to take a firm stand against its own members who oppose subsidy reduction as it benefits everyone including the poor.
It is high time the country’s economic and defense interest take precedence over the personal interest of politicians who oppose subsidy reduction not for the cause of the common man but for their own cause of both political and monetary gains.
Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors.