It doesn't add up: Higher tax, higher oil prices - and higher growth?

By R Jagannathan

On Wednesday, the Prime Minister’s Economic Advisory Council (PMEAC), headed by former Reserve Bank Governor C Rangarajan, issued some dire warnings and some chirpy forecasts.

The warnings first: subsidies, especially in petro-products, must be cut, fiscal consolidation must be “incontestably demonstrated”, the current account deficit (CAD) must be restrained, and the tax-GDP ratio must be raised by withdrawing the post-Lehman excise and service tax cuts that constituted the stimulus package.

The predictions are as follows: inflation will stabilise around 5-6 percent in 2012-13, and GDP growth will rise from this year’s projected 7.1 percent (the Central Statistical Organisation’s advance estimates had put it at 6.9 percent, though).

This is where the PMEAC appears to have injected a forecast that is rosier than what its warnings indicated.

In order to raise revenues for future commitments like the Food Security Bill and the Rashtriya Madhyamik Shiksha Abhiyan, the Council wants excise and service taxes raised by around 2 percent in the coming budget.

The simple question is this: if diesel subsidy is to be eliminated, if kerosene and cooking gas prices have to be raised, if fertiliser subsidies have to be kept in check, and if excise and service taxes are to rise in 2012-13, how will inflation fall from the current 6-7 percent to 5-6 percent?

And if subsidies are cut (i.e. prices raised) and taxes are zooming, how will growth accelerate from the 6.9 percent predicted by the CSO in 2011-12 to 7.5-8 percent in 2012-13?

The only way this can happen is if international oil prices fall (unlikely, if Europe starts reviving and given West Asia tensions) or if the rupee gains strength.

But if the rupee keeps strengthening, the export nirvana the PMEAC is looking for to improve India’s competitiveness, will be threatened.

In fact the PMEAC goes as far as to say that the rupee’s weakness is important to reduce the high current account deficit (CAD, the gap between what we earn from abroad and what we spend before capital flows). It says: “A weaker currency can by improving the prospect of exports - of both goods and services - and also by making the price of Indian assets more attractive to foreign investors, help to contract the CAD.”

It is, thus, doubtful if all of the PMEAC’s predictions can simultaneously come true: lower inflation, higher fiscal consolidation and higher GDP growth.

There is a mismatch between what is likely and what the council is trying to project. Is it merely trying to ratchet up business confidence by talking of higher growth next year?