Why Chidambaram doesn't yet deserve an upgrade

The finance minister is miffed that the rating agencies are not fully convinced about his reforms. In fact, far from giving him an upgrade, they have not ruled out a downgrade if there are any slippages in promised reforms.

Last Friday, Standard and Poors said in its review: “We may lower the rating if we conclude that slower government reforms than we currently expect would not lead economic growth to recover to levels experienced earlier this decade.”

Chidambaram grumbled: “We deserve a ratings and outlook upgrade. There is nothing to worry as the macroeconomic situation is much better now.”

Nothing to worry about? The current account deficit (CAD) is nowhere near our comfort zone (currently it’s around 5 percent of GDP, twice the 2.5 percent we could live with); the rupee is diving below Rs 55 to the dollar - hardly a vote of confidence in the reforms story; we are heading into election season with a Food Security Bill that could bust the bank; subsidy bills for 2012-13 are still to be paid; and the government has appointed yet another committee to decide how much to pay as fuel subsidy.

Little wonder, economist Kirit Parikh, who has been tasked to do this job for the umpteenth time, had this to say in The Times of India today when asked if the public sector oil companies had been done in once again: “We have killed the economy, why are you only talking about the PSUs (public sector undertakings)?”

If Parikh thinks UPA-2 has “killed the economy”, P Chidambaram has no reason to be sulking about what S&P said. After all, S&P stands for Standard and Poors, not Srinivasan & Palaniappan, somebody who will dance to the government of India’s tunes.

For the record, let us weigh a few of the pros and cons of what Chidambaram has actually delivered by way of reforms since August last year. We have seen a flurry of activity, but on balance it appears that the optics outweigh the reality.

By far the most important one is the decision to raise diesel prices to market levels by pushing up prices by small amounts every month. Currently, thanks to this policy, which was only briefly interrupted by the Karnataka elections, the diesel subsidy is down to Rs 3.73 a litre from more than Rs 11 last year.

However, the finance ministry and the petroleum ministry should not take the whole credit for this. Half the reduction came from lower global prices, and only the other half from increases in diesel prices. If the rupee falls, this gain will be wiped out rather quickly.

But Chidambaram has not paid up even for last year. Instead, he is trying to change the subsidy rules post facto to deny oil companies their dues. He wants the subsidy to be linked to the export prices of petro-products rather than imports - when India imports 80 percent of its crude oil.

Since export prices of petro-products are lower (in relative terms) than crude and product import prices due to competition from global refiners, this means a lower subsidy for oil companies. According to The Economic Times , the finance ministry has told the oil ministry it won’t pay the subsidies for last year before accounts close if the latter insists on import parity pricing.

This is cheating - since the goalposts have now been changed after the game has begun. And the changes are intended to help the finance ministry achieve its fiscal deficit numbers. And let’s not forget, 40 percent of the subsidies are even now borne by ONGC, GAIL and Oil India - not Chidambaram.

In an y event, Chidambaram is being too clever by half: what he achieves by way of subsidy savings will impact the oil companies’ profits - and hence valuations. Thanks to this, Indian Oil’s disinvestment is already looking like a non-starter.

The next big thing Chidambaram achieved was a lower fiscal deficit in 2012-13 with a promise to cut more this year - for which he was universally acknowledged.

But look deeper and see how it was done. As we said, the oil subsidies for last year are still not paid. Add the subsidies back, and the fiscal deficit would look worse. And this year, the finance ministry is trying to pay less by changing the rules.

Chidambaram’s ministry is also trying pain and simple confiscation to get more income: it is transferring more of the Reserve Bank of India’s (RBI’s) surpluses to itself.

The Union budget decided to hike the RBI’s dividend payments from Rs 25,000-and-odd crore to nearly Rs 44,000 crore in 2013-14 - and the finance ministry has decided that it will appoint its own auditors to look at the RBI’s books. It has explained this gambit as a good corporate governance practice.

The Economic Times quoted a finance ministry official as saying that the RBI was not consulted on the appointment of its auditor as it would have resulted in a “conflict of interest”.

The ministry obviously does not think that transferring money from the central bank to its own books involves any “conflict of interest”, but consulting the RBI on its auditors is. The ministry does not think that giving directives to banks and insurance companies involves any conflict of interest. Nor is it losing any sleep over manifest corporate misgovernance - such as transferring profits from one oil company to another without consulting minority shareholders. Nor does it think twice about the fact that much of the public sector disinvestments end up with the Life Insurance Corporation (LIC).

Or let’s look at a more recent initiative. To deal with a rising CAD, the government raised duties on gold imports and promised inflation-indexed bonds (IIBs) to help savers. But in April gold imports soared again, thanks to lower prices, and Chidambaram is threatening more curbs . Slamming the brakes on open trade is hardly reform.

As for the IIBs, it seems they will be based on the wholesale price index (WPI) - which is hardly the best way to compensate retail investors (who are impacted by the consumer price index) for inflation. The first lot of IIBs will only help the big boys and institutional investors.

Whichever way you look at it, Chidambaram’s reforms are really half-reforms and hardly the kind to send the S&P rushing to kiss his feet.