India’s new finance boss, P. Chidambaram, is renowned for his intelligence. Now he has a chance to use it, by producing a good plan to cut the country’s mounting fiscal deficit. Last year the budget was in the red by the equivalent of 5.9 percent of GDP, and this year could be even worse. His best bet is to propose deregulation of energy prices. That would give the country a fillip in five ways.
First, freeing up energy prices would lower India’s subsidy bill. The OECD estimates that diesel sops alone costs the government three percent of GDP. The state-owned refiner, Indian Oil Corp, posted its worst ever quarterly loss in the three months ending June. Oil & Natural Gas Corp, the country’s largest oil explorer, said discounts it offered to state refiners on crude-oil supplies cut its annual profit in half.
Second, the ability to charge market prices would raise the value of state-owned firms. Coal India sells its output at around 70 percent of international market prices, according to investor The Children’s Investment Fund. It makes $8.30 of EBITDA per tonne of coal, compared to $45.70 at China’s Shenhua. If Coal India could double EBITDA per tonne that might add $20 billion to the company’s value.
That could lead to another benefit: fatter privatisation revenue if the government continues its programme of divestments. Another 10 percent sell-off of Coal India would still leave the state with 80 percent. And a successful part-sale could help Chidambaram build a case for similar moves on diesel.
Fourth, the effect of a market-based pricing system would inevitably lead to better resource allocation and an increase in supply. This month’s power outage, which left half the nation without electricity, demonstrates how critically that’s needed.
Finally reform would encourage higher levels of investment as businesses took advantage of higher returns and as foreign capital again got a taste for the India growth story. Achieving that last goal would deliver a huge pay-off to the economy and to the government’s own finances – and leave Chidambaram looking clever indeed.