And Now it is RBI's turn to rescue the Oil Companies

Oil firms can sell more bonds via special window

BS Reporter / Mumbai June 12, 2008, 4:07 IST





Public sector oil marketing companies (OMCs) have another reason to cheer with the Reserve Bank of India today allowing additional amount of bonds to be sold through the special market operations to ease the liquidity pressure on these companies.

On May 30, RBI had decided to allow the three public sector OMCs – Indian Oil Corpoation, Hindustan Petroleum and Bharat Petroleum – to sell the oil bonds issued to them through designated banks to help them avoid selling them at a discount. It had, however, put a ceiling of Rs 1,000 crore for a single day.

In a late evening statement today, RBI said that it has decided to enhance the ad-hoc ceiling to Rs 1,500 crore a day.

So far, only IndianOil has sold bonds through the special window.

A NewsWire 18 report said that RBI bought Rs 955 crore of 8.40%, 2025 oil bond today from IndianOil. Yesterday the largest OMC encashed bonds worth Rs 950 crore and has been almost exhausting the limit alone.

The move comes at a time when crude oil prices have been hovering over the $130 a barrel mark and is putting fresh pressure on the OMCs to generate cash.

Though the government has allowed a marginal increase petrol, diesel and cooking gas prices, these companies are still facing liquidity pressure and the gains from have been eroded with the Indian basket, or the price at which OMCs buy crude, has crossed the $125 a barrel mark. On Tuesday the cost of the Indian basket was estimated at $130 a barrel.

Apart from the special window for oil bonds, RBI had also provided OMCs the facility to purchase foreign exchange through designated banks at market exchange rate.

Government's less than half hearted measures

Govt raised prices of petroleum products but the raise is clearly insufficient. Total deficit is now at Rs. 245,000 crores (and every dollar increase in oil prices increases it by USD 700 mn--at current exchange rate).

Price rise will reduce deficit by Rs.22,000 crores and duty reduction will reduce deficit by Rs. 22,000 crores both totalling Rs. 45,000 crores. We still have a gap of Rs. 200,000 crores.

This is proposed to met by oil bonds (banking system)-- Rs. 95,000 crores and upstream companies ---Rs. 45,000 crores, a total of Rs. 140,000 crores. This leaves a gap of Rs. 60,000 crores for which no provision is made.

Money is not going to come from thin air and this gap may have been left in the hope that oil prices will come down and the actual deficit will be lower. It is disastrous to manage economic affairs on hope.

And in any case, what the government is saying is that Rs. 200,000 crores has to be met by oil companies and banking system. Question is whether these sectors have such financial resources and what happens to the long term economic health of these institutions?

And what shall be do in 2009-10? Where is the money going to come from? Remember in 2007-8, oil companies and banking systems have already funded Rs. 70,000 crores.

Keynes vs Monetarists

An interesting article appeared in Mint (WSJ of India) couple of days ago. It talks of Keynesian economics (his solution for 1929 depression was to dig roads and fill them)- which believed in fiscal stimulus and the monetary economics -- which believes in controlling economy through interest rate changes.

today we are in an era where fiscal discipline is assumed (so keynesian economics is dead) and monetary policy is used the world over. in india also, over the past few years we have seen importance of budget being reduced and it is the RBI's policy which is eagerly awaited.

fiscal deficit works if it reaches the intended beneficiaries-- thus dig roads and fill them would lead to money reaching the poor -- but if fiscal deficit goes to fund subsidies, it has proved disastrous-- recent examples would be countries like Argentina, Brazil, Zambia etc.

monetary policy also has to be used carefully--- if its focus is only inflation control, which is how it is being used world over, will hurt growth--- too much tightening hurts growth and too liberal would lead to excesses in economy including asset bubbles, as has happened in USA.

it is my view that our current set of policy makers are all strict monetarists--- Dr. Manmohan Singh, Dr Rangarajan and YV Reddy and their policies are hurting growth. also strict monetary policy would assume fiscal discipline which is lacking in India.

_____________________________________________________________________________________
Views
Keynes has a lot to teach us
John Maynard Keynes was born 125 years ago this week. Three giants —Keynes, Milton Friedman and Friedrich Hayek— dominated 20th century economics and continue to be relevant in this century.  Keynes had led a successful revolution against the mainstream economics of his time. He was also a man of practical action. Keynes has been closely identified with a style of economic policy which believes that monetary policy is often toothless and that fiscal policy is the best antidote to slowdowns and recessions. This was the conventional wisdom in the three decades after the end of World War II. A very crude version of Keynesian policy even went so far as behaving as if huge government deficits were not much of a problem. There was often a gap between what the great man said and how his many disciples interpreted him. The Keynesian consensus fell apart in the 1970s as stagflation gripped the Western world. Monetarism made a comeback, and since then we have come to believe that central banks hold the key to stable economies. The successive bubbles blown by central banks over the past decade and the growing power of financial markets has cut into both the credibility and efficacy of monetary policy. There are signs that fiscal policy is making a comeback. Even the International Monetary Fund has softened its opposition to bigger fiscal deficits. (Fiscal deficits of the type India has will continue to be a worry.) But there is another Keynes who has a new relevance in our times. He was a student of probability. Uncertainty and expectations play a big role in his economic writings. He believed that investment in an economy is driven by something as subjective and psychological as "animal spirits". Keynes was also a master speculator. He understood both power of financial markets and their shortcomings. "Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done," he famously wrote. How true. 

india's looming economic crisis ..... we could be headed for hyperinflation....

reposting the table of the previous article


Year SBI Advance Rate GDP at constant Prices GDP growth WPI Inflation Exchange Rate
1970-71 7.00-8.50 474131 14.35 7.5020
1971-72 8.5 478918 1.01% 15.15 5.60% 7.2790
1972-73 8.5 477392 -0.32% 16.67 10.04% 7.6570
1973-74 8.50-9.00 499120 4.55% 20.04 20.22% 7.8370
1974-75 9.00-13.50 504914 1.16% 25.09 25.20% 7.7940
1975-76 14 550379 9.00% 24.82 -1.09% 8.9730
1976-77 14 557258 1.25% 25.33 2.08% 8.8040
1977-78 13 598885 7.47% 26.65 5.21% 8.4340
1978-79 13 631839 5.50% 26.65 0.00% 8.1500
1979-80 16.5 598974 -5.20% 31.22 17.12% 8.1930
1980-81 16.5 641921 7.17% 36.91 18.24% 8.1900
1981-82 16.5 678033 5.63% 40.36 9.33% 9.3460
1982-83 16.5 697861 2.92% 42.33 4.90% 9.9700
1983-84 16.5 752669 7.85% 45.52 7.53% 10.7070
1984-85 16.5 782484 3.96% 48.47 6.47% 12.4300
1985-86 16.5 815049 4.16% 50.61 4.41% 12.3061
1986-87 16.5 850217 4.31% 53.55 5.82% 12.8882
1987-88 16.5 880267 3.53% 57.91 8.14% 13.0318
1988-89 16.5 969702 10.16% 62.23 7.46% 15.6630
1989-90 16.5 1029178 6.13% 66.87 7.46% 17.3248
1990-91 16.5 1083572 5.29% 73.73 10.26% 19.6429
1991-92 16.5 1099072 1.43% 83.86 13.74% 31.2256
1992-93 19 1158025 5.36% 92.29 10.06% 31.2354
1993-94 19 1223816 5.68% 100.00 8.35% 31.3725
1994-95 15 1302076 6.39% 112.60 12.60% 31.4950
1995-96 16.5 1396974 7.29% 121.60 7.99% 34.3500
1996-97 14.5 1508378 7.97% 127.20 4.61% 35.9150
1997-98 14 1573263 4.30% 132.80 4.40% 39.4950
1998-99 12.00-14.00 1678410 6.68% 140.70 5.95% 42.4350
1999-00 12 1786525 6.44% 145.30 3.27% 43.6050
2000-01 11.5 1864773 4.38% 155.70 7.16% 46.6400
2001-02 11.5 1972912 5.80% 161.30 3.60% 48.8000
2002-03 10.75 2047733 3.79% 166.80 3.41% 47.5050
2003-04 10.25 2222591 8.54% 175.90 5.46% 43.4450
2004-05 10.25 2389660 7.52% 187.30 6.48% 43.7550
2005-06 10.25 2604532 8.99% 195.50 4.38% 44.6050
2006-07 12.25 2848157 9.35% 206.10 5.42% 43.5950
2007-08 12.75

India's looming economic crisis... we could be headed for hyperinflation....

India is facing severe liquidity crunch

We are fast heading towards bankruptcy as a country. Oil deficit is USD 60 bn and Fertiliser deficit is USD 25 bn, a total of USD 85 bn, which is more than 8% of GDP. This is not deficit as government is refusing to foot these bills. It will ask banking sector to fund oil companies. Incremental deposits in public sector banking sector are USD 100 bn, and it is unlikely that the banks will be able to lend more than USD 30 bn as incremental money to oil companies.

As a result, we would soon witness that oil companies are unable to pay for crude oil imports and therefore refineries will stop functioning. We are losing USD 5 bn a month on oil subsidies alone and therefore the refineries will be able to function at the most for another 6 months.

This situation will not only make blue chips like IOC, BPCL and HPCL sick companies, but also would potentially turn India’s crown jewel State Bank of India into a sick financial institution. This is because whatever money SBI lends to oil companies would not come back.

Early signs of what is stated above has already started appearing :-
SBI has borrowed in aggregate Rs. 18,000 Crores from RBI in 2 repo bids.
Mr. Sarthik Behuria, Chairman of IOC has made a statement that IOC has stopped import of diesel and its refineries will stop functioning in 4 months.

What we are facing here is not an issue of whether there is a deficit or not, and whether oil prices should be raised or not but it is a question of liquidity and because of crunch of liquidity, the country will come to a grinding halt.

Reduction in duties not a solution

Reduction in customs and excise duty is not going to be a solution simply because deficit is too large. For example, India imported oil products of USD 60 bn and if we assume customs duty rate of 5-10%, reduction in customs duty can at best release USD 2 to 3 bn. But this reduction cannot pay for crude. Someone needs to pay for crude. And only solution is to raise oil prices and raise it substantially and immediately.

Government needs to act and act now without losing a minute

What is more worrisome is if the Government does not act decisively and act soon, our currency will lose value. Already the rupee has moved from a level of INR 40 in end March to INR 43 in May, a depreciation of 7 to 8% in less than 2 months. Rupee can easily go to levels of INR 60-70 as outsiders lose faith in the currency. This has happened during 1990-92 when rupee moved rapidly from INR 17 to INR 32. Thus even if oil prices stabilize or go down, if rupee loses value, we would still have a huge deficit.

And we could be heading for Hyperinflation

I hate to say this but we could possibly be heading for hyper-inflation where things simply go out of control. Effects of hyper inflation are :-
Hyperinflation results in transfer of wealth from public to government. It is a form of taxation as government tries to meet its expenses by printing money.
Hyperinflation ends when government committs to fiscal reforms.
People start using dollars instead of rupees.
When you fear hyperinflation, borrow and buy assets, commodities.
Genesis of the problem

And on another note, i believe the genesis of many of our problems is the high interest rates and the misplaced notion that interest rates help control inflation. In fact, high interest rates cause higher inflation. In developed countries where borrowing is high for consumption, raising interest rates helps control inflation by curtailing consumption but in economies like India, which are short on capital, raising interest rates hurts supply, increases cost of doing business and causes inflation. In fact, in India, borrowing accounts for less than 5% of consumption!!!!!!

Our government has kept interest rates high for over a year hurting growth and causing inflation. Last year inflation was 4% and interest rates were raised to 11-12%, for over a year interest rates have been high and yet inflation has gone up. And unfortunately we read bogus economic theory that interest rates must be raised to control inflation.

India grew at 9% during era of low interest rates

India managed to break out of Hindu rate of growth and also saw lower inflation only when interest rates were lowered to 7-8%. The economic ideology of curbing growth and controling inflation by higher interest rates is completely misplaced and disastrous for the country. Hence during the high interest rate era, we hurtled from one economic crisis to another.

I enclose a table which gives Interest rate (I have used SBI Advance rate), GDP, GDP growth and Inflation. It is clear that we started growing above 6% only when interest rates came down. From 1980-1996 interest rate was 16.5-19% and inflation was never below 7%!!!! It is only from 1996 that interest rate started coming down that India actually managed to put its act in place and growth picked up above 8% when interest rates fell below 11% (in fact, though the rates were 11%, we had a phase when good customers were able to borrow below PLR).

Moderate inflation is required for growth economies and whenever economy overheats, RBI is justified in raising interest rates to cool down the economy. But to hold interest rates at high levels for long period of time hurts growth and is not a cooling down policy.

Solution

There is only one solution in the short term and that is to raise prices of petroleum products. The current deficit between end product prices and crude is unsustainable. And if crude prices fall, government can always reduce the end product prices.

And RBI must immediately bring down interest rates so that growth is accelerated.

If we do not do the above, unfortunately we could be headed for bigger economic troubles.


Year
SBI Advance Rate
GDP at constant Prices
GDP growth
WPI
Inflation
Exchange Rate
1970-71
7.00-8.50
474131

14.35

7.5020
1971-72
8.5
478918
1.01%
15.15
5.60%
7.2790
1972-73
8.5
477392
-0.32%
16.67
10.04%
7.6570
1973-74
8.50-9.00
499120
4.55%
20.04
20.22%
7.8370
1974-75
9.00-13.50
504914
1.16%
25.09
25.20%
7.7940
1975-76
14
550379
9.00%
24.82
-1.09%
8.9730
1976-77
14
557258
1.25%
25.33
2.08%
8.8040
1977-78
13
598885
7.47%
26.65
5.21%
8.4340
1978-79
13
631839
5.50%
26.65
0.00%
8.1500
1979-80
16.5
598974
-5.20%
31.22
17.12%
8.1930
1980-81
16.5
641921
7.17%
36.91
18.24%
8.1900
1981-82
16.5
678033
5.63%
40.36
9.33%
9.3460
1982-83
16.5
697861
2.92%
42.33
4.90%
9.9700
1983-84
16.5
752669
7.85%
45.52
7.53%
10.7070
1984-85
16.5
782484
3.96%
48.47
6.47%
12.4300
1985-86
16.5
815049
4.16%
50.61
4.41%
12.3061
1986-87
16.5
850217
4.31%
53.55
5.82%
12.8882
1987-88
16.5
880267
3.53%
57.91
8.14%
13.0318
1988-89
16.5
969702
10.16%
62.23
7.46%
15.6630
1989-90
16.5
1029178
6.13%
66.87
7.46%
17.3248
1990-91
16.5
1083572
5.29%
73.73
10.26%
19.6429
1991-92
16.5
1099072
1.43%
83.86
13.74%
31.2256
1992-93
19
1158025
5.36%
92.29
10.06%
31.2354
1993-94
19
1223816
5.68%
100.00
8.35%
31.3725
1994-95
15
1302076
6.39%
112.60
12.60%
31.4950
1995-96
16.5
1396974
7.29%
121.60
7.99%
34.3500
1996-97
14.5
1508378
7.97%
127.20
4.61%
35.9150
1997-98
14
1573263
4.30%
132.80
4.40%
39.4950
1998-99
12.00-14.00
1678410
6.68%
140.70
5.95%
42.4350
1999-00
12
1786525
6.44%
145.30
3.27%
43.6050
2000-01
11.5
1864773
4.38%
155.70
7.16%
46.6400
2001-02
11.5
1972912
5.80%
161.30
3.60%
48.8000
2002-03
10.75
2047733
3.79%
166.80
3.41%
47.5050
2003-04
10.25
2222591
8.54%
175.90
5.46%
43.4450
2004-05
10.25
2389660
7.52%
187.30
6.48%
43.7550
2005-06
10.25
2604532
8.99%
195.50
4.38%
44.6050
2006-07
12.25
2848157
9.35%
206.10
5.42%
43.5950
2007-08
12.75