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