The Diwali gift in question is a decision not to increase prices of petroleum products. However, gifts have a habit of becoming permanent, what with elections in Gujarat and Himachal, with others to follow — perhaps even a general election. This gift is not only of an old horse, it may even be a horse with an army inside it, since the gift has costs. No one knows where international crude prices are headed, but they are close to $100. Apart from temporary uncertainty (Turkey-Iraq) and perhaps even speculation, winter, not to speak of dollar depreciation (triggering switch to commodities), Chinese and Indian growth has driven global demand and there are OPEC supply controls. We may not know the exact figure, but crude oil prices will remain high.

There is crude and crude. The average price of Brent crude (one that is usually quoted) isn’t the best indicator. This sounds like sauce out of Chinese cuisine. Crude can be sweet and sour. Sweet has less sulphur. Sour has more sulphur and is cheaper. Brent is sweet. But because India allows higher sulphur content, a large chunk of our imports is sour. One gets a better sense of Indian import basket costs if one weights Oman/Dubai (sour) and Brent (sweet) in a ratio of 60 to 40 per cent. The simple point being that the Indian import basket will be a little (perhaps $5 now) cheaper than price usually quoted in the media. The media will also report that increases in crude oil prices will reduce Indian GDP (or industrial production) growth. Drawing on macro-models and simulations, the favoured figure seems to be that a $10 increase in global prices reduces GDP growth by 1 per cent. The Approach Paper to Eleventh Five-Year Plan (2007-12) echoes this sentiment. “Simulations with macro-models suggest that if oil prices increase sharply in future, our growth rate could be lowered by between 0.5 and 1.0 percentage points below the levels projected with present levels of oil prices.”

We encountered such propositions when crude prices were $30. This is counter-factual, but despite crude price increases, the Indian growth engine is chugging along. So we need to spell out the argument before accepting such pessimism as Gospel truth and the economic argument is usually conspicuous by its absence. Simulations and models aren’t substitutes for economic arguments, no matter how impressed we are with them. Denis Diderot was once invited by Catherine the Great to her court. Confronted by Diderot’s atheism, Catherine produced the mathematician, Leonhard Euler, who pronounced he had an algebraic proof of God’s existence. This formula was gibberish. But Diderot didn’t know mathematics and, thus embarrassed, returned to France. To return to oil, a tiny bit of the argument seems linked with imports and foreign exchange constraints. That may have been valid in the seventies and early eighties, but is that convincing now? Not only do we export petroleum products (value increases when crude prices increase), we have an embarrassment of forex riches. It is impossible to devise a convincing balance of payments argument for GDP growth slowing.

Next, one can think of an inflation argument. Life would have been simpler had administered price mechanism been scrapped in February 2002. Forget LPG and kerosene, subsidies on petrol and diesel have also become open-ended, with resultant distortions. Because of non-transparency through import parity pricing, refinery margins and indirect taxes (import duties, excise, state-level taxes), there is no obvious way to link crude import prices with the retail prices of petroleum products. If one considers WPI-based inflation, retail prices can be increased, at least for petrol/diesel. Depending on how much the increase is and depending on what is done to indirect taxes, we will probably have an increment to inflation rate by around 0.5 per cent, eminently bearable. But if one considers CPI-based inflation, this is a little less bearable. And if one considers the torpor of the government, nothing is bearable. Sure, China has increased petrol and diesel prices by 10 per cent and Malaysia plans to. But neither country is mis-governed by the UPA. So retail prices won’t increase and that knocks out any inflation-based argument. Note that macro models and simulations always assume higher global prices are passed on domestically. With that transmission mechanism missing, the GDP-dampening argument loses validity.

However, life is still a mess. Oil marketing companies lose money. What else to expect if prices are lower than costs, the option of non-marketing a non-existent one? Let’s issue oil bonds. In 2006-07, this cost 0.5 per cent of GDP and in 2007-08, may account for 1 per cent. For 2007-08, there is a 2 per cent figure floating around, but that includes food, fertiliser and power sector subsidies, not oil bonds alone. There are three problems with oil bonds. First, it is a commercially bad idea, because future debt (bonds) is used to fund present expenses and public financial institutions and banks will probably be forced to artificially subscribe to these bonds. This distorts resource allocation, across sectors and over time. Second, fiscal deficit figures become less transparent, since such off-budget items are not included in deficit calculations and make reduction targets seem more rosy than they are. Third, there is the question of how the deficit is financed. Does government expenditure necessarily switch from more productive sectors? Because investment signals are distorted, is there a similar switch? Or because of what is done on revenue or because of behaviour of banks and financial institutions, is there a switch from more productive private investments to less productive public expenditure?

Given the scenario, that is how a growth-reduction argument should be couched, but that’s not how it is expressed. To quote again from the Approach Paper, “However, all such estimates have a large margin of error. The important point is that even these simulations show that with appropriate oil pricing policies, increased exports and appropriate fiscal and monetary policies, the adverse impact of high oil prices on GDP growth can be substantially moderated in the medium term. They will have an impact on affordable levels of consumption but they need not have as sharp an impact on GDP growth.” That’s very honest and makes me a confirmed sceptic about growth reduction.

The writer is a noted economist