In India, Falling Oil Prices Make Modi's Job Much Easier

Narendra Modi has proven once again how important it is to be lucky in politics. In the spring, he was India’s opposition leader, running for prime minister by focusing on the government’s mismanagement of the economy. He had plenty of ammunition: The coalition led by the Congress Party had presided over years of corruption scandals and stalled reforms—and also had to contend with a growing budget deficit fueled by soaring prices for oil and other imported commodities.

During the campaign, Modi said he wanted to cut back on the costly subsidies the government offered millions of Indians to cushion the blow of those soaring prices. Petroleum subsidies account for one-quarter of India’s 2.6 trillion rupee ($42.4 billion) subsidies bill. But after he won in a landslide, Modi’s first budget (which his finance minister announced in July), was a modest plan that left the subsidies untouched.

That left observers unsure as to whether Modi was backing away from the politically difficult task of making the cuts. “We can either trust that the government will deliver price hikes as the year progresses,” Mirza Baig, head of foreign exchange and interest rate strategy at BNP Paribas in Singapore, wrote in a report after the budget announcement in July. “Or we can be more cynical and suggest that the Modi administration intends to continue the practice of rolling forward subsidy expenditure to next year.”

The good news: Modi has now shown there’s no reason for cynicism, at least when it comes to the budget. Over the weekend, he moved to eliminate state controls on diesel prices for the first time in over a decade, while also increasing prices for natural gas. The change “should offer fiscal savings over time that can be used for more productive uses, such as public investment,” wrote HSBC economists Frederic Neumann and Prithviraj Srinivas in a report published on Monday.

While Modi’s predecessor, Manmohan Singh, can take credit for coming up with the policy, Singh was too weak by the end of his term to push through ambitious changes. Now Modi can be the reformer. “The government has now begun the reforms in earnest,” Shubhada Rao, an economist at Yes Bank, told Bloomberg News. Added T.K. Ananth Kumar, former finance director at state-run explorer Oil India: “These two big decisions are going to help bring in a lot of investments and increase energy supply.”

In a democracy, it’s no small thing to raise prices on consumers who are also voters, and Modi deserves credit for his willingness to push ahead with potentially unpopular reforms. However, he can also afford to take the risk now, safe in the knowledge that many Indians won’t feel much of a pinch, thanks to the global plunge in oil prices. The price for Brent crude oil has dropped 22 percent this year. After hitting a low of $83.78 last week, Brent crude has rebounded a bit to around $86, but this is still the cheapest that oil has been since 2010. “The beauty is that, with the current drop in crude prices, there will be no immediate sticker shock to consumers,” wrote the HSBC economists. Indeed, diesel prices will fall around 5 percent, even with termination of the subsidies.

Certainly Indian voters seem willing to give the prime minster the benefit of the doubt. Over the weekend, Modi’s party faced its biggest electoral test since the springtime landslide. Voters in two of India’s most important states, Maharashtra and Haryana, went to the polls and gave solid victories to the Bharatiya Janata Party and its allies. Investors are hoping Modi’s luck will continue. The benchmark Sensex index rose 1.2 percent and is now up 25 percent since the year began.

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