Fueling the Price-Hike!

Article By: Amit Abhyankar

With the UPA Government announcing increase in fuel prices (June 5), widespread protests enveloped the country, with almost all political parties including Left parties, BJP, Socialist party coming out on the road against the price-hike. While government maintains that the hike was inevitable, the opposition talks about plenty of alternatives being available. What’s the reality? Here’s an effort to go into the details of the issue- the economics & politics behind it.

With State Assembly Elections out of the way and with Parliament being not in session, the time seemed just ripe enough for the oil price rise. And accordingly petrol prices were hiked by Rs. 4 a litre & diesel by Rs. 2 a litre. This is 7^th price hike by the UPA Government in just two years. Bur why such a stern resistance to oil price increase by just couple of rupees?……..because these products are universal intermediates that enter into the cost of production of a number of goods & services. With latent inflationary expectations, this price rise is expected to have cascading effect. Even the outsourcing activities of India are very much dependent on the future oil prices, say major outsourcing think-tanks. India’s cost of living is heavily dependent on oil price. As oil price increases, salary levels in India will rise much faster than the inherent official inflation level, affecting extent of outsourcing.

The Politics

Post-hike developments including Sonia Gandhi requesting for roll back of the price rise & refusal to accede to this request by Murli Deora, with backing of Manmohan Singh, reflect a conscious play-act in which Sonail Gandhi, as a Congress Party Leader, takes on the role of defender of the common man’s interests and Manmohan Singh presents himself as a pragmatic policymaker.

The Congress party also issued a directive to Congress-run State Governments to reduce the proportionate Sales tax (levied by States) on petrol & diesel. This was, it seems, Congress Party’s cynical form of politics, rather than the agenda of Government at Centre. And the congress-run state governments have complied, making the opposition-controlled States villains in eyes of common people. The popular anger against the price-hike thus gets automatically shifted against the opposition-controlled States. What a dirty political masterstroke!

The Government Claims

The government is using the ‘theory of necessity’ to justify the hike, suggesting that there is no alternative. With increase in global petroleum prices, the hike is said to be inevitable. Government is said to be using its resources to subsidize & stabilize (or rather freeze) kerosene & LPG prices (around 3,500 crore rupees in form of subsidies), which directly affect the ‘needy’. Government is arguing that if domestic retail prices are not adjusted to reflect changes in global prices, resulting loss would show up in the accounts of the ‘oil marketing companies’ like Indian Oil Corporation, Bharat Petroleum, HP and IBP (and not upstream oil companies) as ‘under-recoveries’. [These oil marketing companies receive their supplies of petrol & diesel from refineries at price that equal their import price + Customs Duty.] If the prices are not raised, it is argued, the under-recoveries by such companies would touch Rs. 73, 500 crores in the current fiscal year. The Petroleum Ministry has gone to the extent of claiming that ‘under-recoveries’ of Public Sector oil companies would require petrol prices to be increased by Rs. 9.33 a litre, diesel by Rs. 10.43 a litre, kerosene by Rs. 17.16 a litre and LPG by Rs. 114.45 a cylinder. Actual hike is only a fraction of the requirement, the government argues.

Now the Reality

Firstly, the method of calculating subsides on domestic LPG and kerosene is based on “import parity pricing” of petroleum products and not unrecovered costs (which is more appropriate). Therefore, the subsidy amount being based on a flawed methodology results in misleading figures. It’s quite an exaggeration to say that government is shouldering a lot of burden through subsidies. Firstly, the Central Government reaps Rs. 77,692 crores (2004-05 figures) from oil sector through duties, taxes, royalty, dividends etc. Compared to other Asian economies, India‘s levies on oil are high. Additionally, the Government imposes a `cess’ on indigenously produced crude and collects about Rs 6,000 crore annually from the public. For year 2006-07, this amount would touch Rs. 7,500 crores figure as Chidambaram has increased this cess in the last budget. This amount adds up to the Consolidated Fund of India. And compare this with amount of annual subsidy which is just around Rs. 3,500 crore. So there’s no net burden on government. In fact, the Government is collecting much more than the burden it claims to be sharing.

Even oil companies are reaping profits from the current pricing system. The import parity allows oil companies to factor in the Customs duty to arrive at the import parity prices. Since the country does not import petrol or diesel, the amount collected as notional Customs duty from the public, estimated at Rs 10,000 crore, goes to bolster the financials of oil companies.

The deliberate use of the ‘under-recoveries’ to suggest actual losses has been one of the defining features of the media’s coverage of the petroleum industry in recent years. In reality, ‘under-recoveries’ is a notional concept, which allows substantial padding to prices.

Thus, the claims of a huge subsidy burden and bleeding oil companies are exaggerated, as most of the burden is borne by the consumers.

The Economics

The problem is “Is it possible to shield the consumer from fluctuating global oil prices?”. C.P.Chandrashekhar (Frontline) opines that there is an adequate buffer to shield consumers from the increase in global oil prices.

The answer to the question as to ‘who is going to share the burden of oil cost’ is relatively simple. The burden needs to be shared by-

1) The upstream Oil Companies (viz. ONGC, the Oil India Ltd, the Gas Authority of India, Ltd. and excluding Oil ‘Marketing’ Companies) and refineries—– which receive prices that more than compensate for costs;

2) The Central Government —- which collects revenue in form of Custom Duties + Excise Duties + Cess + Dividends etc;

3) The State Government—- which benefits from Sales Tax;

4) The Consumer—–who is shielded partially from full impact of international prices.

The real question is how the burden should be shared. C. Rangarajan Committee tried to find an answer. (C. Rangarajan was former Governor of RBI.) The Committee, after much deliberation & examination of many facts & figures, which we need not dwell into at the moment, concluded that it is the Centre Government (and firms controlled by it) which is in best position to shoulder the maximum burden for it has alternative sources of resource mobilization available. State Governments would find it much more difficult to waive the revenue they are getting through Sales Tax on oil products, for the simple reason that alternative available to them for additional resource collection are very limited. Hence the States should be last to be touched. The Committee thus recommended fixing of excise duties at around Rs. 14.75/litre for petrol & Ra. 5/litre for diesel.

The Problems

The biggest problem is the lack of transparency in pricing of petroleum products. Import parity method of determining price is criticized by many. It results in the government having a vested interest in hiking oil prices in order to bolster its revenues. In fact, successive reports of the Parliamentary Standing Committees attached to the Petroleum Ministry have called for dismantling of this arbitrary & opaque system of pricing.

The second big problem is lack of competition in this sector. Only state-owned oil companies are permitted to market the subsidized oil products. Plus the subsidies to PSUs means distorted market in undue favour of state-owned companies, virtually killing the private competitor.

Short-term measures

Had the recommendations of the Rangarajan Committee been implemented, the price increase would have been less to the extent of 80 paise for petrol & Rs. 1 for diesel. If further adjustments in duties & taxes and upstream oil company profits had been made, the price increase could have been much lower than the one imposed. Last year, France imposed a ‘windfall’ tax on oil refining companies with the logic that the oil companies should not be allowed to mint money at the expense of society at large. Similar experiment here is not unwarranted.

Rather than resorting to these measures, however, what Centre has done is to reduce the subsidy on kerosene (by targeting it at below poverty line households), raise prices of petrol & diesel and share the remaining burden with oil companies. Chidambaram’s refusal even to consider a cut in excise duties indicates a rigid mindset that is deeply rooted in fiscal fundamentalism – refuse to consider other options & then claim there is no other way. The Union Cabinet only seems to be interested in protecting its own revenue & dividends.

Long-term measures

The prevailing tax structure needs an overhaul. The import-parity pricing regime should be dismantled and oil companies allowed to charge market-determined prices.

The Government’s intervention in the sector needs to be rationalised to facilitate the market process with subsidies targeted at the poor and the really needy. The petroleum sector requires a comprehensive competition framework and not stringent regulations.

A price stabilisation fund must be created to take care of spikes in international crude prices.

A petroleum and natural gas regulatory board should be established to foster competition and ensure transparency in the determination of prices of petroleum products.

Conclusion

One of the most significant threats to sustained economic growth of the country is the global oil scenario. This requires an effective conservation strategy, which can be feasible only if prices of petroleum products are determined transparently and allowed to reflect in their economic cost.