New Delhi: India’s emboldened new government may face one of its trickiest economic issues -- subsidised fuel prices -- sooner than it likes -- as crude oil’s rally to $60 pushes refiners to the brink of profitability.
The Congress party’s unexpectedly strong showing in elections that ended last week has revived hopes of pushing through a host of important reforms, analysts say, but it would probably prefer to wait before relaxing its control of motor and cooking fuel prices, even though now appears the ideal moment.
It may not have that luxury if oil climbs further, forcing the government to bulk up on more unwanted debt in the form of oil bonds to cover losses at state oil refiners like Indian Oil Corp and Bharat Petroleum Corp Ltd, which say domestic rates are now about 5% below global levels.
Even after being handed the strongest mandate in two decades, allowing the Congress party to shake off the constraints of its former communist allies, it is unlikely to rush ahead with such a sensitive issue, preferring instead a phased approach.
”It may be perceived as anti-people at least for political reasons. The government cannot remove the controls in one go,” said TK Bhaumik, economic adviser for the JK Group.
”It is political economics, which does not suggest fuel prices liberalization at this stage ... a decision may be taken in the next stage of reforms.”
That’s not to say the cabinet won’t take up debate on an issue that analysts say helped demand grow by a third since 2004, as state-owned refiners were forced to sell petrol, diesel, cooking gas and kerosene at low, fixed rates to control inflation and help poor and middle-class households.
Market-driven prices would help curb fuel use in India, one of the only major consumers expected to see positive demand growth this year. Demand is even expected to shrink in China, which last December switched to a market-based pricing system, although Beijing still retains significant control over rates.
“We had prepared a cabinet note on granting freedom to oil companies to sell petrol, diesel at market prices but it was not taken up because of elections ... This is the right time to correct this anomaly,” said an oil ministry official who did not want to be quoted on the politically sensitive issue.
When India last cut prices by up to 11% in January, the government had used a baseline basket price of $57-$60 a barrel, he said. It stood at $58.13 this week.
The Congress party has pledged that extensive reform plans will not come at the cost of the public sector, but hopes are already rising in the state oil sector, which suffered nearly $22 billion in lost revenue last year due to cheap fuel sales.
“It is a more stable government so we will expect some bolder decisions, particularly deregulation of transportation fuels and target subsidies to below poverty line families,” S Behuria, chairman of top retailer Indian Oil Corp, told Reuters this week.
Investors have greeted the possibility of freer prices -- and more stable profits -- with caution. Shares of oil firms like IOC and BPCL have lagged the broader market’s 20% rally since Friday, rising only 11-14%.
The government may tip its hand on price reforms next week when it decides whether finance minister Pranab Mukherjee and oil minister Murli Deora will continue in their roles, but its priorities would be clearest in June, when it presents its first budget.
Before the Congress-led government was voted back to power, it had appeared to signal price reforms in its interim budget by saying it would not issue oil bonds, which are given to state refiners as compensation for sell fuel at low state-set prices.
Pricing freedom would increase tax revenue and remove massive subsidies bills, helping offset the cost of economic stimulus measures that have stretched public finances and boosted the fiscal deficit to 6 percent of GDP at the start of the year, double the end-of-year target, according to the government.
“The inflation scenario is benign now. I think there will be some action on this (on easing price controls). It has a better chance than ever. It will restore fiscal credibility,” said DK Joshi, principal economist at Crisil.
The annual inflation rate fallen sharply since peaking at nearly 13% last August to just 0.48% two weeks ago.
It would also help private refiners Reliance Industries and Essar Oil compete with state firms on the local market, where they get no subsidies to maintain low prices.
India’s oil secretary RS Pandey recently said current local fuel prices were largely in tune with global oil prices, which analysts say makes it the ideal time for reform.
“Crude prices are still low, so the transition will be good ... So this is the best time,” said Praveen Kumar, head of the South Asia Oil and Gas Team at FACTS Global Eenergy.
“Market-driven fuel prices will help curb demand and minimise wasteful practices like substitution of fuel oil by cheap subsidised diesel,” he said.
It would also return India to the path set out in 2002, when the previous government announced a policy to make fuel prices market-linked but later government began intervening in pricing -- a risk that could of course arise again if oil surges.
“If crude prices reach unmanageable levels like $100, the government may partially subsidise the retail prices,” said Amitendu Palit, an economist with National University of Singapore. ”However, since crude prices are much lower now, the government should use the opportunity for carrying out reforms.”