Yesterday’s decision to hike fuel prices was long overdue.
But it is also inadequate. Crude oil prices have increased by more than a quarter in the 20 months since June 2006, which was the last time prices at the petrol pump were increased. The latest price hike is only a weak attempt to bridge the gap between domestic and global oil prices.
Of course, a one-shot 25% hike would be political suicide. So, it’s good the government has taken a welcome first step.
The entire game of importing oil at high prices, while selling it domestically at artificially low prices, was possible through dodgy accounting. Domestic oil companies had to suffer losses because local fuel prices were held below global levels. They were given bonds, instead of cash. The oil bonds already make a mockery of the claim that the fiscal deficit has been slashed of late.
Oil subsidies are already 1.4% of the gross domestic product (GDP) and could rise to around 2% of GDP over the next few years if fuel prices are set by official diktat. These bonds are a burden on government finances, and will have to be paid off by future generations. The government is, in effect, asking our children to pay for our subsidies. Postponing problems is never a good course in public policy.
It’s no surprise that the shares of oil companies out-performed a buoyant stock market on Thursday. Of course, the correction in oil prices will pinch consumer wallets and lead to a spike in inflation, giving the Reserve Bank of India even less reason to cut interest rates.
But these are short-term worries. Market pricing will help address the longer-term issues of energy security. This follows from basic economics. Prices reflect scarcity. And they are the main input in decisions to consume and produce. Higher fuel prices will act as an incentive to use oil more sparingly and make the use of alternative types of energy more attractive. It will also be an incentive for oil companies to prospect for more black gold.
There are thus very clear long-term benefits in letting markets rather than ministries decide fuel prices. We need to move as quickly as possible to free pricing of oil and its many products. The last 20 months have shown what sort of distortions price controls can impose on the economy.
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