Late last week, the Union government began the process of getting the oil pricing act right. After months of debate and policy paralysis, it took the first step towards market determination of key refined oil products.
Under the new arrangements, announced on Friday, petrol prices will be decontrolled totally and will be market determined. This decontrol will take place both at the factory gate and at the retail level. Diesel prices, too, will be decontrolled steadily. For the time being, the price of diesel has been increased by Rs2 per litre. Liquefied petroleum gas and kerosene prices, probably the most sensitive politically among all petroleum products, too, have been increased.
The economic case for market determination of these prices has always been strong. The government setting of these prices distorts them and makes the task of managing the economy more difficult as, beyond a point, calculating the social welfare of such a pricing regime reduces to a single line: Don’t increase prices. While this may sound nice, it has a deadly effect on the oil marketing companies. By the government’s own admission, these companies will suffer “under-recoveries” of Rs53,000 crore even after this announcement of price correction.
This, however, is only one aspect of the overall macroeconomic situation. Oil pricing reform is only the first step in fiscal consolidation. India’s gross debt stands at 79% of its gross domestic product (GDP) in 2010-11. If it were business as usual, this would not have been a cause for concern. But today, there is a debt overhang on the global economy. Rising debt can create serious macroeconomic problems even for healthy economies, as the European experience shows. Among the Bric (Brazil, Russia, India and China) group of countries, India has the highest debt. The rather low sovereign rating enjoyed by India should be seen in this light. As a result, the government needs to take all feasible steps to bring this debt level down. Politically, it is difficult to initiate cuts in social sector spending, the biggest expenditure growth items of recent years. Oil pricing reforms, too, are politically difficult, as can be seen from protests and political reactions since Friday. But the government has to begin consolidation somewhere.
Oil is an exhaustible and non- renewable resource. As such, there is a strong case to tax it properly to reflect its consumption and non-availability for future generations. There have been noises that government should reduce the excise component of these taxes on oil. That is a bad argument. The government has to have some revenue if it is to provide basic services.
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