New Delhi: It may yet blink, but the government’s efforts to cut its oil subsidy bill by Rs.20,300 crore by increasing the price of diesel and limiting the supply of subsidized cooking gas may well be at the forefront of efforts to shore up the fisc and send out a strong message.
A meeting of the cabinet is scheduled for Friday evening and the proposal to allow foreign airlines to invest in Indian ones is on its agenda; the buzz in New Delhi’s power circles is that foreign investment in retail will soon be allowed; and the finance ministry has warned, not once, but twice, of the imminence of hard measures (analysts have interpreted this to mean an increase in excise duty, and the reintroduction of a surcharge on income tax).
On Thursday, in a necessary but hugely unpopular move, the government announced an increase of Rs.5 a litre (the actual price varies across cities) in the price of diesel. Opposition parties such as the Bharatiya Janata Party (BJP) and the Communist Part of India (Marxist), or CPM, and even some of the government’s own allies criticized the move as anti-people and inflationary.
“It shows that the government has no issues with the loss to the national exchequer when it happens due to corruption in which it is neck deep. However, when it comes to important subsidies, it says it does not have enough money. The fuel price hike would have a cascading effect on food inflation, which is already rising,” said Brinda Karat, senior leader of the CPM and also a member of the party’s politburo.
BJP leader Yashwant Sinha agreed.
“It is a mortal blow of Rs.5 increase in diesel price and will cause hardship,” PTI cited him as saying. “Had it been raised in small amounts, it would not have been that objectionable or difficult. Diesel increase will have a cascading effect on the economy as a whole. Prices are already not under control, so this is going to contribute to overall inflation and create mayhem in the economy.”
The Trinamool Congress (TMC), a key ally in the Congress-led United Progress Alliance government, also opposed the hike in diesel price, saying it was not consulted on the step and demanded its rollback. “We were not consulted for this and we are unhappy with the diesel price hike decision,” PTI cited railway minister and TMC member Mukul Roy as saying.
The government didn’t have any option, said Sandeep Dikshit, a Congress spokesperson. “Government has taken a considered opinion, even as it may be painful, but it had no option. No government would raise the price of diesel or petrol if it was not needed.”
The government also announced that while it was not tweaking the prices of kerosene, petrol and liquefied petroleum gas (LPG), it would limit the number of subsidized cooking gas cylinders a household could buy to six. And it reduced the excise duty on petrol by Rs.5.30 per litre even as it kept its retail price constant, a move that will reduce the loss oil companies suffer by selling fuel at a price lower than the cost of production.
India subsidizes the prices of most fuels and its annual subsidy bill towards this was expected to be Rs.1.87 trillion this year. The government expects that to come down by around Rs.15,000 crore on account of the hike in diesel prices and an additional Rs.5,300 crore on account of the limit on cooking gas. The impact of the cut in the excise duty on petrol wasn’t immediately clear. The governnment said oil marketing companies would notify every month the price at which non-subsidized cooking gas would be available.
The Confederation of Indian Industry (CII) backed the government move. The decisions “are borne out of necessity”, it said in a release. “CII fully understands the economic compulsions for such a decision. Rationalization of fuel subsidies is a necessity from the point of fiscal consolidation and, therefore, CII congratulates the government on this bold decision.”
Any improvement in the fiscal situation—India’s deficit is expected to be much higher than the estimated 5.1% of gross domestic product this year—should help in more ways than one. For instance, one analyst pointed out that it would encourage rating agencies to take a kinder view of India ahead of the announcement of fiscal stimulus by the US Federal Reserve on Thursday, something that could result in some of the money released finding its way to India. Then, there are the structural benefits of a lower deficit.
To be sure, the government has announced similar hard measures previously only to retreat in the face of political opposition. If it does, this potential wave of tough steps and reforms could be over even before it begins.
Still, the increase in diesel prices is expected to be inflationary.
Indranil Pan, chief economist at Kotak Mahindra Bank Ltd, said the first-round impact of the diesel price hike will add 60-65 basis points to headline inflation and added that he doesn’t expect a rate cut on Monday. A basis point is one-hundredth of a percentage point.
The Reserve Bank of India (RBI) will review it monetary policy on Monday. “Chances of a rate cut increases in October policy review,” he said, adding that the inflationary impact from RBI’s point of view has to be more calibrated, given rising crude oil prices.
However, another expert argued that the increase will be read by RBI as a signal of the government’s serious intent to manage the fisc, thereby encouraging the central bank to relax its hard policy stance. D.K. Joshi, chief economist at Crisil Ltd, said the government had no option but to try to reduce its subsidy burden by raising the price of diesel and added that this could create space for a rate cut on Monday.
“The needle has now tilted in favour of a 25 basis points rate cut,” he added.
The decision on fuel prices was taken by a cabinet committee on political affairs headed by Prime Minister Manmohan Singh, and it was in keeping with the tenor of messages coming from North Block to tame the fiscal deficit.
“Out of this (Rs.5 increase), Rs.1.50 per litre is on account of increase in excise duty. The balance increase of Rs.3.50 per litre will reduce the under-
recovery of oil marketers,” the petroleum ministry said in a release.
recovery of oil marketers,” the petroleum ministry said in a release.
According to the government, these measures will reduce the losses suffered by OMCs only on account of selling fuel at subsidized prices by Rs.20,300 crore. The government’s move comes at a time when the Comptroller and Auditor General of India of India wants to audit the revenue losses reported by OMCs.
Thursday’s decision was taken after the finance ministry refused to accede to the demand for a higher subsidy bill. India’s oil import bill increased from Rs.4.09 trillion in 2009-10 to Rs.7.26 trillion in 2011-12. The rationale for the increase was stated as “high international crude oil prices and sharp depreciation of Indian rupee against US dollar”.
Mint reported on 6 September that the government would announce an increase in fuel prices and cap the number of subsidized cooking gas cylinders per household after the end of the monsoon session.
The government has been promising action to rein in subsidies for the last six months, but has held back due to resistance from within the ruling coalition and rising inflationary pressures.
India’s automobile industry was surprised by the government’s decision to increase the diesel price, said a senior official at the Society of Indian Automobile Manufacturers (SIAM) lobby group.
“This increase is high. We have been saying that it should be done in a phased manner. However, we do not see much of an impact in the longer term on auto industry. Whether in short term, it will have an impact or not, we will have to wait and see as even diesel cars are available on discount,” said Sugato Sen, senior director at SIAM.
The auto industry is also reading the increase in diesel price as a sign that there may be no increase in the tax on diesel cars. The lobby group had recommended that fuel prices be raised instead.
“They (government) have followed SIAM’s recommendation. Taxing diesel cars seems to have gone on the back burner. What we need is a clear policy on diesel pricing so that we can form our strategies regarding future investments,” said R.C. Bhargava, chairman of Maruti Suzuki India Ltd.
The segment is a critical one for Maruti Suzuki, India’s largest car maker, and other car companies. About 90% of sales in 2011-12 for five of its popular models—the Ritz, the Swift, the Swift DZire, the Ertiga and the SX4—came from diesel variants.
Pravin Shah, chief executive of Mahindra Automotive, said the increase in diesel price was expected. “I don’t think it will have an impact on demand. There are other things such as high interest rates affecting demand more,” he said.
The subsidy on diesel has led to a distortion in car sales, with a large proportion of buyers opting for vehicles run on the fuel to take advantage of a price differential that was as much as Rs.32.