Recent news reports suggest petrol and diesel prices in India may soon be deregulated, or at a minimum, may see further reductions. Déjà vu?
When the administered price mechanism was dismantled in April 2002, the government seemed committed to aligning fuel prices with market dynamics, of course, with continued subsidies on the so-called common man’s fuels—liquefied petroleum gas (LPG) and kerosene. The government’s resolve lasted only until late 2003 when crude prices started rallying and it was obvious that diesel and petrol prices increasing in sync would mean political hara-kiri.
With that was laid to rest the notion that a third of the subsidies on LPG and kerosene would be recovered from profits on diesel and petrol, with the remaining subsidy shared between the upstream companies (Oil and Natural Gas Corp. Ltd, GAIL (India) Ltd and Oil India Ltd) and downstream companies (Bharat Petroleum Corp. Ltd, Hindustan Petroleum Corp. Ltd and Indian Oil Corp. Ltd).
Could the latest manoeuvre have a little to do with garnering some electorate goodwill from an increasingly cash-strapped consumer?
The government in June rationalized—to an extent—levies on petroleum products. The customs duty on crude oil was abolished from 5% earlier. The customs duty on petrol and diesel was reduced to 2.5% from 7.5%, and the duty on all other petroleum products was reduced to 5% from 10%. The excise duty on petrol and diesel was cut by Rs1 a litre.
Even after these seemingly progressive actions by the government, total levies on petroleum products are staggering—total levy on petrol is 56% of the price to the consumer, 36% on diesel and 13% each for kerosene and LPG. During the peak of the economic expansion—fiscal 2004 to 2007—the excise and erstwhile customs duty revenue collected by the central government—and we ignore the sales tax that flows to the state governments—have exceeded the oil bonds issued and fiscal subsidy on petroleum products by about Rs50,000 crore annually—a cumulative 4.5% of current GDP, or almost twice the fiscal deficit.
Of course, the true economic benefit to the government is greater than the Rs50,000 crore, since the oil bonds cost them nothing today, barring the coupon payment, whereas the taxes are cash in the kitty.
India is perhaps the only country in Asia that’s been unable to use the economic upturn to bolster its fiscal situation, in spite of the convoluted situation of India’s petroleum industry only having helped the fiscal cause. This truly points to the fact that taxation isn’t the way out of the problem here and the incremental savings are better placed in the hands of the consumer, who undoubtedly will do a better job allocating these.
Whether the oil marketing companies are making money selling diesel and petrol at today’s crude oil prices is moot. The decline in crude prices is a cyclical phenomenon. If the government does take the radical step of deregulating petrol and diesel prices, as they have tried a couple of times in the past, it will be nothing but a transitionary effort that will buckle in the face of an inevitable crude oil rally.
Oil bonds are a miserable invention for a broken system. What looks good for the oil marketing companies’ income statements isn’t a cash flow solution for them. The lack of natural buyers for these bonds invariably means that oil marketers need to issue debt every now and then, the interest they pay is higher than the interest they receive on the oil bonds, and illiquidity means that the value of these bonds held on the balance sheets itself is always suspect. Perhaps the smartest decision to date by the Reserve Bank of India has been not giving these oil bonds the status of statutory liquidity ratio—the amount which banks are mandated to park in government securities.
The subsidies are causing ridiculous imbalances. In 2006, a committee formed to advise the petroleum ministry recommended rationalizing the myriad taxes on the petroleum products and aligning petrol and diesel prices with international prices, but also opined that the LPG and kerosene subsidy was quite convoluted.
They wrote that offering kerosene at subsidized prices under the public distribution system to all consumers was causing “waste, leakage, adulteration and inefficiency.” But what they most lambasted was the LPG subsidy, calling it indefensible as it was primarily reaching a strata of society that does not need it.
Further examples of lopsided consumption as a result of this meaningless system come from the rapid increase in diesel-powered cars and electricity production from diesel that’s been growing at 25-30%.
We are set in an ideological time warp with the petroleum system in India. The mindset that the government is the best resource allocator—be it the profits off petrol and diesel or the enormous tax burden that especially petrol consumers have to bear. So the consumer pays more, the oil companies don’t benefit and the government runs an endless deficit. Free market capitalism anybody?
Rajeshree Varangaonkar and Bharat Indurkar have day jobs with US-based hedge funds. They write every other Thursday. Send your comments to email@example.com