Steering out of the oil slick

Steering out of the oil slick

After the recent roiling of the international crude oil market, prices on Tuesday hovered around $111-111.5 per barrel. A combination of factors—Japan being “out of action" for the next few months to the continuing uncertainty in the Middle East—has kept prices volatile. A Reuters report said the International Energy Agency had marginally reduced its global oil demand forecast for 2011.

Instead of looking at this window as a period to relax, India needs to aggressively effect energy reforms, if the danger of harsher corrective measures, at a later date, is to be avoided. This is unlikely in the next few months as the country heads for state elections. But after that, oil price deregulation should be put in place.

The fact is that India continues to be hit hard by rising prices. This seems “invisible" at the moment, as the increase in prices is not passed to consumers. By one estimate, a $1 increase in crude oil price (per barrel) increases the country’s trade deficit by $800 million and leads to under-recoveries on the part of oil marketing companies to the tune of $700 million. These are not trivial sums. Unless a substantial fraction of these costs are passed to consumers, the danger of the much-talked-about “twin deficit"—the current account deficit (CAD) and the fiscal deficit—getting out of hand is very real. If oil prices persist around $105/barrel (a favourite assumption of many analysts), CAD could touch 3% of the gross domestic product. This assumption may not hold as the $105/barrel figure is conservative given the demand pressures that will arise once Japan is back on its feet and the global economy powers ahead.

The ideal solution would be to pass all costs to consumers, but given that it is unrealistic, a mixture of adjusting taxes and price decontrol is required. The first and foremost condition is to ensure that oil products are kept within the purview of the goods and services tax (GST) whenever it is introduced. This will call for some tough political bargaining between the states and the Centre. The states today levy anywhere from 15% to 33% sales tax on these goods. For them, this is a money-spinner. This has to be ended.

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