UPA’s bet on good economics

New Delhi: The country is now only a step away from a complete dismantling of the administered price mechanism for petroleum products, after the government on Thursday removed diesel from its purview.

This has set the stage for an increase in diesel prices, if state-owned oil companies, which have been empowered, decide to do so in an attempt to bridge the ₹ 9.60 a litre they lose on account of having to sell diesel below the actual cost of production.

Such a move will not be popular and could provide a fresh inflationary impetus that will have a multiplier effect across the economy and also alienate the politically key constituency of farmers who depend upon subsidized diesel to operate pump sets to irrigate fields.NextMAds

To mitigate the political fallout of the move of effectively decontrolling diesel prices, especially among the urban populace, the Congress-led United Progressive Alliance (UPA) increased the cap on the annual supply of subsidized cooking gas cylinders to nine from the current six per household, starting 1 April.

There was considerable confusion after the government cancelled a scheduled press briefing and excluded any reference to the move in the press release that was issued after the cabinet meeting.

Oil minister M. Veerappa Moily told reporters that state-owned oil marketing companies (OMCs) have been permitted to raise diesel prices by a small quantum periodically till such time that they are able to make up their losses.fourthMAds

He declined to provide details of a diesel price increase, while adding that rates may be raised as early as Thursday night. PTI said late on Thursday that the government had allowed OMCs to raise diesel prices by 50 paise a litre while petrol prices will be cut by 25 paise per litre. In Delhi, petrol costs ₹ 67.56 a litre.

These OMCs currently sell kerosene and (liquefied petroleum gas) LPG at a loss of 30.64 a litre and 490.50 per 14.2kg cylinder, respectively. At an aggregate level, these losses are estimated at 1.65 trillion for the current fiscal.

Analysts say the significance of the government’s move is in the import of the decision that sends out several signals that assuage some of the concerns and doubts evinced globally and domestically about the ability of the UPA to take politically uncomfortable decisions.sixthMAds

It sends out the right signal on the UPA’s willingness to address fiscal correction, a message that is particularly relevant to foreign investors lining up to meet finance minister P. Chidambaram when he launches his road shows next Monday.

It sends out the right signal to the Reserve Bank of India, which had presaged further rate cuts on credible fiscal correction.

And it also sends out the right signal to rating agencies that were threatening to downgrade India’s sovereign rating on account of unchecked fiscal profligacy.

D.K. Srivastava, director at the Madras School of Economics, said the diesel price decontrol should help the government contain its burgeoning subsidy bill, even though it will have a limited impact in containing the fiscal deficit for the current fiscal year to 5.3% of gross domestic product (GDP). “These are (the) last round of reform measures taken by the government before the budget next month,” he said.

D.K. Joshi, chief economist at Crisil Ltd, said the recent measures announced by the government were inevitable.

By taking these politically tough decisions ahead of the presentation of the Union budget, the government had politically sanitized the budget session and also provided relief to the finance minister in the cushion that it provides in the potential reduction in the outgo on subsidies. With the economy expected to recover to a growth trajectory of 6.5% in the next fiscal, the government’s revenues too will rise.

Jai Mrug, a Mumbai-based political analyst, said that politically the most important thing about the decision was its timing.

“The government has lined up goodies it wants to give to the people post-budget including availability of food for those below the poverty line and the direct cash transfer,” Mrug said. “They have to deliver these goodies and in the light of a serious fiscal situation, correction is required to manage the fiscal deficit and this is being done before these goodies are rolled out.”

Coming as it does barely eight days after the railway minister increased rail fares (after a gap of 10 years), the move also sends out a challenge to the government’s political adversaries. The political opposition has collectively condemned the UPA’s move and is seeking to derive political mileage from it.

Bharatiya Janata Party (BJP) spokesperson Prakash Javadekar said, “This is a disguised attempt to increase the prices of diesel through back channels. It will have an adverse impact on farmers and the transport sector. This will have a cascading effect.”

Similarly, Communist Party of India (Marxist), or CPM, leader Prakash Karat said the move constituted another attack on the public. “First the prices of petrol went up and now prices of diesel will go up,” he said.

India’s automobile industry welcomed the move. The passenger vehicle industry has undergone a radical change after the decontrol of petrol prices in June 2010. The resulting price differential between petrol and cheaper diesel created an unnaturally high demand for diesel cars, according to the Society of Indian Automobile Manufacturers (SIAM) lobby group.

Pawan Goenka, president, automotive and farm equipment sectors, Mahindra and Mahindra Ltd, said, “In our opinion such an increase in diesel price will have very little impact on UV (utility vehicle) and CV (commercial vehicle) demand, but may slightly shift demand to petrol in the passenger car segment in the small and mid range. An increase in diesel price beyond ₹ 5 (a litre) may start impacting overall industry volume.”

The current move is based on recommendations by the Vijay Kelkar committee on fiscal consolidation. Similar recommendations were made by committees chaired by Planning Commission member B.K. Chaturvedi and former member Kirit Parikh.

The government has been considering the idea of linking domestic and international fuel rates for some time now, and India first moved towards decontrolled fuel prices in 1997. However, the United Front government’s decision was reversed by the BJP-led National Democratic Alliance after it came to power for the second time in 1999. Interestingly, while prices of petrol were deregulated in June 2010, OMCs still need the government’s approval to raise prices. Diesel prices were last revised by ₹ 5.63 per litre in September. Diesel is currently priced at ₹ 47.15 per litre in Delhi.

Mint’s Sahil Makkar and Anuja, and PTI contributed to this story.