Flawed formula

The pricing mechanism in India, which is based on the international price of petrol, is a major reason for the rising fuel prices, alongside the increase in the price of crude oil and the falling rupee.

A protest by the Janata Dal (Secular) in Bengaluru during the Bharath Bandh on September 10 against the Union government for increasing fuel prices.

The rising retail prices of petrol and diesel ought to worry the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) government at the Centre as they can well become a political issue in an election year. The current prices, the highest in recent times, have had a cascading effect on food products, with consumers paying astronomical amounts for daily consumables such as vegetables. The high prices are also expected to inflate India’s current account deficit. With crude oil touching $80 a barrel in the global market, domestic oil prices of petrol and petroleum products have reached unaffordable levels. In several cities, the retail price of petrol is well over Rs.80; for instance, in Mumbai it was as high as Rs.89.69 on September 22. The fall in crude oil production and the sanctions imposed by the United States on Iranian imports are among factors causing the rise in oil prices, though there is reason to believe that the Indian pricing mechanism itself is responsible for the high fuel prices in the country.

Some State governments have attempted to reduce taxes to bring consumers some relief, but it has not been enough. Tapan Sen, general secretary of the Centre of Indian Trade Unions (CITU), explained to Frontline that as far as global crude oil production was concerned it was a conscious decision to produce or not to produce. If prices tended to collapse, oil production would automatically be reduced. This ensured the maintenance of a demand-supply equilibrium. In the Indian context, it was clear that the day-to-day adjustment of fuel prices was done not only because of the volatility of international prices and production. Since 2013, a downward trend in fuel prices had been observed, but the benefit, Sen said, was never passed on to the people. It was neutralised by a higher incidence of taxation, at both the Central and State levels.

Indirect taxation is one of the single biggest sources of revenue for both the Central and State governments, with the tax on fuel representing around 50 per cent of the indirect tax revenue for both. The State and Central governments’ dependence on this was responsible for the high fuel rates, said Sen. When the fuel prices were falling, the people could have got relief , but this did not happen.

The basis of pricing of fuel was another factor. Earlier it was a cost-based pricing system on the basis of which an administered pricing mechanism (APM) was in place.

Sen told Frontline that in response to a question in Parliament regarding the basis of the administered price for diesel, as it was at a higher level, the government had said that the cost was high as there was a major dependence on imports and that the basis for calculating the administered price was the total of import cost of crude plus refining costs plus transportation costs plus a reasonable return. But the entire pricing regime was changed from that mechanism. Henceforth, petroleum pricing was to be in line with the price of petrol in the international market. “We were not importing petrol but crude. So why should our pricing be determined by the price of petrol in the international market? We said, add your refining costs plus transport costs and arrive at a basic price and add whatever tax you want to charge. At present, the rate of taxation on petroleum and diesel products is almost the same as the basic price,” Sen said.

An additional factor is the price of finished petroleum. There is a big gap between refining costs in India and abroad because of cheap labour in India. “So, technically, if you go by the cost of crude import, convert it at the present exchange rate and add refining costs, which is on an average Rs.1 to Rs.2 per litre and transport, the basic price should be 30 per cent less than the present basic price. Similarly, if you calculate the crude price at $80 per barrel and if you assume Rs.70 is the rupee-dollar rate, the refinery price will not be more than Rs.48,” he said. An additional problem that had cropped up was the declining value of the rupee. When it was stable, the prices of crude were coming down. Yet petroleum prices were calculated as per the finished product in the international market. Petroleum prices were on a par with international prices. The pricing mechanism plus aggressive taxation had added to the costs.

The declining value of the rupee was leading to an increase in fuel prices every day, Sen said. Without causing any loss to the national economy, if a cost plus reasonable pricing for petroleum had been done, people would have received some relief, he said. The tax was not rational as the pricing was the same as the basic price. The Central government was increasing its Central excise duty, and States are not increasing value added tax (VAT). But as the basic price was going up, VAT would automatically go up as per the ad valorem concept. The main problem was that the basic price was being determined by the finished price in the international market. It was imperative that the government reduce the burden of both Central excise duty and VAT on petroleum products. It was common knowledge that petroleum prices always have a cascading effect, and ordinary people get affected badly. Sen said that in the case of such an important product, the tax burden should not be so high. If the petrol price was Rs.80 a litre in Delhi, the incidence of tax was almost Rs.40 in other States. The cost plus pricing regime needs to be adopted instead of the trade parity regime where the price is decided as per the finished product in the international market, and the advantage of low refining costs should be passed on to the people. “Our costs are quite competitive in that sense. But the increase in prices is unprecedented. Even when crude prices were $120 per barrel before 2014, prices never went up that high in India. Now when it is around $80 a barrel, the prices are touching Rs.100 a litre.

“In the last one month, one can say that the fall in the value of the rupee has led to the price hike. But it must be recognised that the change of the pricing regime was, of course, initiated in the tenure of the United Progressive Alliance, which was continued by the BJP-led NDA. While VAT is responsible for the increases in the States, in the last four years, the Central excise duty has been increased several times. Every fall in the crude oil price was neutralised with the increase in the Central excise duty. In one budget they reduced it, but it was neutralised by the cess on it,” he said.