Setting prices alight

The sharp increase in petroleum product prices is unnecessary and threatens to stoke inflation.

WITH elections out of the way and Parliament not in session there was an air of inevitability about petrol and diesel prices going up. On June 5, the government announced a sharp increase in fuel prices; diesel prices were hiked by Rs.2 a litre and petrol prices by Rs.4.

The United Progressive Alliance (UPA) government's seventh upward revision of prices in the space of just two years was heralded by a cacophony of voices pleading for an immediate increase in the prices of the two most important fuels. Corporate chieftains, business writers in the media and bureaucrats in government argued their case with the same sets of "facts" trotted out in the past. High international oil prices were, of course, cited as the chief culprit necessitating the increase. But there were other excuses as well. With their hearts bleeding for the public sector, they argued that "under-recoveries" of publicly owned oil companies were mounting by the day.

As usual, the Left remained the lone spoiler in all this. It warned against effecting a price hike, and when the price increase was actually announced it followed through with a nationwide protest in coordination with other Opposition parties. The Left's arguments against the hike were also repetitive in nature. Its main argument has been that although international prices have remained buoyant there are other options available to the government. It emphasised that these options needed to be exercised not only to spare the public at large but also to rectify the serious anomalies that plagued the oil sector.

Petrol prices are now about 33 per cent higher than when the UPA government came to power in 2004. The opposition to the increase rests on two sets of arguments. First, since petroleum products are basic ingredients in every conceivable economic activity, it is necessary for the government to absorb some of the shock that arises from happenings in the world oil market. Moreover, this threat is palpable at a time when inflationary expectations are latent. For instance, the threat of wheat prices going up sharply cannot be ruled out. This is what is implied when critics voice fears that increasing petroleum prices will have a "cascading effect".

The other set of factors is structural, related to the very design of the petroleum sector in India. For instance, the serious anomalies in the tax structure on petroleum results in the government (read the Finance Ministry) having a vested interest in hiking oil prices in order to bolster its revenues. The taxes and duties on petrol account for almost 60 per cent of the final price that consumers pay; in the case of diesel it accounts for a little over one-third of the final price. The Left parties have called repeatedly for a reduction in these taxes. This is not only to cushion consumers but also to rectify a situation in which the government makes money by causing misery.

In the last few years, every price increase has been preceded by a bout between the Petroleum Ministry and the Finance Ministry, the former pleading for a more pragmatic course and the latter calling for a heftier increase in prices. This time too, reports in the media indicate that there was a tussle between Union Petroleum Minister Murli Deora and Finance Minister P. Chidambaram before the hikes were announced.

Chidambaram's refusal even to consider a cut in excise duties indicates a mindset that is deeply rooted in fiscal fundamentalism - refuse to consider other options and then claim there is no other way. Earlier, the report of the committee on pricing and taxation of petroleum products, headed by C. Rangarajan, Chairman of the Prime Minister's Economic Advisory Council, adopted a similar posture (Frontline, March 24, 2006). The over-arching importance given to revenue neutrality effectively closed all options of reforming the petroleum-pricing regime.

In particular, both the government and the Rangarajan Committee failed to address one of the most pernicious features, the import-parity principle. In fact, successive reports of the Parliamentary Standing Committees attached to the Petroleum Ministry have called for the dismantling of this arbitrary and opaque system of pricing. The last report of the committee was tabled in Parliament 10 days before the hike.

The import-parity principle, which is basically notional in character, seriously distorts prices. Moreover, it skews the field even more against public sector oil companies, particularly vis--vis the biggest private player, Reliance Industries Ltd. For instance, on the eve of the hike, the government, media and corporate chieftains claimed that the "under-recoveries" of public sector oil companies amounted to Rs.73, 512 crores (Rs.46,330 crores on account of petrol and diesel and Rs.27, 182 crores on account of kerosene and liquefied petroleum gas or LPG). The deliberate use of "under-recoveries" to suggest actual losses has been one of the defining features of the media's coverage of the petroleum industry in recent years. In reality, "under-recoveries" are a notional concept, which allows substantial padding to prices.

In its presentation to the Left parties in May, the Petroleum Ministry claimed that the "under-recoveries" of public sector oil companies would require petrol prices to be increased by Rs.9.33 a litre, diesel by Rs.10.43 a litre, kerosene by Rs.17.16 a litre and LPG by Rs.114.45 a cylinder. Obviously, the government hoped that since petrol and diesel prices were increased by only a fraction of the amount actually needed to cover the "under-recoveries" it would be seen as having been considerate to popular sentiments.

More significantly, the biased nature of the policy regime results in public sector oil companies, particularly oil-marketing companies such as Bharat Petroleum Corporation Ltd. and Hindustan Petroleum Corporation Ltd., bearing the burden of the subsidy. The Left parties have pointed out that before the Administered Pricing Mechanism (APM) was dismantled in 2002 and replaced by the import-parity regime, the government was bearing the subsidy. In 2001-02, when international oil prices were about $25 a barrel the government incurred a subsidy from the oil pool account of Rs.-11,140 crores. The new pricing regime has shifted most of the burden from the government to public sector oil companies. The government's own subsidy fell by about Rs.8,000 crores between 2001-02 and 2005-6. Meanwhile the Union government's revenues from the oil sector - by way of taxes, duties, dividends and other payouts by the oil companies - increased by 20 per cent between 2002-03 and 2005-06, amounting to an increase of Rs.13,205 crores. The savings made by the transfer of the burden of subsidies on LPG and kerosene and the increase in revenues show that the Union government has mopped up Rs.21,205 crores in additional revenues . The government's actions can be likened to a delinquent parent promoting his own well-being at the expense of his offspring.

That is not all. The Left parties and parliamentary committees have repeatedly pointed out that options exist aplenty for the government if it truly wants to refrain from hiking prices at regular intervals. The latest report, placed in Parliament on May 22, has reiterated the need for a price stabilisation fund, funded by the cess on crude oil that the government imposes on public sector oil exploration companies (primarily the Oil and Natural Gas Corporation). In his last Budget Chidambaram increased the cess from Rs.1,800 a tonne to Rs.2,500 a tonne, which will yield the government Rs.7,500 crores during 2006-07.

The government's export-import policies also cast a pernicious shadow. The strange logic of promoting exports results in the government subsidising exporters of petroleum products (particularly Reliance Industries Ltd., which operates the largest refinery in India). The bill on this account adds up to between Rs.3,500 crores and Rs.4,000 crores annually. These figures show that neither consumers nor public sector oil companies need have suffered if the government had been more restrained in its eagerness to treat the oil sector as a milch cow.

In effect, the government has saved substantially by transferring the subsidy bill to the oil companies and by increasing the cess on indigenous crude, but forgone revenues by promoting exports. A back-of-the-envelope calculation, netting what the government has gained as a result, would indicate that the government has gained by as much as Rs.30,000 crores through increased revenues and the transfer of the subsidy bill to oil-marketing companies. Removing the export subsidy would take the total to about Rs.34,000 crores. It is estimated that the public sector oil companies' "under-recoveries" can be reduced by about Rs.10,000 crores with the recent price hike. To place these figures in context, the government has made about three and a half times what public sector oil-companies are expected to garner as a result of the last price revision. Or, to put it another way, what the government has made would have been sufficient to wipe out a substantial portion of all "under-recoveries". The last revision, therefore, appears needless.

There are other options. Last year, France imposed a "windfall" tax on oil refining companies whose margins shot up after international oil prices escalated sharply. The logic was that the oil companies should not be allowed to mint money at the expense of society at large. The Left has demanded a similar tax on such profits. It is well known that Reliance's refining margins have increased significantly in the last couple of years.

As long as the framework that governs the oil sector remains intact, and as long as the government chooses to treat the sector as a golden goose, price increases remain an ever-present danger. State governments are likely to come under increasing pressure and face popular wrath as they hike fares to cover their losses in transport services. Meanwhile, public sector companies are likely to be wrecked by a policy regime whose sole purpose appears to be to tilt the field in favour of private and multinational players.

Until recently, a general apathy prevailed among the public whenever oil prices were hiked. Perhaps the government's marketing of the idea that it was helpless in the face of far-away happenings in the international oil markets worked. But developments since the last round of increases indicate that sullen acceptance is giving way to outrage and anger as it becomes more and more evident that the Finance Ministry is the prime driver of prices. Nationwide protests against the hike indicate there may yet be hope for reason and fairness to prevail over obfuscation and greed.