100 a barrel?

How should the government respond to oil prices coming within touching distance of US 100 a barrel? It8217;s a question the government has been avoiding, even as the Wholesale Price Index for fuel and energy prices has gone into negative territory. Being in denial is not sustainable policy. It transfers the burden on to oil companies, which in turn approach the government for subsidies. In another apparently clever but myopic step, the government has moved the subsidy from the budget to oil-bonds, which would eventually have to be repaid by the oil companies. Private sector oil companies face losses if they sell domestically and are therefore compelled to export. This, in turn, reduces the supply of oil domestically and destroys the retailing network of these companies.

If the government is deferring this decision because it is worried about the impact the move would have on voter sentiment, it is buying votes with the money of oil PSUs. It will also only be postponing the problem and leaving it for the next government to tackle. If, however, there are no immediate elections, such an approach will just mean creating trouble for itself by introducing distortions in the economy.

There is another aspect to consider. Oil prices are rising relative to the dollar since the greenback is weakening in relation to other currencies. When the Fed cuts interest rates and the dollar weakens, oil prices 8212; quoted in dollars 8212; rise. So if the government continues with its attempts to peg the rupee to the dollar, it forces the oil prices to be high in rupee terms. A stronger rupee would mean oil is cheaper in rupee terms and that helps domestic consumers and oil companies both. So instead of keeping oil prices from adjusting, part of the problem can be solved by allowing the rupee to appreciate. A rise in the price will, inevitably, push up transport costs. It will also, to some extent, push up prices of products like vegetables. The government should therefore adopt a twin approach to minimise the impact of high oil prices: it should allow both the price of the rupee and oil to be market-determined.