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Tuesday, October 19, 2021

Boiled in oil

India needs to get its fuel pricing right before oil prices start to rise again

Written by Bibek Debroy |
January 16, 2009 12:57:29 am

SACRED texts describe assorted hells and a recurrent image is of sinners (in hells) being boiled in oil. If there is one sector that illustrates the pitfalls of non-reform,or of half-baked reform,that’s oil. Unlike three decades ago,global crude prices are no longer a BoP (balance of payments) issue and not only because we also export refined stuff. Despite an unfavourable external environment now,forex reserves will remain comfortable,unless unreasonable exchange rate policies force them to dwindle. Short of prices shooting up to $300 a barrel,and OPEC no longer being the monopoly it once was,there is no BOP issue. Yet,there is a strategic reasons to diversify our sources of energy,because once global growth recovers,oil prices will climb again.

However,the boiling in oil mess is entirely domestic. First,we don’t recognise that only the identified poor merit subsidies. If that’s accepted,we will identify the poor and figure out more efficient methods of subsidisation,like direct cash income transfers.

Second,we won’t believe in differential pricing for the same product. At least,we won’t believe in it seriously,even if such principles are built into the PDS (public distribution system),because we recognise problems of leakage. Leakage and diversion aren’t reduced even if petrol meant for the poor is coloured blue.

Third,wishing to subsidise the poor,but not knowing how to do this,we think we have a solution in subsidising specific products rather than specific individuals. So we have a perceived hierarchy of products through kerosene,LPG,CNG,diesel,petrol,aviation fuel. The lower down the hierarchy,the more the product is consumed by poor people. This is a doubtful proposition. To the extent diesel or CNG is used for transportation,it affects the poor too. Products are also substitutes,even if imperfect. Kerosene can be used to adulterate diesel or petrol. CNG vehicles can run on LPG cylinders. For that matter,subsidised kerosene can be smuggled across the border to Bangladesh. Since we haven’t decided to subsidise only the poor,the vocal urban middle class,which masquerades on television channels as the common man/woman,will want subsidies on LPG. There is evidence from the 1990s to show the genuine poor have switched from firewood to LPG. Hence,everyone who uses LPG must be poor. Having decided some kind of product-wise subsidisation is warranted,even if stupid,we need to fix the extent of subsidy on specific products. And this is arbitrary.

Fourth,not content with this messing up of retail pricing of petroleum products,we leave it out of the sales tax harmonisation exercise referred to as VAT (value added tax). What’s special about petroleum (and liquor)? After all,there is going to be a common tax revenue pool from which the states will obtain shares. What’s the big deal about these products? (The constitutional provision on what the states can tax isn’t cast in stone.) The present aviation turbine fuel mess is largely this. The states want compensation if such taxes are eliminated. Lest we forget,compensation was part of the VAT package from which petroleum was excluded. We could have resolved the present problem then,had we not insisted on exclusion.

Thus,the government has complicated and messed up the retail prices of petroleum products,that is,the prices at which oil marketing companies can sell. And some retail prices are subsidised,so a company will incur losses if it sells these. Had all these marketing companies been public,no one would have bothered. As we all know,taxpayers pay for losses of PSUs. That’s the beauty of administered pricing. We never know who we are cross-subsidising and how.

But fifth,given the background of other errors,there was an additional transgression,that of throwing open refining and marketing to the private sector. To make life even more interesting,the government began to determine prices at which refineries sold products to marketing companies. There must be parity with imports,since while most crude is imported,some is sourced domestically. Therefore,any link between crude prices and retail petroleum product prices completely breaks down. The petroleum ministry may have answers,but those aren’t transparent. Consequently,if global crude prices increase (or decrease),we don’t quite know by how much retail prices should rise (or fall). However,there remains the matter of compensating refining and marketing companies for losses,since prices may be lower than warranted. In that case,investments won’t occur. There will be shortages. Thus,even if it presently doesn’t enter into fiscal deficit calculations,think of oil bonds as some compensation. It isn’t complete compensation,so disincentives and deterrents to investments still remain.

But these are trivia compared to the bigger tangle. When do you solve a problem? When it is most tractable. Since a fundamental concern is transmission between global crude prices and domestic retail prices,with an eye on inflation,one should try to get out of the tangle when both are low. Instead,the sixth mistake was the worst: wishing the problem would go away and avoiding hard decisions. Consequently,the mind boggles at the numbers involved when crude prices were at their record levels of more than $140 in July. Without subsidies,kerosene prices would have had to increase by more than Rs 20 a litre and LPG cylinder prices by more than Rs 340. Cross-subsidisation across products isn’t the solution. Therefore,since retail prices have to increase,reform is easier at $40 a barrel. Reform is also easier when retail price increases are incremental and in small and gradual doses,instead of suppressed increases leading to gigantic gaps. All this should be obvious and there is no better time than now. So why don’t we reform?

Lobbies on the production or consumption sides aren’t a satisfactory answer. These exist everywhere. Nor is the bleeding-heart mindset in the name of the poor completely convincing as explanation. Perhaps the answer lies in money that can be made from discretion. That’s invariably the explanation in every area of non-reform or tardy reform. The words “oil” and “grease” usually go together. Machinery needs them both and government machinery is no exception.

The writer is a noted economist

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