Every time there is an upward revision in the price of petrol or diesel, all hell breaks loose for anywhere between 1-4 days. The chart below shows how the prices have moved in the last 10 years. Ironically, despite this rise, a line chart of the growth in traffic in our cities would look a lot steeper. If you drive in city traffic on a daily basis and the price rise has been pinching your pocket, just for a moment imagine what would happen if it falls back to the 2002 levels. I am sure you understand what I mean.
Nevertheless, I often wonder why the government provides fuel subsidy in India and what made the government consider the idea of deregulation of fuel prices? How does fuel subsidy in India impact inflation? How does rise in the price of fuel benefit the government (does it)?
The answer to the first one may be easy. Whenever, energy prices go up, whether it is petrol, diesel, electricity or LPG, it has a direct impact on the popularity of the ruling government. This is true in the UK, USA, India or any other country for that matter. What then made the government pull the trigger on diesel subsidy?
The current fuel subsidy regime is not sustainable given the rising crude prices in the international markets. Especially given that the government wants to maintain the total subsidies under 2% of GDP for FY 2013 and reduce it to under 1.75 % of GDP over the following three years.
The total quantum of crude oil imported into the country during the year 2011-12 stood at 171.73 Million Metric Tonnes (“MMT”), an increase over the 163.59 MMT imported in the previous year. With international oil prices being firm throughout the year, the imports of crude oil have increased significantly in value terms.
For the year 2011-12, US $ 139 Billion was spent on crude imports, compared to US $ 100 Billion for the year 2010-11.
Until a few years back, a majority of passenger cars use to run on petrol while trucks and other Medium & Heavy Commercial vehicles which transport essential commodities such as vegetables and other food items to our cities were run on diesel. This to some extent justified the price differential between petrol and diesel. It may also have justified the need to give subsidy on diesel while approving price deregulation of petrol i.e. to let the Oil Marketing Companies (“OMCs”) decide on the pricing of petrol. Lately however, diesel run passenger cars have become extremely popular which has resulted in the need for doing away with the fuel subsidy on diesel as well.
The problem with that however is that, it would further intensify inflation as the price of food and other essential commodities will rise. Besides, it will surely pinch the pocket of the farmer as his cost of running farm equipment goes up. To counter the latter, the government could consider higher cash subsidies but higher inflation is something which the government is already struggling to find a solution for. The only long term solution is to find ways for people to switch to power sources like wind and solar energy and drive more fuel efficient cars so that the demand for fuel goes down.
Under Recoveries of OMC’s
The under recoveries of OMC’s for the year 2010-11 amounted to Rs. 75,962 Cr. The Government of India provided a total fuel subsidy of Rs. 41,000 Cr for the same year. Now compare this with the figures for the year 2011-2012 where the under recoveries jumped to Rs. 1,38,541 Cr.
Clearly, a majority of the fuel subsidy in India is being spent on diesel alone. Would it be fair that the Government increase its subsidy on fuel? How else would the OMC’s survive? But again, if the government increases fuel subsidy then a very real question would be – How will the Government survive? Should the Government deregulate the price of diesel as well, as it is seeking to do by allowing OMC’s to make minor monthly corrections in the price of diesel?
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About the Author
Rajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.Follow @SanaSecurities