The
Indian economy has been at tipping point for some time
now, poised to enter a period characterised by slow
growth and high inflation. The decision of the government
to hike the prices of petrol, diesel and LPG could well
be the final push. In the government’s view the hike
was inevitable, given the sharp increase in the international
prices of crude and India’s dependence on imports to
meet much of its consumption. If the hike came only
when it did it was only because electoral compulsions
and the opposition had forced the government to hold
back for long.
The government has argued that since “under-recovery”
by the oil marketing companies (OMCs)—or the shortfall
in the price at which certain petroleum products were
being sold relative to their costs of acquiring and
distributing those products—was leading to huge losses,
the government had no option. It could for a time compensate
the oil companies with tradable oil bonds on which interest
was paid by the government. But that merely postponed
the problem and increased its dimensions. A price hike
was inevitable.
By opting to hike petrol and diesel prices by more than
10 per cent and those of LPG by more than 15 per cent
the government has transferred a significant share of
the burden of increased international oil prices onto
the domestic consumer. This could not have occurred
at a worse time. Inflation is already running at more
than 8 per cent. Since oil is a universal input that
directly and indirectly enters into the cost of production
of almost every other commodity, the increases announced
would have effects that are likely to take inflation
to double digit levels.
In different circumstances, the government may have
chosen to sharply reduce its own expenditures to cool
the system and dampen inflation. It could have argued
that, even though this would reduce the rate of growth
of the economy, with GDP growth running at 9 per cent
a year, such a reduction is an acceptable trade-off
to keep prices in check. But reduced government expenditure
would trigger a recession, increase unemployment and
curtail allocations to crucial social sectors, worsening
poverty and deprivation. That would unfairly affect
the poor extremely adversely. Given that this is an
election year, the government’s expenditures are likely
to rise rather than fall, which is one cause for comfort.
But this also means that although growth may not collapse,
inflation may soar even further.
Obviously, the government cannot avoid responding to
the huge rise in international oil prices, which has
been generated by a combination of conflict-induced
supply shortfalls, rising demand and rampant speculation.
The question is whether a sharp hike in retail prices
is the best response. Since the weighted average price
of the basket of crudes imported by India has risen
to above $130 a barrel, as compared with $30 plus-a-barrel
four years back and $60 plus-a-barrel just two years
ago, some action was inevitable. Inaction meant that
the burden of the divergence between changes in the
higher international price of oil and in the domestic
prices of oil products would fall solely on the three
oil marketing companies (Indian Oil Corporation, Hindustan
Petroleum Corporation Limited and Bharat Petroleum Corporation
Limited). But action need not mean just a price hike.
The under-recoveries or losses suffered by the oil companies
are computed by assuming that these companies access
the petrol, diesel, LPG and kerosene they market at
prices that reflect international crude prices, international
conversion costs and margins in the refineries and current
international transport costs. But it is only when oil
is actually imported, processed domestically and then
marketed to the oil marketing companies at a cost plus
price defined by international standards that the latter
suffer such losses. To the extent that crude is not
imported, the losses are only notional. In 2006-07,
India’s consumption of crude oil was around 147 million
tonnes, of which 34 million tonnes (or just short of
a quarter of crude consumption) was being produced domestically.
If it is assumed that domestically produced crude and
products derived from domestically produced crude are
being supplied to the oil marketing companies at “international
prices” then two other implications follow. First, it
is being assumed that the oil producers are making huge
“super-profits” because of the global rise in crude
oil prices and the refineries are earning margins comparable
with international producers, which would make them
extremely profitable too. If the upstream oil companies
and the refineries are made to share the burden of adjusting
to the current oil shock, then the price at which products
would be available to the oil marketing companies would
be lower than assumed, which indeed is the case.
Second, , projections of under-recoveries and losses
are based on the assumption that the level of consumption
remains more or less what it would have been prior to
the price increase. Aside from the fact that the price
increase itself could reduce demand (even if only marginally),
what this ignores is the policy alternative of directly
curbing consumption. As is argued by Prabhat Patnaik
in an accompanying article in this issue, the most reasonable
policy option in the face of the steep increase in oil
prices is a curb on aggregate consumption and the use
of rationing to allocate the targeted volume. That would
obviously reduce imports and the notional losses of
the oil marketing companies.
The government, given its predilections, has chosen
to ignore this policy option, resulting in under-recoveries
that are estimated to rise to as much as Rs, 2,50,000
crore in 2008-09, as compared with Rs.77,000 crore last
year . Even if the actual figure was lower (say, Rs.2,00,000
crore as claimed by some), it is true that if the OMCs
were not compensated in some way, their viability would
be at stake.
But posing the problem in this way obfuscates the real
issue, which is the need to curb consumption. As a result,
the discussion gets diverted to assessing how the government
should share the burden imposed by the increase in international
prices. There were at least six other alternatives available
to the government in terms of adjusting to the oil price
shock. These alternatives were : (i) raising retail
prices; (ii) reducing customs and excise duties even
with unchanged retail prices, so to transfer the benefits
of the duty reduction to the oil marketing companies;
(iii) generating revenues by taxing the super profits
of the oil companies that are involved in the production
and export of crude at the current high prices, so as
to compensate the marketing companies; (iv) generating
resources through additional taxes on or lower tax concessions
for India’s super-rich individuals and the corporate
sector, so as to pay for subsidies that protect the
ordinary consumer against the effects of the global
oil price shock; (v) borrowing money through the issue
of oil bonds to compensate the oil marketing companies
for their losses; and (vi) getting the state government
to reduce sales taxes so as to partly neutralise the
impact of increases in prices charged by the oil companies
to retailers. These different alternatives reflect varying
answers to the basic question of how the burden of financing
the additional cost of import was to be shared.
The central government claims that it is relying on
a combination of some of these measures (price increases,
duty reductions and oil bonds) to reduce the burden
imposed on the consumer. Many state governments have
pitched in with sales tax reductions that have compensated
the consumer at the expense of their already limited
revenues. The difficulty is that, despite these claims
and efforts, the price hike finally resorted to is by
no means “moderate” and its effects come when the ordinary
citizen is already shouldering the burden of rising
inflation. What would have been more sensible and fair
was to opt for a combination of the other means of adjusting
to the oil shocks, so as to keep prices constant.
The government did reduce duties on petroleum products,
but only by a small amount. While the 5 per cent customs
duty on crude oil has been scrapped, the customs duty
on petrol and diesel has been reduced from 7.5 per cent
to 2.5 per cent and the customs duty on other petroleum
products from 10 per cent to 5 per cent. But the heaviest
taxes on petrol and diesel, namely the excise duties
of Rs.14.45 per litre on petrol and Rs. 4.60 per litre
on diesel have been reduced by just Re. 1 per litre
in both cases.
The use of petrol and diesel as sources of tax revenue
has meant that the retail prices of these products include
a substantial duty component. Prior to the recent duty
adjustment and price hike the tax component in the retail
selling price of petrol and diesel was placed at 53
and 34 per cent respectively. As a result in 2006-07,
out of the proceeds from sales of petroleum products
at the retail level, as much as Rs.10,043 crore accrued
to the government as revenues from customs duty and
another Rs.58,821 crore as revenue from excise duty.
After the changes, in the retail price of Rs. 50.52
per litre, the actual price (Rs. 27.96) still accounted
for just 55.3 per cent of the price paid, the excise
duty (Rs. 13.45) for 26.6 per cent and state level sales
taxes, dealers’ commission and delivery charges for
the balance 18.1 per cent . State level sales taxes
accounted for the bulk of the last, and were reduced
to neutralise part of the price increase. (The relevant
proportions in the case of diesel (price Rs. 34.76)
were 77.5, 10.4 and 12.1 per cent respectively.)
It hardly bears stating that if the government had chosen
to forego its oil revenues completely, but the retail
price had been kept at its earlier tax-inclusive level,
the losses of the oil marketing companies would have
been much less. These losses could have been substantially
compensated for with direct payments financed by additional
taxes and a dose of borrowing in the context of an emergency.
What is more, there could have been a far greater share
of the burden that could have been borne by the oil
companies. The President of the Centre of Indian Trade
Unions and CPI(M) Central Committee Member, M.K. Pandhe
had written to the Prime Minister advancing the following
argument: "With crude oil prices now exceeding
$100/bbl, it is necessary that windfall gains be recovered
from private oil and gas producing companies like M/s
Cairns, Reliance etc who are contractors extracting
oil and gas in India through Production Sharing Contracts
(PSC). When these contractors participated in the famed
NELP policy, none of them could have envisaged crude
oil prices beyond $30/ bbl. It would be a failure on
the government's part to allow such upstream contractors
additional gains of $70/bbl - $80/ bbl in the name of
import parity without any link with actual production
cost. " In support of his case that these windfall
profits should be taxed and the proceeds used to compensate
the oil marketing companies directly, he quotes the
view of Senator Patrick J Leahy, chairman of the US
Senate Committee on Judiciary who reportedly argued:
“Of course, the bottom line is very simple: People we
represent are hurting. Your companies, the foreign oil
interests, are profiting. And we need to get this somehow
into balance. We look at the past profits of oil companies
and what they're making on previously discovered oil;
oil that was very profitable for them at $55 to $65
a barrel is obviously making them windfall profits at
$130 a barrel."
But that is not all. Many of the refineries in India
are charging conversion costs that are far in excess
of what is warranted by economic costs based on best-practice
technologies. Normative costing would help to reduce
prices as well as force these companies to reduce costs
and accept reasonable returns.
The government can afford to lose more of the revenues
it obtains in the form of taxes on oil. Further, the
losses of OMCs could have been compensated with additional
taxes on and reduced tax concessions to those companies,
businesses and individuals who have benefited hugely
from the high growth of recent years. The argument of
the opposition too is that this could have easily been
done and they have accordingly offered many suggestions.
They are indeed right. If the government chose to ignore
their suggestions, it must be because it believes that
taxing the rich to pay for protecting the poor and middle
classes from the effects of an unprecedented oil shock
is not acceptable. What also seems to have been ignored
is that this biased belief could cost this government
a victory in the next election.
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