It
is commonplace to decry the supposedly unsustainable
burden of subsidies on the state exchequer, and to
see desirable "reform" as the removal of such subsidies.
In his Budget Speech, Finance Minister Pranab Mukherjee
lived up to this completely, and declared his intention
to bring down the subsidy bill particularly for fuel
and fertilizers. The Budget Estimates for 2012-13
indicate a decline in the fuel subsidy bill by as
much as Rs 25,000 crore. Clearly, if global oil prices
continue to remain high, this is a feat that cannot
be achieved without increasing fuel prices domestically.
It is unfortunate – but not altogether surprising
in the prevailing climate – that hardly any of the
commentary around the Budget pointed not just to the
severely inflationary implications of this, but also
the fact that this is unnecessary. Also, there is
a remarkable tendency in India to believe that this
particular price – which is after all the price of
the most essential universal intermediate, fuel –
should be equalized to global prices, even while per
capita incomes in India and the incomes of most consumers
remain so far below the global average.
As it happens, retail prices of fuel in India are
among the highest in the world, and significantly
higher than in several developed countries including
the United States. Chart 1 shows that relative to
per capita income, Indian retail prices of petrol
are already extremely – and unreasonably – high. For
example, in February 2012 the Indian retail price
of petrol (averaged across 32 centres across the country)
was 42 per cent higher than in the US, and 26 per
cent higher than in China.
Chart
1 >>
(Click to Enlarge)
The full extent of this burden is apparent from Chart
2, which plots the ratio of petrol price to per capita
GDP in selected countries, in index form with the
ratio equivalent to 1 in the US (which has the lowest
such ratio among non-oil exporting countries). It
is clear that Indian consumers are being forced to
bear an inordinate burden relative to the average
purchasing power. Even compared to other developing
countries like Brazil and China, the burden is extreme.
And this does not take into account the inequalities
within the country which make the burden even more
onerous for poorer consumers.
The situation is similar for diesel prices, which
is what makes the matter more extreme. Diesel is close
to being a universal intermediate – entering into
costs faced by farmers, the cost incurred in much
other production and obviously the cost of transport.
High prices of diesel therefore feed directly and
indirectly into all other prices, including especially
the necessities consumed by the ordinary citizens.
Cutting subsidies that keep this price down is a direct
assault on the real incomes of the poor.
Chart
2 >>
(Click to Enlarge)
There is a further dishonesty in the government’s
approach to the issue, driven by the tendency to look
at the subsidy burden in isolation from the broader
elements of price formation, particularly the tax
regime. In fact, the petroleum sector is not a burden
on the government, but rather a cash cow that yields
large revenues in the form of customs duties and excise
duties. Since most of these duties are still specified
as ad valorem rates proportional to the value of the
commodity being taxed, revenues garnered from taxation
tend to rise along with the increase in the international
and domestic prices of the commodity. So in that sense
the government is fiscally a substantial gainer from
a period of high global fuel prices, even as it seeks
to put more burden on domestic consumers.
Charts 3 and 4 show the share of taxes in the retail
prices of petrol and diesel in selected countries
compared to India. It is evident that India is somewhat
in the middle of this group of developed countries,
which have on average per capita GDP that is nearly
thirty times that of India! In other words, the burden
of taxation of this essential good (which is necessarily
inherently regressive in character) is comparable
to countries with massively higher per capita incomes.
The contrast is particularly striking with respect
to the USA, since for petrol the tax burden in India
is four times that in the USA, while for diesel the
tax burden in India is nearly three times that in
the USA.
Chart
3 >>
(Click to Enlarge)
Chart
4 >>
(Click to Enlarge)
Charts 5 and 6 reveal the structure of components
of the retail price in India, based on data for April
2011 presented by the government in response to a
question raised in the Lok Sabha in 2011 (as quoted
in Rohit, "Economics behind the oil prices in India",
www.pragoti.org).
Chart
5 >>
(Click to Enlarge)
Chart
6 >>
(Click to Enlarge)
As it happens, the government’s tax collections from
petroluem products already far outweigh the subsidies
and under-recoveries from oil companies that consitute
the drain on the public exchequer. A study by Surya
P Sethi, former Energy Advisor to the Planning Commisison,
revealed that for the three years at the close of
the last decade, tax revenues from oil products had
been substantially higher than the outgo on subsidies
etc., even in that period of very high global oil
prices. Unfortunately more recent data on this are
no longer available on the website of the Petroleum
Planning and Analysis Cell.
Chart
7 >>
(Click to Enlarge)
The nature of the Budget Speech was such that the
actual measures to be taken with respect to petroleum
pricing were not elaborated. Rather, statements were
made that require action from other Ministries in
future, action that will necessarily involve raising
oil prices, with all the attendant adverse implications.
One point should be clear from this discussion: subsidies
in the energy sector are common across almost all
countries, including developed countries, and are
particularly necessary for developing countries like
India. The domestic price of oil cannot be set at
levels that recover the costs of import, since those
costs are too volatile and rising. Rather the domestic
price should be set on the premise that it is one
element in a tax-cum-subsidy framework, with the price
serving as part tax when international oil prices
are unduly low, and part subsidy when international
oil prices are as high as they are today.
This raises the critical issue of how a subsidy should
be viewed. Proponents of reduced fuel subsidies argue
that passing on rising prices and therefore getting
more "realistic" domestic price (that is
close to global market prices) would also encourage
more fuel-efficiency and reduce excess fuel consumption.
But this misses the point that the majority of Indian
citizens anyway have very low fuel consumption, and
it is only a small section of the population that
can afford to be profligate in its direct and indirect
fuel use.
Higher fuel prices in this context basically raise
costs for domestic producers in both agriculture and
non-agriculture, and have cascading inflationary effects
that attack the real incomes of the bulk of people
whose fuel consumption is already low. It is far better
to work for stability and containment of energy prices
while taxing the high-fuel consumption patterns of
the rich. So, taxes on luxury cars, air travel, generators
for domestic use or similar expenditure will all contribute
to the desired effect of controlling undesirably excessive
fuel consumption without attacking livelihoods and
living standards of all the people.
Avoiding these strategies and causing instead a regressive
increase in fuel prices is not an economic choice
– rather it is a choice about income distribution
and deciding to put the burden on the bulk of the
population rather than the privileged few.
