On
November 4, the government decided to link the domestic
price of petrol to its import parity price while increasing
diesel price by half of that warranted by its import
parity. This effort to restore the link between the
domestic prices of petrol and diesel and global crude
prices as required by the liberalised pricing scheme,
resulted in an increase of Rs 2.20 per litre in petrol
prices and Rs 2.10 per litre in diesel prices. In addition,
the price of LPG was increased by Rs 20 per cylinder
with immediate effect and is slated to rise subsequently
by Rs 5 each month.
It hardly bears stating that such increases in the prices
of a universal intermediate like oil, whose direct and
second-order effects on the domestic price level are
bound to be substantial, are causes for concern. Such
increases are reflected in the prices of commodities
and services (such as transportation) consumed by the
poorest sections of the population, placing a burden
precisely on those who are losers from the government's
liberalisation policy. Further, they result in cost
increases in areas like agriculture which squeeze the
already low levels of net incomes of farmers. It is
surprising a government that uses the (self-contradictory)
slogan of ''liberalisation with a human face'' should
see no alternative to such increases.
The case for the increase in prices sounds simple: the
average price of the basket of crude imported by India
has risen from less than $30 a barrel in February to
more than $50 per barrel; and imports account for 70
per cent of India's crude requirements, which have been
rising rapidly from 81 million tonnes in 2002-03 to
an estimated 91 million tonnes last fiscal year. Given
this, if the government does not raise domestic prices
of oil, either the oil companies would have to suffer
huge losses or the government would have to dole out
huge subsidies. Neither is acceptable to India's reformers,
so prices must rise.
The problem with this reasoning is that it misses out
on three important aspects of the current oil scenario.
First, the increase in global crude prices is not ''natural'',
but reflective of a shock resulting from factors as
diverse as an unwarranted war in Iraq, engineered civil
strife in Venuzuela, and conflicts over control of at
Russia's oil major Yukos. A responsible government is
one that attempts to deal with such, hopefully transient,
shocks in a manner that buffers their impact on vulnerable
sections.
What the current oil shock has made clear is that the
shift away from an administered price regime was an
error, because it reduces the manoeuvrability of the
government in such situations. Prices of commodities
like oil should be seen as one instrument in the government's
overall tax-cum-subsidy regime, and prices need to be
held down if necessary and financed with revenues garnered
from elsewhere, so that the distributional effect of
international shocks are not adverse in an already unequal
society.
Second, it is known that oil companies are earning substantial
profits and if need be they can be called upon to take
a temporary reduction in excess profits to achieve larger
goals.
Finally, and most crucially, domestic oil prices include
a huge component of ad valorem duties or duties levied
as a proportion of factory prices. When international
prices rise and domestic prices are adjusted in tandem,
the government's revenues also rise substantially. Thus
if duties are reduced to neutralise the price increase
what is ''lost'' is not actual revenues but notional revenues
that are far in excess of what was originally expected.
Consider the following back-of-the-envelope calculation.
When the current increase in global crude prices began,
central excise on petro-products stood at 30 per cent
plus Rs 7.50 per litre. In the case of diesel the rate
of excise was 14 per cent plus Rs 1.50 per litre. Further,
the ad valorem customs duties on petrol and diesel amounted
to 20 per cent. The duties on kerosene and LPG were
no doubt lower at 18 and 26 per cent. So, for simplicity,
treat the average level of duties to be around 35 per
cent on oil products.
The average price of imports of crude oil is estimated
to rise from around $27 a barrel in 2003-04 to over
$40 a barrel this year or by around 50 per cent. India's
oil bill in 2003-04 stood at $20 billion. Even if prices
were constant this would have risen to $22 billion this
year because of increases in the volume of imports.
Add on the effects of a 50 per cent increase in oil
prices and the import bill would have risen to $33 billion.
If the average rate of duty had remained at around 40
per cent, the government would have obtained $13.2 billion
as revenues as compared with $8.8 billion - an excess
of $4.4 billion or Rs. 19,800 crore.
In practice of course, duties have been reduced to help
hold domestic prices. On June 16, soon after it assumed
office, the Government reduced the ad valorem excise
duty rates on petrol from 30 per cent to 26 per cent,
on diesel from 14 per cent to 11 per cent and on LPG
from 16 per cent to 8 per cent so as to partially neutralise
the effects of price increases by the oil marketing
companies (OMCs) on the consumer prices of these products.
Further, on August 18, the customs duty on both petrol
and diesel were brought down from 20 per cent to 15
per cent. The excise duty on petrol was reduced from
26 per cent to 23 per cent while that on diesel has
been reduced from 11 per cent to 8 per cent. And, the
customs duty on LPG and kerosene sold through the Public
Distribution System (PDS) was halved to 5 per cent.
In addition, the excise duty on PDS kerosene was reduced
from 16 per cent to 12 per cent.
The net result of all this is that the average duty
is possibly in the range of 30 per cent over the year
as a whole. This would make the revenue received by
the government around $9.9 billion, or $1.1 billion
(Rs. 5000 crore) more than originally expected. Needless
to say, these are all back of the envelope calculations,
and the actual figures would be different. But what
they do suggest is that in all probability the government
has thus far had to suffer no revenue losses in its
effort manage the effects of the oil shock on domestic
prices. Figures of ''revenue losses'' routinely reported
by the financial press are notional and reflect the
wrong presentation of information in an effort to lobby
for the play of market forces. In fact, the government
may still be taking in additional revenues to keep expenditures
higher than those warranted by the deficit targets set
by the irrational Fiscal Responsibility and Budget Management
Act.
It is this which makes the recent hike in the prices
of petroleum products, including diesel, completely
unwarranted. But perhaps not so for a government which
speaks of a ''human face'' but persists with an agenda
that is fundamentally inequalising.
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