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India: The Oil Price Hike

What on earth are they thinking?  In the midst of an almost unprecedented and continuous increase in the price of necessities, which is increasingly translating into generalised inflation, the UPA government has chosen to “free” the price of petroleum products, to bring them in line with international prices.  What this translates into is a significant and immediate increase in oil prices.  And since oil is a universal intermediate (which enters directly or indirectly into all other prices), this necessarily means a further rise in inflation.

This is a move that is inexplicable from the point of view of general economic policy.  Inflation has emerged as a major problem for the government especially in the past few months, first with food price inflation and now with more general price increases, such that in the year up to May 2010 the Wholesale Price Index increased by 10.2 per cent.  Food price inflation continues to be much higher, at 16.5 per cent, putting what by now must be an unbearable burden on the common people.  In fact the Reserve Bank of India has already cited the high rate of inflation as a reason for tightening monetary policy, making it harder and more expensive for producers and individuals to access loans.

Presumably, therefore, measures to reduce inflation ought to be high on the government’s list of priorities.  The current measure suggests that this is far from the case.  An increase in oil prices will not just have a direct effect on prices (estimated by the Finance Ministry to add just below 1 per cent to the existing rate of inflation).  It will also have a cascading effect — as all goods have to be produced using some energy, usually oil or equivalent, and then transported, so all of their prices will increase subsequently.  So the country will have to face a further onslaught of inflationary pressure which is this time entirely policy-induced.

Further, the global prices of petroleum products in the past three years have been marked by the most extreme volatility, more than doubling and then falling to nearly half within a period of 18 months.  The fluctuations hardly reflect “economic fundamentals” which have not changed much in the past few years; rather they show the impact of global speculative forces on fuel prices.  In any case, they are now rising again, but this does not mean that these can be treated as benchmark prices in any meaningful sense.  Deregulation means that domestic prices will now also fluctuate equally wildly.

Clearly, this is the worst possible time to go in for a liberalisation of petroleum prices, which will inevitably be associated with rising prices of such goods.  What is the economic logic behind this startling and clearly insensitive move?

In fact, the UPA government has been trying for some time to decontrol oil prices, despite the global volatility in these prices and the lack of convincing arguments in favour of such deregulation.  The Rangarajan Committee on the pricing and taxation of petroleum products was set up in the hope that it would recommend such a move.  But that report did not really point to this conclusion; so the government, not to be thwarted in its desire, set up yet another committee.

This time it was an Expert Group chaired by former Planning Commission member Kirit Parikh, with the more or less explicit mandate to recommend wholesale liberalisation of the pricing of petroleum products.  The Expert Group duly did just that, and the government has been quick to accept its recommendations.

The official reason for this move is that it is necessary to stem the “losses” being suffered by the oil marketing companies (OMCs).  When the domestic prices of oil products are controlled but the price of imported oil is rising, oil marketing companies receive from the consumer less than what it costs them to acquire the products they distribute.  This leads to losses (called “under-recoveries”) for companies like Indian Oil Corporation, Bharat Petroleum Corporation, Hindustan Petroleum Corporation and IBP.

But this argument misses the point that all of these companies deliver a range of products and services, the prices of all of which are not controlled.  In fact, profits after taxes of the most important oil companies have remained positive and often quite substantially so in the past ten years.  Under-recoveries are notional losses that only lower book profits relative to some benchmark.  Thus, there is little danger that the industry would be bankrupted even if prices were kept at their earlier levels.

It is true, of course, that the burden of such under-recoveries should not affect only the books of the oil marketing companies, but should be shared by upstream oil companies like ONGC, OIC and GAIL, as well as by the central government which gets customs duties and excise duties from petroleum products, and by the state governments which benefit from sales taxes.  This would mean that the oil refineries should offer discounts when selling products to the OMCs and government should reduce the taxes it levies on oil products.

This precise question was examined by the Rangarajan Committee.  It was found that there is indeed an adequate buffer to shield domestic consumers from the effects of increases in international prices, so long as segments that can afford to take a cut in petroleum-related revenues because they have alternative sources of resource mobilisation are willing to accept such a reduction.  Instead, the current strategy is one that puts the entire burden of irrational shifts in the international prices of oil on the consumer, even if the burden sharing involved is extremely regressive and the worst affected will be the economically weakest segments of the population.

So why has the government chosen to do this?  The most obvious reason seems to be that the government has chosen to favour the private companies that have been allowed to enter and expand in this sector.  This has encouraged the government to take a measure that will cause great harm to most of the population so as to bring in more profits to a few large and powerful companies.

This brings to mind the popular adage: “Either the government owns the oil companies, or the oil companies own the government.”

Jayati Ghosh is Professor, Centre for Economic Studies and Planning, School of Social Sciences, Jawaharlal Nehru University, New Delhi, and Executive Secretary of International Development Economics Associates (IDEAs).  This article was published in MacroSan on 28 June 2010; it is reproduced here for non-profit educational purposes.

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