By Priyanka Gupta & Utkarsh Bhadauria, MBA Capital Markets, NMIMS
The pace at which the Indian economy is moving, the fuel prices in India are not keeping pace with it. The latest move of the government to deregulate the fuel prices of some commodities is turning out to be a debatable issue. The government was regulating the fuel prices for a long period of time; as a result it was also offering heavy subsidies on such fuels. This could not have continued for eternity. It is better the economy deals with the fuel hikes right now rather than dealing with it disruptively after a decade or so, this will help the market to get adjusted to the current market situation rather than being taken aback by a sudden fuel hike.
The government has finally deregulated the price of petrol and hiked the prices of diesel, kerosene and LPG, though by less than recommended by the Kirit Parikh Committee. The government on June 25th decontrolled petrol prices, causing a hike of Rs 3.5 per litre, and increased diesel prices by Rs 2 a litre, LPG by Rs 35 a cylinder and kerosene by 3 a litre, amid protests by opposition parties. The adjustment that has been made in the prices of fuel was necessary, considering the very high amount of subsidy that was inbuilt in their pricing structure. Even after the hike, kerosene is being sold at Rs.15.07 per litre below cost while a 14.2-kg LPG cylinder is under priced by Rs.226.90 taking into consideration that the poorer strata of society were affected to the least possible extent and as such, the prices of kerosene and LPG were kept under control.
The move would help bring down fiscal deficit and release revenues for other social sector schemes and reform programs. A lower fuel subsidy bill may help the government reduce the fiscal deficit substantially. It was estimated to come down to 5.5 per cent of GDP during 2010-11 from over 6.6 per cent last fiscal year.
The rationale behind the deregulation of fuel prices is to cut budget deficit as this is a greater concern than the oppression issue from the opposition parties. It has been estimated that 9% inflation is expected due to deregulation. Moreover, it has been observed that the impact of funding increase in fuel price through fiscal deficit or through direct increase in price would be the same on inflation.
Opposition parties claimed that price decontrol will turn out to be a disastrous step for the economy but till date despite price controls inflation had been in double digits. Moreover, it has been observed worldwide that price decontrols lead to lesser inflation and more economic growth in long run as seen in case of US, Europe and Japan where inflation is just 2-3%. Even in India during oil price shocks (1970-80) when increase in fuel price was straightway passed on to the consumers it was noticed that for the first time poverty fell and farm production rose in the long run. Even now it could be seen that food inflation in particular has started showing a downward trend and has gone back to single digit due to serious efforts and policies of the government. Price controls can provide short term relief to consumers, but act as longer-term disincentives to production and efficiency.
The fuel prices in India are also not in correspondence with the international prices. How long could have this pressure been sustained? “Are the fuel subsidies really required”?
In this environment friendly scenario, where people should be discouraged for fuel consumption, our govt is actually promoting it in form of subsidies. Instead of devising alternate methods generating renewable energy i.e. instead of investing in the research and development our country is wasting valuable money on subsidies!!
The hike in fuel prices was also necessitated because of the rising gulf between the cost of production and the retail prices. Without the increase, public sector oil firms were projected to lose Rs.74, 300crores in revenues in 2010-11 fiscal years and after the hikes, they will still be saddle with Rs.53,000crores of losses.
The administered pricing mechanism (APM) was dismantled in 2002, however, the government continued to control prices of sensitive petroleum products, not allowing a complete pass through of prices into the system. As a result, under recoveries incurred by oil marketing companies (OMCs) rose five-fold (from Rs 20,000crores in 2004-05 to over Rs 1lakhcrore in 2008-09).
According to analysts, the government’s plan to eventually fully decontrol fuel prices will boost the prospects of major players like HPCL, BPCL and IOC, whose margins have been under pressure, because of selling fuel at subsidized prices. Even stock prices of these oil marketing companies (OMCs) soared, after the government hiked diesel prices, and aligned petrol prices to those international markets. HPCL led the gainers’ list, with the stock jumping 13.7% to close at Rs 401. BPCL shares climbed 12.8% to Rs 621, and IOC gained 10.4% to Rs 377. These stocks outperformed the broader market by a wide margin. Moreover growth of these OMC’s ultimately lead to greater revenues and higher employment opportunities.
India's reform of fuel pricing is likely to have significant effect on the regional oil products market. It's a game changer for Indian companies. Refiners Reliance Industries and Essar are to compete with state-run firms for retail market share; private Indian refiners typically see better refining margins. Private companies will now compete with state run companies to sell their products. While fuel hike and the proposed price decontrol seem to be extremely positive for the oil marketing companies and the broader economy, it is unlikely that they will unilaterally raise prices without the government’s intervention.
With deregulation there will be demerits creeping in like the price of common man fuel such as kerosene might increase and can adversely affect the poor strata of society but these demerits can be managed with effective govt. policies and regulations like giving tax incentives, discouraging use of vehicles in some other form etc. For e.g. what Delhi Gov. has done- the state government of Delhi reduced VAT from 20% to 12.5% ultimately reducing the diesel price by Rs2.70 a litre.
After fuel price hike, it’s the responsibility of state governments to cushion this hike by lowering taxes on petrol and diesel. For example states like Tamil Nadu and Andhra Pradesh charges a whopping 30% & 33% tax on petrol and 21% & 22% on diesel respectively. These high rates are untenable with fuel price hike. So some step should be taken by state governments to reduce the overall impact of fuel price hike like reduction in tax even by 5%, would result in a saving of Rs 2.10 on a litreof petrol and Rs 1.62 per litre of diesel for the consumer.
A point to be noticed in the present subsidy method is that the funds used for providing such a subsidy belong to the general public. These funds are being used to provide subsidy to the vehicle owners relatively a richer lot than the majority of the population in India. For e.g. taking premium cars into consideration. They are not very fuel efficient. Thus the question here is why should the public owning fuel efficient vehicles pay for the inefficiencies of Mercedes, Audis etc. Owners of these vehicles are also getting the benefit of the subsidy. Do they deserve it? When we are giving subsidies to these people, we are actually defeating the intention behind giving a subsidy. Subsidies should be given to the poor and the middle class to bring in an equitable social balance in the consumption pattern i.e. to make available essential commodities to the poor at a lower cost. But what has been happening is exactly the opposite. Thus the fuel prices in our country need to be completely deregulated as soon as possible.
To counter with the demerits of deregulation of fuel prices, an electronic subsidy card can be introduced. This may be given to the deserving (poor and needy). Under this plan the poor can claim benefits as subsidy reimbursement rather than the traditional subsidy approach. In this manner the subsidy will reach the deserving strata of society rather than being distributed to all the fuel users (including the rich).
So we feel that deregulation of not only fuel prices but also of other commodities is necessary for growth and development of an economy in long run. But at the same time government intervention (focused and targeted) is required in case of essential commodities on which poor man thrives. Thus as we perceive it, deregulation is and will be the key for the correct, balanced and accelerated future growth of our economy.
About the authors
Utkarsh Bhadauria is a 1st year MBA student at NMIMS, Mumbai. He holds a bachelor’s degree in Commerce from Mumbai University and can be reached at utkarsh_bhadauria@hotmail.com
Priyanka Gupta is a 1st year MBA student at NMIMS, Mumbai. She has completed her Economics honors from Delhi University and can be reached at priyankagupta1827@gmail.com
