Indian Government Removes Transportation Fuel Subsidies in Landmark Reform

Subsidy Stoppage

On 25 June, in a brief broadcast on Indian television, Oil Secretary S. Sundareshan announced the landmark deregulation of fuel prices in India. The decision was made by the country’s Empowered Group of Ministers (EGOM) and appears to be based on the findings of the Kirit Parikh expert panel, which recently submitted its recommendations to deregulate fuel prices to the cabinet (see World Markets Energy: India: 4 February 2010: Government Panel in India Recommends Deregulating Gasoline, Diesel Prices). As a result Sundareshan stated that gasoline (petrol) prices would be deregulated both at the refinery gate and at the retail level and increase on average by 3.5 rupees (US$0.08) per litre. The government stated that gasoil prices would be increased on average by 2 rupees per litre and that prices would be deregulated in due course. Kerosene prices would increase, on average, by 3 rupees per litre, while liquid petroleum gas (LPG) prices would increase on average by 35 rupees per kg cylinder, both from midnight on 25 June. However, the policy will not wipe out subsidies on the four fuel types, which the government still expects to be 530 billion rupees this year, even after the fuel price hike.

There were two key motivations behind the government’s move to raise fuel prices and deregulate marketing of some fuels. First, the government sought to reduce its own budget deficit from an estimated 5.5% of GDP in FY 2010/11 by bringing down oil subsidies—a consideration which apparently trumped concerns over the immediate impact on monthly wholesale price inflation —which the government stated would increase by 0.9%, exacerbating headline inflation, which hovered at 10.6% in May 2010. Indeed, the government may have considered that a subsidy grant of 260 billion rupees to oil marketing companies in the financial year ending in March 2010 could also have had a negative impact on inflation as well as exacerbating the budget deficit. The gasoline subsidy, which is primarily a fuel for automobile owners and is not widely consumed by the poor, has been deregulated first, perhaps to test public reaction to the reforms.

The second driving factor for fuel price deregulation is the need to improve the investment capabilities and financial situation of domestic refiners, particularly in view of recent policy trends in the sector. As of April 2010 India unveiled new Euro IV fuel standards to be implemented in 13 cities nationwide, with the rest of India converting from Euro II to Euro III standards over the next five or six months (see World Markets Energy: India: 2 April 2010: New Euro IV Standards to Increase Fuel Prices in India). The policy move, which was accompanied by a modest increase in fuel prices in April 2010, was aimed at reducing sulphur dioxide emissions and improving the competitiveness of the domestic sector. As a result of the policy oil refiners have been forced to invest in new processing units, although producing fuels with lower sulphur content will increase operational costs. There are thus incentives to raise fuel prices to underpin the future investment capabilities and performance of the refining and marketing sector. The news of the fuel price increase has been greeted favourably by refiners and marketing companies alike, with Essar Oil, Shell India, and Reliance Industries (RIL) all reviving plans to make more of their fuel retail outlets operational. The policy moves are estimated by the Ministry of Petroleum to shrink losses of oil marketing firms by about US$13 billion in FY 2010/11 to US$11.4 billion. In response to the plan Indian Oil Corp. (IOC) has announced that it is reconsidering a plan to launch a follow-on public offer of 10% by the end of the year, which could result in greater foreign and private investment. The move could lower risks to their earnings and revenues and could have a positive short-term impact on their share prices.

Outlook and Implications

Nevertheless, there are still a number of uncertainties related to the government’s fuel price decision. First, a number of details of the policy are still lacking. How gasoline prices will change, the schedule of gasoil price deregulation, and what level crude oil prices have to touch for the government to intervene and "moderate prices" are some key issues where there is a lack of clarity.

The second issue is the potential for a political and social backlash over the fuel price increases. In response to the fuel price increase demonstrators from the Bharatiya Janata Party (BJP) blocked junctions in New Delhi to protest, while others burned effigies of Prime Minister Manmohan Singh. Left-wing groups such as the CPI-M and Left Front also held demonstrations in a number of states including Kerala, Orissa, and West Bengal. Fuel prices are a significant political issue in India and exploited by political parties to win votes, a key reason for the lack of progress made on the issue. Nevertheless, by retaining subsidies on kerosene, which India’s poorest use for lighting, and on LPG, which is used as a cooking gas, the government is trying to ensure the poorest are not too badly affected by price increases, which were at levels below what the Kirit Parikh panel recommended.