Global Insight Perspective | |
Significance | The price rise provides some immediate relief to domestic fuel retailers who were vocal critics of the previous system, where their daily losses had reached 725 crore rupees (US$168 million) as a result of the widening chasm between domestic retail prices and an international crude price of US$120/b and higher. |
Implications | The modest nature of the increase and the cut in excise duties and customs tax means that the government is now saddled with an increased share of higher energy costs as it attempts to limit the backlash from industry and the general public. |
Outlook | This is a move in the right direction but one that may not go far enough given the outstanding financial burden on retailers and upstream companies—and a risk that international prices could still go higher. With elections next year, the government is clearly hoping that fortune will favour the meek. |
Compromise or Policy Fudge?
The government of Dr Manmohan Singh has finally acted to move fuel prices upwards after weeks of internal wrangling between the Petroleum and Finance Ministries over who will bear the brunt of increases.
Fuel retailers had reported losses of 725 crore rupees (US$168 million) a day under the previous price structure as a result of low domestic retail price relative to international prices. Hindustan Petroleum Corp., Bharat Petroleum, and Indian Oil Corp. have all warned that they would run out of funds as early as July, despite existing support from government oil bonds and upstream companies.
However, the move fell well short of the Petroleum Ministry's hope for a 20% average price increase with a lift of around 10% for transportation fuels. Gasoline (petrol) prices will be raised 5 rupees to 50.52 rupees (US$1.18) per litre and diesel up 3 rupees to 34.48 rupees/litre. The price of cooking gas, or liquid petroleum gas (LPG), was also increased for the first time since 2002, by 50 rupees per cylinder, while kerosene prices remained unchanged. Petroleum Minister Murli Deora said that to bring Indian prices into line with current international prices would have required a 50% increase in gasoline prices and a doubling in the diesel and LPG price.
Meanwhile, the Finance Ministry was also persuaded to reduce its tax take from domestic oil use, with excise duties on refined products cut by 1 rupee per litre, while customs duties on crude oil imports will be scrapped. Deora told the press that duty cuts will remove an estimated 22,660 crore rupees from the government's potential fiscal take over the remaining 10 months of the financial year.
Additional oil bonds will also be issued to retailers amounting to 94,601 crore rupees, while upstream producing companies including the oil and Natural Gas Corp. (ONGC) will be required to give 60,000 crore rupees'-worth of discounts to state-owned oil refiners and marketing companies, according to The Hindu.
The decision to raise administered oil prices presented a complex challenge to the government. The increase comes in the context of already rapidly accelerating inflation fuelled not only by supply constraints but also by strong demand growth fanned by high liquidity in the financial system. The benchmark wholesale price index rose 8.1% during the week of 17 May, breaching the psychological 8.0% mark and remaining far in excess of the Reserve Bank of India's threshold. Inflation in India remains a highly politicised issue. The rural poor, most affected by spiraling prices for staple foodstuffs, form the majority of the electorate—a fact brought into sharp focus by the critical state election cycle this year, which precedes general elections scheduled to be held by May 2009.
However, the rising fuel subsidy burden remains an increasingly unsustainable weight on the already-weak fiscal balance. Losses at state-owned oil companies remain a direct contingent claim on the federal budget. While the budget deficit has narrowed in recent years, this is largely a cyclical effect of rising revenues on the back of the economy's booming growth. The chronically narrow tax base arrayed against inefficient and high public expenditure has resulted in comparatively high levels of public debt. Resources required for vital long-term investment in the economy's physical and human capital are being encroached upon, while public debt serves to crowd out private investment from the financial sector. Finally, subsidies continue to distort the market, preventing a natural adjustment in demand to the higher price environment. India's trade imbalance has continued to widen as already-robust imports are inflated by surging global fuel prices. With the floor price of food and fuel prices now elevated, maintaining subsidies at current levels over the long term will become increasingly untenable.
The reductions in fuel tax and duties and pledges of direct financing support for low-income households stand as an attempt to reconcile political risk with the fiscal exigency of subsidy reform. However, popular protests and swift moves by the opposition Bharatiya Janata Party (BJP) to capitalise on growing discontent indicate that rising commodity prices and inflation in general will remain a central election issue. The negative ramifications for the self-proclaimed pro-poor Congress party are evident and are likely to manifest themselves in forthcoming state elections. Tensions within the coalition—particularly with the Left Bloc—are set to intensify, further undermining the legislative process.
Outlook and Implications
India's move echoes those in Indonesia, Taiwan, and Malaysia, where the burden of supporting fuel subsidy regimes against a backdrop of US$120-plus/b oil in the international market has been judged a greater danger to government stability in the form of increasing deficits and loss of budgetary restraint than the popular opprobrium and inflationary impact accompanying retail price rises.
However, although share prices for India's fuel retailers have rallied in the wake of the rises, the modest nature of the consumer price rise—and the fact that the move only reduces, rather than wipes out, retailer losses—means that the government is unlikely to have decisively dealt with this issue. With a further 11 months in power, any further increases in international energy prices, greater-than-expected domestic consumption, or mounting inflationary pressures as a result of the fuel price increases could force the government to revisit this issue and lose further credibility, having increased fuel prices once already this year.