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Oh, these oil prices!

As global crude prices continue to rise, the United Progressive Alliance government needs urgently to put in place a strategy to deal with the fiscal and inflationary consequences — if it is not to be checkmated. Under the present system of subsidised domestic pricing for petrol, diesel, kerosene, and the LPG, the country’s public sector oil marketing companies (OMCs) lose more than Rs.500 crore a day. With international prices topping $130 a barrel, twice what they were a year ago, and India importing more than 70 per cent of its needs, the annual cumulative losses are expected to exceed Rs.180,000 crore. Unless these losses are made good through budgetary support, the public sector oil undertakings will be forced to compromise their investment and exploration plans to the detriment of the country’s future energy security. The dilemma of the UPA government is this: If domestic prices for oil products rise, inflation, which is already high, will increase. With the 15th general election due within a year, the political consequences are feared. But if prices are left untouched, the fiscal deficit will increase, again with inflationary consequences. Two key issues need to be addressed clear-sightedly. Who should bear the subsidy burden? Secondly, how can the subsidy bill be brought down? The answer to the first question is obvious: the OMC losses must be borne by the Central budget, not by PSU balance sheets. The answer to the second question is more complex.

Right now, about 40 per cent of the retail sale price of petrol and diesel consists of excise and import duties. Sales tax constitutes another 15 per cent to 25 per cent depending on which State one is in. Reducing these levies, while moderating the increase in retail prices, will improve the bottom line of the OMCs. Nearly a quarter of Central tax revenues come from levies on oil products but given the other positive trends in the economy, it should be possible to calibrate an excise-cum-subsidy adjustment that is broadly revenue-neutral. Over the medium-term, a prudent tax policy will require a widening of the revenue base away from excessive dependence on petro products. With the average oil price predicted to hit $150 and even $200 a barrel in the months ahead, the slack provided by excessive indirect taxation will eventually be exhausted. Protecting the poor by subsidising kerosene is one thing but there is no reason why the owners of private vehicles, for example, should be protected from global price trends. The real longer-term answer is taking energy conservation seriously. This means a strategic policy of targeting the present energy inefficiencies, reducing the energy-intensity of the economy, expanding public transportation, and sending out the right price signals towards this end. That will be good economics as well as good politics, also because it will be a progressive response to the critical challenge of climate change.

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