Tinkering for Short-term Gain The June 5 decision of the union cabinet to raise the price of petrol by Rs 4 per litre and of diesel by Rs 2 per litre is the sixth successive hike in their prices in the last two years. But the pass-through of higher crude prices has remained largely incomplete. More seriously, a long-term development perspective is nowhere evident. Myopic political and economic tinkering seems to have prevailed. The parliamentary left parties

PETROLEUM PRICING

Tinkering forShort-term Gain

he June 5 decision of the union cabinet to raise the price of petrol by Rs 4 per litre and of diesel by Rs 2 per litre is the sixth successive hike in their prices in the last two years. But the pass-through of higher crude prices has remained largely incomplete. More seriously, a long-term development perspective is nowhere evident. Myopic political and economic tinkering seems to have prevailed. The parliamentary left parties – the CPI, CPI(M), RSP and Forward Bloc – have allied with the Samajwadi Party, the Telugu Desam Party, the Rashtriya Lok Dal and the Asom Gana Parishad to organise protests on June 13. In order to blunt the impact of such protests the Congress high command decided on June 9 that in the states where it heads the government (over a dozen states) a decision would be taken to (in effect) adjust the ad valorem rate of sales tax/VAT to forgo the incremental tax revenue from the price hikes. The Tamil Nadu government, headed by the DMK, has also fallen in line. The left has however decided to hold out until the Congress-led government at the centre takes the lead by deciding to forgo the incremental tax revenue from excise duties. The whole episode has raised two important questions. One, given that domestic refineries are heavily dependent on imports of crude oil, to the extent of 76 per cent of their requirements, and the industry has moved to a regime of import parity pricing since March 2002, how long can a largely incomplete passthrough of higher crude prices be sustained? Two, given that the component of taxes in petrol and diesel retail prices are as high as 55 per cent (38 per cent for central taxes alone) and 34 per cent (23 per cent for central taxes), respectively, why not continue to reduce the rates of excise and customs duties to cushion the inflationary impact?

India had earlier followed import parity-based pricing, but it was in the wake of the first oil shock and the big discovery of Bombay High in the 1970s that the administered price mechanism was adopted, under which essentially cost-plus pricing prevailed, and diesel, kerosene (for the public distribution system) and liquefied petroleum gas or LPG (for household consumption) were cross-subsidised by petrol and aviation turbine fuel, insulating domestic prices from the volatility in the international market. But with import dependence, in terms of crude oil equivalence, gradually moving back to over 70 per cent of apparent consumption, financial engineering ceased to be effective. In 1997, the then United Front government decided to dismantle the administered price mechanism and gradually revert to import parity-based pricing.

Earlier this year a Committee on Pricing and Taxation of Petroleum Products, chaired by C Rangarajan, had recommended some (combined) tinkering – trade (i e, import and export) parity-based pricing instead of import parity-based pricing, a reduction in the effective rate of protection at the refining stage, a move to specific excise duty from specific-cum-ad valorem excise duty, targeting of the kerosene subsidy, abolishing the LPG subsidy, and so on. But the government has so far allowed the report to gather dust in its filing cabinets, despite Rangarajan’s advice, as the chair of the PM’s economic advisory council, to not allow “political compulsions” to influence the pricing of petroleum products.

It is not as if the Congress-led government at the centre has not cushioned the prices of petroleum products by tinkering – bringing down customs and excise duties. Excise duties on petrol and diesel have been brought down from 30 per cent and 14 per cent, respectively, in June 2004 to 8 per cent plus Rs 13 per litre and 8 per cent plus Rs 3.25 per litre, respectively, now. And, customs duties on petrol/diesel and crude oil have come down from 20 per cent and 10 per cent in August 2004 to 10 per cent and 5 per cent, respectively. But presently the centre is being called upon to reduce these duties even further.

Again, all this is just tinkering. From a long-term development perspective the pricing of petroleum products should take account of the fact that we are dealing with a sector that has a very high capital-output ratio, requires huge investments, is highly import dependent, is based on exhaustible resources, and merits a serious consideration of environmental issues.m

Economic and Political Weekly June 17, 2006

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Petroleum Pricing: Tinkering for Short-term Gain

Tinkering forShort-term Gain

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