Why diesel price decontrol could actually benefit consumers

Why diesel price decontrol could actually benefit consumers

As crude oil prices keep climbing in the international market, losses of oil marketing companies keep climbing in India.

This is a result of the wrong policies of the government in controlling diesel prices. While there is full justification for providing subsidies on kerosene and residential LPG to those below the poverty line, it does not make any economic sense to sell diesel at subsidised prices.

Such subsidies will reduce funding available to the government to spend on welfare measures in health and education sector. It will also increase fiscal deficit resulting in higher inflation which affects the poor more than the rich. However the political class is against any pass through in diesel to compensate for the increase in crude oil prices.
One of their arguments is that the so called ‘under recoveries’ of the oil companies is a phantom concept which overstates their losses. Currently the under recovery for diesel is Rs 13.89 per litre which is less than the total tax revenues of Rs 9.32 per litre. This, reportedly, results in loss of around Rs 1 lakh crore per year to the oil marketing companies.

While some of the cost items which are used to estimate under recoveries are indeed questionable (since India exports diesel, it is irrational to include customs duty to estimate product cost), losses incurred by the oil marketing  companies while selling diesel are real. Even when a more realistic model used by international oil companies based on traditional economic principal of marginal costs is used, losses incurred by the marketing companies are close to the under recoveries.

Their main argument is that the diesel price increase will hit the poor by increasing the trucking costs resulting in higher food and other products they buy. Since diesel is used for public transportation like buses and trains, it is argued that higher diesel prices will also hit those poor who use them. In the case of farmers, it is argued that diesel price increase will hit them since they use diesel because of the frequent failures to secure reliable power supply. It is surprising that there has been no research to support or refute any of these arguments which are frequently reported as truth.

It is true that the diesel price increase will undoubtedly affect trucking, public transport and power sector. It will also contribute to higher inflation rates. But what is not appreciated is that passing the higher costs of crude oil will have minimum impact on those who are below poverty line and belong to lower middle class. It is also not appreciated by the political class that there is no free lunch in this world especially when India has to import more than 78 per cent of its crude oil requirements.

Real problem

The real problem concerning the diesel price liberalisation is how the additional cost burden is borne by different diesel users. There is no problem with the owners of passenger car who are in a position to pay unlike the poor. Every time there is an increase in diesel prices, trucking industry registers strong protest. Often truckers threaten to go on strike. It is interesting that while trucking union never fails to protest, it tries to pass on not only the incremental cost of higher diesel prices, often it succeeds in over compensating because of its near monopoly position.

In the present case if diesel under recoveries are eliminated and diesel price goes up by Rs 13.89 per litre or 32 per cent, trucking costs should go up by only 12 per cent. Since trucking costs for food and most other items accounts for  less than 5 per cent of their total cost, diesel cost increase would result in prices for these items going up by less than 0.6 per cent. This clearly refutes the often advanced argument that the diesel price increase will have cascading impact on vegetables and goods as a result of truckers increasing their freight. Of course under recoveries can be eliminated only in small steps to make the price shocks more manageable. 

As in the case of trucking diesel accounts for about 35 per cent of the total cost of operating buses. We also need to consider that the total expenditure of those who are lower middle class for their transportation needs may not be more than 10 per cent of their monthly expenditures and thus any increase in bus fares will not put such a heavy burden.

In the case of agriculture sector,  a large percentage of marginal farmers may not have any equipment like tractors, thrashers, tillers, harvesters, pump sets, etc which use diesel. Thus only a small percentage of farmers will really face economic hardships when diesel price increases. One can argue that since the minimum support (MSP) price set by the government will reflect any diesel price increase, even these farmers are well protected.

In conclusion diesel price increase and that too in small steps will have little impact on those products and services (food, public transportation, etc) used by the poor. Even in the case of non-poor, burden will be manageable. It is high time the government stops the tyranny of diesel subsidy on Indian economy.