'Pricing must not revive double digit inflation'

The Central Government’s January 17, 2013 decision to partially deregulate diesel prices, which implies that the public sector oil marketing companies (OMCs) have been authorised to revise diesel prices, although by a small amount, is aimed at reducing the under-recoveries on diesel. 

Over the last few years, diesel pricing has accounted for more than 50 per cent of gross under-recoveries. It is argued that lower under-recoveries of state-run OMCs (viz. IOCL, BPCL and HPCL) would significantly decrease the subsidy burden of the Government and PSU upstream companies on a full year basis, if implemented on a consistent basis. It may be pointed out that the Government had on earlier occasions partially deregulated prices of petroleum products but did not implement it.

There are several doubts related to terms like under-recoveries, losses and deficits. Are under-recoveries equivalent to losses of OMCs? If that is so, how are they paying dividend to the share holders? For instance, IOCL has paid a dividend of 50 percent to its share holders last year.

Moreover, the Central and State governments earn a very high percentage of revenue from petroleum products, how can these products contribute to fiscal deficits. To understand these it is necessary to see the finance flows among the stakeholders of the petroleum sector.

It includes Central and State governments, the oil exploration and extraction companies like ONGC, GAIL and OIL, the oil refining and marketing companies like IOCL, BPCL and HPCL and finally the consumers who buy the products and pay the prices and taxes or receive subsidies.

The idea of under-recovery is based on a notional price of the product which the consumer would have paid had the product been imported or exported. In case the product was imported, it would be referred to as import parity price and if it was exported, it would be called export parity price.

Fine balance

There is a slight difference between the two due to different taxes that would be levied in each process; the export parity price is lower than the import parity price. India currently follows a mix of the two, 80 per cent import parity and 20 per cent export parity.

This mix is referred to as trade parity prices. Both the sets of prices are connected to the international market prices of the product, which includes a profit margin of the marketing company. Under-recovery arises when the prices paid by the consumers of domestic market are below the trade prices.

It is certainly not equivalent to a loss since losses are calculated with respect to the cost of production. However, if the under-recovery is very large and does not cover the cost of production then it can also lead to a loss for the marketing and refining company.

International crude prices are extremely volatile; it changes seasonally and is very sensitive to political developments, particularly in the Middle East.

The cost of production of petroleum products also changes sharply due to these factors, changing the profile of under-recovery and loss of the oil marketing company. Currently, the crude price at 110 dollars a barrel is on the higher side and on an increasing trend which is putting a pressure on the finances of oil marketing companies.

The governments, both Central and State, have played a major role in determining the prices of petroleum products due to the tax factor, which are included in the retail prices that consumers finally pay. Both these Governments have a large share of taxes earned from the petroleum products. The governments play a major role in subsidising petroleum products like kerosene and LPG used by poor and the middle income groups.

This is not done in a transparent manner. The under-recovery due to kerosene and LPG are borne initially by the oil marketing company. However the Central government compensates them, but in an ad hoc and non-transparent manner. In 2011-12, the IOCL, the largest of the oil marketing companies, received a budgetary support of Rs 45,000 crore from the Central Government.

Further, since upstream companies make a gain when crude prices go up in the international market, they give discounts to oil refining and marketing companies. In the year 2011-12, IOCL received discount worth Rs 26,000 crore from ONGC, GAIL and OIL. At the end of the year, IOCL did make a profit and paid a dividend to its share holders. From the point of view of the Central and State Governments, they have to tread a fine balance.

Tax revenues

Petroleum products have been a major contributor to the tax revenues but they are also basic inputs to wide ranging economic activities which includes agriculture, manufacturing, transportation and households. It impacts all strata of the society.

If prices of basic fuel rise fast, it is certain to have an impact on inflation, which would be detrimental to the economy. India had a very high inflationary pressure in the past few years when it went well into double digits and remained sticky for a considerable period. Now the inflation rate is slightly better at around seven per cent.

It should not be pushed back into double digits again by raising inflationary expectations. Like inflation, the fiscal deficit has its own evils. Raising price of diesel would certainly reduce the fiscal deficit, since budgetary support to oil marketing companies can be lowered or done away with. But it should not be done at the cost of reviving double digit inflation.

(The writer is on the faculty of Economics, Ambedkar University, Delhi.)

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