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Breaking the vicious cycle

The rupee's slide is linked to our demand for oil. So cutting subsidies on fuel is important.

india Updated: May 24, 2012 21:30 IST

A steep hike in petrol prices has jolted Indian consumers out of a false sense of security that the government can shield them from the relentless rise in oil prices. Incremental increases since November 2011, when the government last put a lid on petrol prices, have bunched up to a 10% surge six months down the line.

The shock of the government relaxing its intervention questions the official belief that capping fuel prices pays political dividends. India changes its fuel prices with an eye more on the election calendar than on the Brent graph, losing much of the damping desired and stretching, in the process, both the buyer and seller of oil. With the price of petrol at the gas station now in sync with international crude oil prices, the Indian consumer will be subjected to the harsher discipline of market forces that encourages thrift. The government would be better off allowing the economy to adjust continuously to crude oil prices.

The reason put out for the delayed hike in petrol prices is the plummeting rupee. But the rupee is falling in part because India has to shop abroad for oil. In 2011-12, we imported $155 billion of oil, nearly a third of our total imports and almost enough to cover the trade deficit of $184 billion. Oil imports climbed $50 billion from a year ago due to spikes in crude prices.

And also because India’s energy consumption remained oblivious to how international prices moved. Our oil demand does not decline as prices rise and this adds to the downward pressure on the rupee. It’s a vicious cycle that can be broken by freeing up all fuel prices and reimbursing only those who cannot afford market rates. A sizeable chunk of the economy is getting a free ride on the government’s fuel subsidy.

The Centre paid R68,481 crore to oil companies in 2011-12 to sell diesel, kerosene and cooking gas below cost. This made up for a third of the central government’s subsidy bill. This year, finance minister Pranab Mukherjee wants to cap the petroleum subsidy at R43,580 crore. Suggestions for a countervailing tax on big diesel cars and rationed supply of cooking gas cylinders to the well-heeled can weed out some of the freeloaders.

The immediate impact of the latest hike in petrol prices is likely to be around a tenth of a percentage point up move in wholesale inflation. The bigger inflationary impact will follow from the government’s decision on raising the administered prices of diesel and gas.

If the entire surge in international energy prices is passed on to consumers, wholesale inflation could shoot up by over 3 percentage points.