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Fuel will top up inflation

With petrol prices up and diesel set to follow, India has to cut its high-energy cost economy.

india Updated: May 21, 2011 07:15 IST

Last week’s increase in the price of petrol by Rs 5 a litre reaffirms the government’s abiding temptation to decide when and by how much fuel prices should increase. A year after petrol prices were freed from bureaucratic oversight they have been raised nine times, the last one timed till after critical state elections. The immediate impact of the latest hike is likely to be less than a tenth of a percentage point move up in wholesale inflation. The bigger inflationary impact will follow from the government’s decision likely later this week on raising the administered prices of diesel and gas. If the entire surge in international energy prices is passed on to Indian consumers, wholesale inflation could shoot up by over 3 percentage points. But if petrol prices are any indication, the government could settle for shifting half the extra burden on to buyers and shouldering the other half with oil producers.

Before petrol prices were freed, diesel, kerosene and cooking gas made up for nine in every ten rupees Indian oil companies and the government lost on account of selling fuel below its market price. In the 12 months to March 2011, the government picked up a tab of Rs 38,386 crore of the Rs 78,000 crore under-recoveries of the oil companies. This loss was sharply higher than the Rs 46,000 crore a year earlier, but a lot less than the Rs 100,000 crore lost in 2008-09 when crude oil touched $147 a barrel. With crude back above $120 now, there are legitimate fears the losses this year could balloon. If the government hikes prices by 10% each, the oil companies would still be losing R6 on every litre of diesel they sell and over R300 on every cylinder of cooking gas. Unfortunately, the government-appointed Kirit Parikh Committee’s recommendations for deeper reform remain on paper. Freeing up diesel prices alone would have whittled the losses substantially. Steeper hikes in the prices of cooking fuels likewise. The subsidy-sharing mechanism between oil companies and the government will shape the fisc. Finance minister Pranab Mukherjee has budgeted for an ambitious reduction in the fiscal deficit this year to 4.6% on a supposition that the government fuel subsidy is limited to Rs 23,640 crore. Slippage on this score will exert its pressure on the price line.

Free fuel prices are a precondition to reducing the tax burden petroleum carries in India. Although the government does not put out numbers, conservative estimates suggest half the excise duty collection in the country is from petroleum products. Even with a subsidy in place, petrol used to cost thrice as much at an Indian gas station as it did in the US. As domestic petrol prices rise this gap opens up. Part of the reason for India’s relative lack of competitiveness among Asian manufacturing exporters is its expensive energy. Dismantling its high-cost energy economy is a crusade India has shied away from for too long.