To lower or not lower the price of fuel, is the conundrum for the government. The price of petrol and diesel has reached its peak and what is surprising for the common man is that these prices are associated with crude oil prices at just above $80 a barrel. But this was not the case when the price was $140/barrel? How is one to understand these dynamics?
In the past, under the UPA regime, the price of both petrol and diesel was regulated by the government which meant that subsides were given to ensure that the prices were tolerable. Petrol was first to be fully deregulated while diesel was marked to market gradually and by the time the NDA took over, it was fully market-driven. This also coincided with the price of oil coming down. This helped all the parties concerned as the consumer too paid a slightly lower price.
In the last two-three years, the price of crude oil has remained fairly stable at around $60/barrel or lower but the consumer still paid price of Rs 75-80 for petrol and the reason was that the government had increased its taxes on fuel which ensured that revenue flowed in. As revenue increased, it helped to control the growth in subsidy as well as the fiscal deficit. Kerosene and LPG today are the only two regulated products.
However, in the last few months the international price of crude has increased sharply. And the reason is more in the realm of geo-political reasons, the latest one being USA withdrawing from the treaty with Iran which also forces other nations to comply with or face consequences. This had added to the negative sentiment and pushed up the prices. Iran accounts for between 4-6 percent of total supplies at its peak level which can distort the oil dynamics. While shale production can increase, there is a time lag involved as capacities have not been ramped up adequately once the oil price had come down. Besides, shale is generally used for domestic consumption (though exports have been increasing of late). Further, as we are away from the peak demand season with the winter months passing, it is but natural that the shale supplies will increase only if producers are convinced that prices are here to stay.
Now, how does the Indian picture fit in?
Prices were kept under check before the Karnataka Elections with the reason being that the government wanted the prices to remain unchanged lest they affect voting patterns. Therefore, the Oil Marketing Companies (OMC) took the hit as they did not increase prices and absorbed the cost. Now with the elections having concluded, the OMCs have started raising prices once again leading to these new peak levels being attained.
Therefore, now in India there are three things to watch. The first is the subsidy on fuel which has been capped by the government at around Rs 25,000 crore for the last two years. If this is not touched, then the government cannot compensate the OMCs for any loss in case retail prices are not increased.
The second is the OMCs. In the past they have shared the burden with the government and made losses. Therefore, they have to choose between making a loss and lowering their profits in order to subsidize the consumer. Right now it looks like that the answer is a big no.
The third option is for the government to cut the excise duty or the state Value-Added Tax (VAT) on these products. The government does not want to relent because this is a very useful source of revenue. If one looks at the price of petrol and sees the difference between the final price and the cost for the OMC, the cumulative government collection is between 90-100 percent for petrol and 65-70 percent for diesel. Hence, when we pay Rs 80/litre for petrol, Rs 35-40 is going to the government (both state and union). This is one reason why there is reluctance to bring this under GST as it will cap the taxes that can be levied and a very useful lever will be lost.
The question is whether or not any of these three constituents will give way to keep prices down.
But what if we let the price rise? There are two issues now. The first is that it directly enters our price indices and 10 percent increase in crude oil prices increased Wholesale Price Index (WPI) by around 0.75 percent (direct and indirect) and Consumer Price Index (CPI) by around 0.4-0.5 percent. As this keeps going up, the CPI can cross the 5 percent danger mark and once it is past 6 percent, there will be aggressive rate hikes from the Reserve Bank of India (RBI). This can affect growth at a time when industry is waiting to expand in case demand picks up. We may get back to the pre 2014 days when high inflation and high interest rates coexisted.
Second, higher crude oil prices will put pressure on trade deficit and CAD and finally the rupee will fall sharply adding to inflationary pressures. Therefore, this can become a more generalized problem.
More importantly, higher petrol and diesel prices cannot be ignored from the political point of view as we have other state elections coming up where the voting pattern can be affected as the Opposition can work on sentiment.
This is why we need to control the increase in retail prices of petrol and diesel.