Hike in oil prices: Government

benefits, but does it help economic

growth?

With the rupee crashing against the dollar, the petroleum ministry has once again
highlighted the need to raise fuel prices to stem the so-called 'under-recoveries'
of oil companies. According to the latest data, as on September 1, the oil
marketing companies were incurring a daily under-recovery of Rs 461 crore
against the sale of diesel, kerosene and domestic LPG. There is an under-
recovery of about Rs 12.12 against every litre of diesel sold.

Anup K Pujari, director general of foreign trade, says the government must not
increase its oil subsidy bill any more if the rupee continues to depreciate further
against the dollar. "Yes, the rise of petroland diesel prices will lead to some
amount of inflation. But the consequences of keeping the prices artificially low
would damage the economy more," he says. Pujari was speaking to ET
Magazine in his personal capacity, and not as DGFT.

To be sure, the under-recoveries are not losses they reflect the difference
between the costs of importing diesel and petrol at the international price and the
price at which it is actually sold in the domestic market. India doesn't actually do
that it imports crude oil, refines it, and sells it in the domestic market. So
under-recoveries are a 'notional' price and don't reflect actual losses that oil
companies face, which are almost certainly lower. Though how much lower has
always been a puzzle.



Difficult Options

"If the government artificially keeps petroleum prices low, it will impact not just the
oil marketing companies as is commonly perceived, but erode the profitability of
upstream companies like ONGCBSE 7.17 % and Oil IndiaBSE 2.62 % as well. After all,
one third of the burden (subsidy) is shared by the upstream companies," says
former ONGC chairman Ajit Kumar Hazarika. "The unpredictability of the
quarterly subsidy bill from government has already turned a big challenge for the
ONGC. It is hampering planning on fresh investments," he adds.

Government policy on exactly how the oil subsidy amounting to almost Rs 1 lakh
crore in 2012-13 and that's before the recent weakening of the rupee is paid
out adds to the problem. Oil companies have long complained that successive
governments have been tardy in actually paying out the subsidy due to the oil
companies, leading them to face a liquidity crunch in the short term.
This forces them to raise short-term borrowings to meet immediate bills, affecting
their bottom line further at a time when interest rates are high. Balanced against
the weakening of the finances of the oil companies is the broader impact of any
fuel price hike on the rest of the economy, at a time when growth is already
fragile at best.
A study by NR Bhanumurthy, Surajit Das and Sukanya Bose at National Institute
of Public Finance and Policy, looked at the impact on growth of raising
domestic oil prices in response to an effective rise in the price of India's crude.
They then compared this to a scenario where such increases in the international
price were not passed on to consumers. Their conclusion was unambiguous.

"Greater the pass-through and lower the government subsidy...[other things being
equal]... lower the growth. The intuition behind this result is that when the oil
subsidy bill as part of the revenue expenditure comes down, without any
corresponding increase in either capital expenditure or any other component of
revenue expenditure, lower government expenditure would cause lower growth."
Further, "...higher cost-push inflation is expected to reduce growth."

Biggest Beneficiary

It's long been known that while there is an element of subsidy in fuel prices faced
by end-consumers, they are also taxed heavily on every purchase of fuel by both
central and state governments. In fact the biggest beneficiary of any increase in
fuel prices are arguably state governments, since the tax they charge on fuel is
as a percentage of the price.

According to current data, state government revenues from various taxes on fuel
amounted to Rs 126,512 crore in 2012-13. Then there are corporate taxes and
dividends paid by the oil companies to the central government. This amounts to
another Rs 117,000 crore or so, as of 2012-13. Ironically then, governments earn
more from the sector than they pay out in subsidies to it.

In fact as the paper by Bhanumurthy and others above points out: "Clearly, the
contribution of this sector in exchequer has always been much higher than the
sum of total revenue expenditure on petroleum and the petroleum bonds. Thus,
in effect there is no net subsidy accruing to this sector."

That fuel prices will rise are almost a given the effects on growth will be seen
playing out in the months ahead.