Economics behind the Oil Prices in India

Even as the entire country, particularly the poor people, are reeling under heavy pressureof inflation, the UPA government has hiked the prices of diesel, kerosene and LPG by Rs 3per litre, Rs 2 per litre and Rs 50 per cylinder respectively. The reasons given for this move can be broadly categorised as follows:

1. The prices have merely moved in tandem with the international prices.

2. The government could not take the burden for it more than what it already takes in the form of heavy subsidies for various petroleum products.

3. There is a case for deregulation of prices of these three products on the lines of petrol as it is becoming unsustainable for the exchequer and the public sector oil companies who are facing 'under-recoveries' for a long time. This step is a forward movement in that direction.

4. In a period of inflation, such increase in prices would bring the demand down and, hence, would put a downward pressure on inflation.

This note attempts to call the bluff of the government by presenting both the factual picture and the vacuous economic logic behind these arguments. The note is divided in four sections. The first section makes an international comparison of prices of petroleum products. It is found that despite deregulation of petrol, the prices in India are significantly higher than the world prices. The second section attempts to locate the reasons for this. It is found that a large portion of the retail prices that the consumers end up paying consists of taxes levied by both the central and state governments. The third section presents a brief critique of the argument of the government that it is heavily subsidising the petroleum products and hence deregulation is the only way forward. In fact, we find that government's receipts through taxes is markedly higher than the subsidies that they provide on petro-products. In the last section, we address the last point mentioned above that this step would help ease inflation.

1. International Comparison of Petroleum Prices

A case was made by the government, through the Kirit Parikh Committee report, that there is a need to deregulate petroleum products. The essence of their argument was that these products, in particular diesel, LPG and kerosene are heavily subsidised and, hence, put tremendous pressure on the Indian exchequer. If the prices instead are deregulated, they will be brought in tandem with the international prices which can be beneficial to both the fiscal policy and the consumers in general. It can be seen that nothing is further from the truth if we look at the petrol prices, which is the only product which has been deregulated.

Table 1, compiled from the latest annual report 2009-10 of the ministry of petroleum and natural gas, shows that the prices of all the products, except kerosene, are significantly higher than their respective prices in the international market. A significant thing to note is that this is true for even the 'subsidised' diesel and LPG. We will come to the question of such a dubious definition of subsidy in section 3.

Table 2 compares the prices of petrol with some select countries. Except for 2008 with respect to Sri Lanka, the Indian prices have been higher than all these countries across space and time. The country that is hailed as the example to emulate, the US, has always had a significantly lower, sometimes even half, prices than India.

This shows that the claims made by the finance minister or the committee is in sharp contradiction to facts coming from their own source. In this context, the following questions arise in one's mind which need to be answered. First, why do Indians pay more than the prevailing international prices? Second, if these facts are in the face, on what basis does the government make these claims? Both these questions would be dealt with in the next two sections.

2. Break-up of Retail Prices

Let's take the first question – why do Indians pay more? The answer to this question is that the tax structure on petroleum products is very skewed in India. It is difficult to find the exact data on the cost and tax components of different petroleum products but we present here the data acquired during a question and answer session in the parliament. Table 3 presents the data for as recent as April 2011 under these components. It can be seen that for petrol and diesel the taxes are quite high. In the case of petrol, taxes are close to 50% of the retail price. In other words, half of the price we pay is the actual cost of petrol, which itself is higher than the international prices, and the other half goes to the government as indirect taxes. And within taxes, more than half comes from the excise duty alone. In the case of diesel, which the government claims to be heavily subsidised, it is 30%.

Left parties in particular, both during UPA-I and UPA-II, have been demanding rationalisation of taxes on these commodities but the government has never paid any heed to this. In the name of resource mobilisation, the government is increasingly becoming dependent on indirect taxes. Since petroleum products have a relatively inelastic demand, i.e. less affected by change in prices, this forms a stable source of resource mobilisation. It is not by mistake that the Kirit Parikh committee completely overlooks the tax issue even as it talks about the need to deregulate the prices.

There are, however, two issues involved here. First, indirect taxes unlike the direct taxes are, by their very nature, iniquitous. The incidence of indirect taxes falls equally on the consumer whether she is rich or poor. In other words, poor shell out more as a proportion of their income than the rich to pay for these taxes. Also a government whose priority is to give relief to the corporates and the middle classes, there is a continuous pressure to decrease direct taxes. Hence, there is an increased pressure on indirect taxes to fulfil the resource mobilisation targets, a trend consistently visible over the last few union budgets.

Second, notwithstanding the subsidies provided to the poor by the government under different heads, if the indirect tax payments are relatively higher, they stand to lose on the whole. Next we check for this possibility though in an indirect manner because it is difficult to measure taxes and subsidies at the level of different quartiles based on income.

3. Tax Vs Subsidy in the Petroleum Industry

The next question that we ask is whether the government is actually running a deficit vis-a-vis the petroleum sector. A macroeconomic view of the petroleum sector gives us an exactly opposite picture. Surya P. Sethi, former energy adviser to the Planning Commission, estimated the contribution of this sector through taxes to the central as well as the state governments and contrasted it with the total subsidies provided by the government.

He finds that the tax contribution of this sector is way more than the total subsidies. Table 4 presents the data in this regard. He presents the data till 2008-09. To extend the data to 2010-11, a search at the same source as his, remained futile since the Petroleum Planning and Analysis Cell has removed both the historical as well as current data on this.

This table shows that in all the three years from 2006-07, the tax contribution of the petroleum sector is higher than the subsidies provided by the government, inclusive of the so-called under-recoveries. During the year 2010-2011 (data taken from Editorial, Peoples' Democracy, July 03, 2011), the contribution to the central government exchequer from the petroleum sector is reportedly Rs 1,36,000 crore and to the state governments about Rs 80,000 crore. The subsidy provided by the government including the oil bonds issued on the public sector oil marketing companies during the same period is Rs 40,000 crore, ie, 20 per cent of petroleum sector’s contribution in taxes and duties.

It is clear that the petroleum sector is not a drain on the Indian exchequer but let us also address the issue of under-recoveries which becomes the sore point for the government and the media. It is this figure which is often quoted to show that the oil companies are incurring losses due to the governmental regulation. What do these under-recoveries mean? The difference between the cost price and the realized price represents the under-recoveries of the oil marketing companies (OMCs). The realized price is the post-tax price.

There are two problems with this dubious concept. First, if the pre-tax prices are higher than the cost price, there can never be any loss to the exchequer on the whole. Since it is the public sector companies which primarily fund the under-recoveries, this amounts to saying that the government is taking more from the left hand (taxes from these oil companies) and paying less to the right hand (under-recoveries) and yet claiming that it is running huge deficits. Nothing can be more deceitful than this concept of 'under-recoveries'. In accounting terms, these under-recoveries would disappear as soon as the taxes are lowered significantly to an extent that the post-tax prices are higher than the cost price.

Second, these companies, despite under-recoveries, are making enormous profits. The reason for the difference between under-recoveries and profit statement of the OMCs is that the latter takes into account other income streams like dividend income, pipeline income, inventory changes, profits from freely priced products and refining margins in the case of integrated companies. So, quite apart from the first reason, the concept of under-recoveries does not hold much ground especially since they are otherwise making profits.

4. Oil Prices and Inflation

The most recent defence for the price hike has come from Pranab Mukherjee, who says

“Incomplete pass-through of higher crude prices will have an impact on aggregate demand through higher subsidy expenditure, which is expansionary and can add to inflationary pressure. If we increase administered prices of petroleum products and reduce fertilizer subsidy, we allow room for some inflation. If we do not, then the consequent increase in the fiscal deficit will counter the moderating trend in aggregate demand and push inflation high anyhow. In addition, there is also upward pressure on wages. [Domestic investment, saving rates, inflow of foreign capital] post-2008 are gradually regaining their momentum. To some extent, this recovery is being held back by domestic inflation, which seems to have gained a foothold in the past two years” [Business Standard, July 07, 2011. The news report is here]

This is one of the most non-serious argument that I have seen in the recent past coming from this already deranged government. On a serious note, however, the message is clear. The finance minister is trying to kill at least 2 birds, if not more, with the same stone. On the one hand, he signals that this step would be favourable to the international and national finance capital to invest because it would reduce the fiscal deficit as also control inflation. On the other hand, he is favouring the oil companies by moving towards deregulation in other petro-products too.

As is usual with these neo-liberal arguments, there are serious problems here too. First, a higher fiscal deficit or increase in wages do not lead to inflation unless the economy is hitting its near-full capacity. That is the demand-pull inflation does not enter the picture till very late in the day. Mukherjee's view is what the British treasury held which Keynes and Kalecki had so comprehensively refuted. It is ironical that such views are coming into vogue when the orthodox economics is on the backfoot in the wake of the current crisis. But then, why expect Pranab Mukherjee to be conversant with these debates.

Second, as is clear, the current phase is primarily a case of cost-push inflation. In such situations, the government should attempt to curtail indirect taxes, which are an important factor in costs. What the finance minister proposes is actually going to aggravate the problem of inflation and not control it.

Third, there is another implicit argument, which was made explicit by Manish Tiwary, another stalwart of the Congress who epitomizes idiocy on the national television. That is, an increase in prices of diesel, kerosene and LPG would decrease the demand of these products and would control the inflation from the demand side. Quite apart from the points made above, this argument falls flat because the demand of these products is quite inelastic in nature, and hence, only increases the burden on the people.

That this government has lost all sense of proportion is evident from the arguments ranging from ridiculous to the outrageous made by its senior leaders. Embroiled in the wave of corruption, the present dispensation, which has scant regard to the livelihood of millions of poor people, has lost all moral authority to govern this country. However, peoples' protest whether on price rise or corruption would sure show this government its place in the days to come.

References

Sethi, Surya P. “Analysing the Parikh Committee Report on Pricing of Petroleum Products”, EPW, Vol XLV, No 13, 27 March 2010

Get the latest reports & analysis with people's perspective on Protests, movements & deep analytical videos, discussions of the current affairs in your Telegram app. Subscribe to NewsClick's Telegram channel & get Real-Time updates on stories, as they get published on our website.

Subscribe Newsclick On Telegram