Fuelling a transition

Indian Express, 29 June 2011

The government recently raised the administered price of kerosene, diesel and cooking gas at which oil companies sell their products. At the same time it reduced custom and excise duties on these products, and has appealed to state governments to cut sales taxes on them to soften the impact on consumers. While this combination may have been done for short-term political gains, it could pave the way for reform bringing in a rationalisation of the tax and subsidy structure in the sector.

At first blush, the diesel and kerosene price hike and cut in excise and custom duty appears to be rather odd. The government increased the price of kerosene and diesel so that the pre-tax price of these products received by oil companies rose, and then cut excise and customs duties on them, so that the price paid by the customer increases by a marginal amount. The hike will reduce the losses of oil companies and their monthly borrowings required to cover losses. The tax cuts will reduce central government revenue.

Mamata Banerjee responded to the package by cutting sales taxes in West Bengal. So did Kerala. Other state governments and the various political parties governing them may come under political pressure to do the same. State governments who cut sales taxes will also see a reduction in their tax collections. As a consequence of the price and tax change both the central and state governments are likely to see larger fiscal deficits.

The policy package as a whole will not reduce the borrowing requirement of the public sector as a whole (including government and public sector companies). For this reason, it seems odd that the goverment should taken on so much political opposition when the real impact of the step on its overall balance sheet will be very small. What sense does the policy package make?

In the immediate context, this policy combination addresses two issues. First, it reduces the cash crunch being faced by oil companies. While they will continue to have a large stock of borrowing as they sell at prices that do not cover their costs, this amount will come down. If their cash problems were likely to lead to a disruption of supplies, then the probability of that happening has been reduced. The second part of the package, the reduction in custom and excise duties, it has been argued, is because the government chickened out. It needed to get the health of oil companies back in shape but could not take the political risk involved in raising diesel and kerosene prices when inflation is already running high.

It is most likely true that these were the immediate compulsions that guided the package announced. However, these policy changes may have other, perhaps unintended, consequences. If this policy change suggests the direction of change, then this could take the sector to a point when oil companies are allowed to cover their costs and there are no under-recoveries of cost of oil companies. The subsidy to be provided to the oil sector would have to be transparent, and the present hidden subsidy and lack of clarity on what is subsidied and what is taxed, would go.

Currently, the oil subsidy comes in the shape of oil bonds as well as transfer of profits of state owned oil and gas production companies like ONGC to oil refining companies. The choice of instrument used to deliver the subsidies is ad hoc and often changes. Not long ago, the oil-pool subsidy was not even clearly stated in the union budget and not counted as part of the fiscal deficit. Even merely moving away from the fog that exists on petroleum product taxes and subsidies would be a step in the right direction. The corporate governance difficulties the present regime raises for minority share holders of oil companies, including for oil producers, will be reduced.

Once the under-recovery is out of the way, oil marketing companies would then no longer be eligible for money from the government or oil bonds and would have to compete fair and square with other companies. This will make the marketing business a more level playing field. Though the sector is open to private companies, and one of the biggest refineries in the world, the Reliance Jamnagar refinery is in India, private sector companies like Reliance and Essar Oil which established retail outlets in 2002, shut down after they were unable to cover their costs under the administered price regime.

Further, in the long run, it has been well recognised that India needs to move away from the administered price mechanism in petroleum products. It has also been recommended by many committee reports that India must rationalise petroleum taxes. One way of thinking about petroleum taxes is that in the destination, India should have a GST and a Carbon tax on petroleum products. Additional issues about strategic dependence as petroleum is imported may influence policy. For giving relief to the poor, instead of products subsidies on kerosene and LPG, direct cash transfers may be given. However, all this can be done only when there is a clear price and a clear tax and subsidy which are not all mixed up, and different for each product. The first step towards a clean policy framewok would be to get rid of the administered price mechanism and remove any scope for government lending to public sector oil companies when they cannot cover their costs.

Once the slate is clean, meaningful discussions on how to impose the carbon tax, or on how much cash subsidy is to be given to poor households, can take place. Hopefully, the effort of the UIDAI working on a scheme for cash tranfers for kerosene and LPG will also yield results and the huge waste, corruption, distortions and deficits created by the present product subsidy regime would change.

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