Friday, February 12, 2010

Deregulation of Oil Prices in India

Raghu is a clerk by profession who lives with his wife and two daughters. He uses the city bus services to commute daily to his office. Though not highly educated, he loves going through the newspapers to keep him abreast of the latest happenings. He is especially fascinated by the news related to the ‘aam aadmi’ (a typical middle class person; the new rage amongst the TV channels and politicians). He was happy that the government was making special efforts to keep oil prices in check so that people like him could benefit. The efforts of the central government had helped him keep his household expense viz. LPG cylinder, bus tickets etc in check. 

But he was surprised how his neighbour Rajesh, a businessman, could afford the latest gas guzzling cars when the government was finding it so tough to keep the fuel prices in check. In order to satisfy this curiosity, he asked this question to Rajesh. Rajesh replied, “In the existing scenario when the international price of crude oil is constantly threatening the 100$ (per barrel) mark and in India you could still afford it for Rs 50 per litre, why not make the most of it?” After replying, Rajesh sped past him in his latest SUV. Raghu was puzzled. Was the government step really pro-aam aadmi or was it bad policy? For the past few days the news related to a panel headed by a gentleman named Kirit Parikh has caught his attention as it is related to “deregulation” of oil prices in India. He wonders what this topic is all about and how does it affect an average Indian? Let’s try to answer his question.

First of all, let’s define “deregulation”. Deregulation (in this case) is the act of doing away with the government administered price regime and replacing that with a market determined one. Why has the issue of deregulation of oil prices in India gained so much attention lately? For this we need to understand the present context. India relies on imports for more than 75 percent of its energy needs and the government sets fuel prices to cushion the poor from high international price. The existing prices (Delhi) for the common fuel are: Petrol Rs 44.63 a litre, Diesel Rs 32.87 a litre, 14.2-kg LPG cylinder Rs 281.20 and kerosene Rs 9.09 per litre. At these prices, the Indian Oil, Bharat Petroleum and Hindustan Petroleum are estimated to lose Rs 46,030 crore in revenues this fiscal. As per the current policy, the revenue loss on petrol and diesel is met by upstream firms like ONGC. Of the Rs 31,574-crore revenue loss expected on LPG and kerosene, the government has so far given Rs 12,000 crore. For a country battling fiscal deficit, it only but worsens the situation.

So, are the international crude oil prices, currently at 70$ per barrel, artificially high (due to speculations) or it is a case of supply-demand mismatch? It seems the latter explanation is closer to reality (anyways we are the price takers). So, we can say that the policy is just not sustainable. Similar concerns are raised in the recently submitted report by the panel headed by Mr. Kirit Parikh. The report goes on to suggest freeing up of petrol and diesel prices, raising LPG rates by Rs 100 per cylinder and kerosene by Rs 6 a litre. By current estimates, deregulating auto fuel pricing would result in a hike of Rs 4.72 a litre in petrol prices and a rise of Rs 2.33 per litre in diesel rates.
So, what are the pros and cons of deregulation of oil prices? Let’s try to enumerate them.

Pros (Advantages)
· It will help us bring down the current fiscal deficit (the raging obsession) which we all know would go a long way in improving our credit ratings and thus help in attracting foreign investments.
· It will help our PSUs (public sector units) remain competitive. After all we intend to divest them in order to fund our social sector initiatives and it’s a no brainer, when will these initiatives fetch better prices.
· It will help in arresting downward revision of credit ratings of PSUs like Indian Oil’s by S&P citing declining cash flows caused by delays in government compensation for selling fuels below cost (source Bloomberg).
· It will restore the competitiveness of our private sector firms like Reliance, Essar who have been literally driven out of the retail business of oil as they can’t afford to sell at such low prices.
· Deregulation will lead to a more equitable sharing of inflation burden, affecting mostly people who can pay (remember Rajesh).
· Alternative measures to counter fiscal deficit like taxation and borrowings affects everyone including the poor and farmers.
· With the oil prices unlikely to come down in near future, it makes more sense to pass the burden of price rise on to the customer else it could become a bottleneck that is structural rather than cyclical in nature and thus become hard to tackle (hope we are wiser by the experiences of fertilizer subsidies). There is just no escaping
· With the recent social initiatives like NREGS, the per capital income of the rural India has gone up so they are in a comparatively better position to absorb the price hikes esp. Kerosene.
· With the oil prices at 70$ per barrel, down from the dizzying heights of 147$ per barrel, it is the case of ‘now or never’ as the price hikes would be much more manageable.
· It might just prove to be shot in the arm for initiatives that are aimed at saving petroleum resources (scarce in nature) and prove a boon for hybrid cars or battery operated alternatives.
· Steps towards deregulation would be taken as a progressive reform by the market and will send positive signals about our economy and will lead to better investor sentiments towards India.

Cons (some remedial measures have been suggested along with)
· This step would lead to higher inflation. So, we can adopt a gradual hike policy for the diesel prices as the transportation sector may be affected badly which could push the food prices further up. Similar arrangements can be made for kerosene oil prices.
· It could cause a great deal of harm to the political base of the central government (after all good economics is bad politics). So, there is all the more reason for the ‘gradualism’ approach. Add to that the PDS (public distribution system) needs to be robust to ensure transparency and effectiveness.
· Leaving everything to the market forces can have negative effects like artificial shortages, irregular pricing etc. So, it calls for transparent pricing mechanism as well as effective government role as a watchdog (as they say, ‘when the cat is away the mice will play’).

So, it seems that “deregulation” is the way forward. In a country saddled with inefficient infrastructure, inadequate health and education facilities, we can barely afford subsidies like these. Let the government take a chance. Let’s bear with it for some time. After all we as citizens of Indian deserve better utilization of the taxes we pay rather than filling in for wasteful usages of people like Rajesh. ‘Go for it now else it will be too late.’


  1. The common man has been bearing with the atrocities since times immemorial . I see no harm in bearing with the "deregulation of fuel prices" too (but for "sometime" as you have mentioned in your post)
    Well thought & I hope the remedial measures are soon implemented by the concerned bodies!
    Good job! :) :)

  2. The biggest problem with such a deregulation is that it will hurt the poor more than actually affecting those who are well off.The price rise will make it difficult for the low income groups to even afford fuel which is a basic necessity while the others can cut their fuel bills by reducing proportional usage(which I agree is good but not at the cost of depriving others of essentials for living).
    I in fact think that taxation is a far superior way of ensuring equity.(Directly refuting one of your Pros).The taxes can be targeted at higher income groups(tax slabs) the same is very difficult to achieve with market price (Govt Distribution & subsidies for poor have not been very successful in the past).

  3. Lucid and analytical article on a burning topic..

  4. Good effort from your side.Just a few queries since u have done a lot of research in it. When u talk about good public distribution system and transparent pricing how you explain Petrol prices in India as Rs 53 when
    Basic cost per litre :Rs 16.50
    Centre Tax per litre:Rs 11.80
    Exice Duty per litre:Rs 9.75
    State Tax per litre: Rs 8.00
    Vat per litre: Rs 4.00
    Total:Rs 50.05
    Total price per Litre: Rs 53.05
    How can the extra Rs 3 can be justified.......

    Just pass on the Knowledge if you know why petrol prices in Pakistan: Rs 26, Bangladesh :Rs 22, Cuba: Rs 19, Nepal: Rs 34, Afganisthan: Rs 36, Qathar :Rs 30 and many more.....

  5. Thanks for your enriching comments.

    @Amol, As you suggested direct taxation(which brings down consumption and thus can reduce demand) can be a better method but in the recent past direct taxes have come down (again politics as taxpayer base is very low in India) even with prices rising. Rather the indirect taxes are levied which are inflationary in nature.

    @Shad, Deregulation will add transparency (difference between cost and price) as politicians won't be able to subsidize it to rake in votes or help out industrialists. After all the demand for Oil has outstripped its supply so its high time we brought down our reliance on it. Your comment add value in the sense that a watchdog is required to avoid speculative pricing. As far as low prices in some countries are concerned, it could be inefficient pricing, politics or their better access to oil. Their cost breakdown (as you did for India) could throw more light. Some google searches show that Kerosene is priced much higher in Pakistan and Nepal w.r.t. India.

  6. High prices of Oil products in India are simply due to very high taxation. The logic of the government was ( and I suppose is ) that by keeping prices artificially high, the demand of petro products can be reduced which in turn will reduce their adverse effect on the BoP side of the country. As these products (especially Kerosene) plays an important part in meeting the energy requirements of poor, so the govt decided to go for subsidizing the same products (for poor) whose prices it has artificially inflated.

    So the question ultimately boils down to the definition and size of poor people in India. As we all know that the data provided by "% below BPL" is nothing but an example official manipulation. Recent media reports and some independent agencies claimed that more than 77% of Indians live on less than INR 22 per day. If we believe that, then we can safely assume that more than 70% people in India are poor. Now if that is the case, then what is the point in inflating and then subsidizing the fuel prices if so many citizens need the subsidy anyway?

    Summary : Let the free market play its role by removing taxes as well as subsidy and I am sure majority (and I means 3/4 majority :) ) will live a happy life. Govt needs to look for some other creative means to raise it revenue or reduce its expenditure.

  7. extremely impressed by your research i was also inspired to do some research especially on deregulation implemented by other countries... my search helped me find that countries namely phillipines and nigeria have already burned their hands by experimenting the same... especially considering phillipines where the case is much similiar to ours, a survey says that 6/10 people which is majority are in favour of cancelling the deregulation of prices once again as they faced 6 times increase in oil prices in span of 8 years...same is in the case of nigeria....already seeing the failures in both the countries where the deregulation was and is implemented why shall we burn our hands in the same fire???? I would also like to know your views and clarify if i am wrong....thanking you
    Jaimin Shah

  8. @ Jaimin, your comments were enlightening. Great job indeed. As you pointed out that deregulation has some severe negative aspects as well. Esp in the case of Phillipines (They were anyways going bankrupt beacause of subsidies), it was seen that the oil companies used this opportunities to hike prices arbitrarily and traders manipulated prices through speculation. So all the more reson to have a proper watchdog both at the national as well as int'l level.
    Other point to watch out is that alternatives like hybrid cars or battery operated ones would never get serious attention unless deregulation takes place. As these are disruptive innovations that might threaten the existing mechanical set up. So strategically the power might shift to the innovators which all the auto companies may not enjoy.
    After all we are price takers so we are likely to be guided by existing prices even if they are speculative. And unless we move our focus from the prices to the distribution of oil products, we will struggle with it.
    My one major concern with the regulated set up is that, in the name of aam aadmi, the rich car owners are walking away with the cake.
    Thanks once again.

  9. @ Amit. Great analysis. Even the Panel on oil deregulation was against taxation. After all with such subsidy, fiscal deficit becomes a structural problem which becomes tough if not impossible to solve.

  10. great blog...lucky to come across it...

    nice to see a article giving depth analysis of the issue... How can government levy high tax on a product and then say market forces need to play to bring change? here for petrol govt (state and central) levies lot of tax and then say the price rise is due to deregulation....

    U have put forward the idea govt as regulator...the idea is good but does it work in india? the trai, the irda....all where created with same mission.... i fear in our corrupt society it wud be very easy for companies to bribe the regulator.... good governance with transparency and accountablity in companies too is needed before pushing the reforms

  11. @ Anony...Thanks for your appreciation.
    I agree that transparency and accountability are needed for deregulation to succeed but we must consider that most reforms are gradual in nature. Isn't that true in this case as well? After all, it's after deregulation that we are questioning the basis of levies? We are a developing economy so things will evolve before they take a proper shape.

  12. I agree that transparency and accountability are needed for deregulation to succeed but we must consider that most reforms are gradual in nature. Isn't that true in this case as well? After all, it's after deregulation that we are questioning the basis of levies?

  13. Well, its kind of funny to see a mere commodity changing the game of politics and dynamics of democracy. No doubt, it is difficult for a layman to understand technicals of finance & economics, but a growing economy burdened under double digit( state & central) fiscal deficit sooner or later has to face this daunting task of deregulating oil. A tight-rope walk for Mr. Man Mohan Singh to having it passed without facing the grunt of at least billion people.
    A bankrupt economy or a ruling Chair!

  14. @Nidhi, a good economics prof would always tell you that you can't solve problems related to the economy if you don't take into consideration the political issues. You have nicely summed up the problem at hand. Thanks for your insights.

  15. see corruption place in india and how we can remove there's corruption..

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