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Three scenarios on how best to tackle the fuel price
May, 31st 2008

Fuel price hike? Or tax the private oil companies? Possibilities like these are being thrown around even as the whos who of Government are reportedly huddling together to thrash out a decision to counter the stupendous climb in crude oil price. As Indias dependence on imported crude continues to remain over 70 per cent, rising oil prices in the international markets to pose a serious threat to India; the Indian basket of crude oil touched an all-time high of $121.71 per barrel on May 20.

If you are only thinking of scenarios where prices of oil can be kept steady, then you must listen to Mr Gokul Chaudhri, a partner and leader of the Energy and Infrastructure practice at BMR Advisors, New Delhi. In an email interaction with Business Line, he offers three different ways in which oil could be prevented from puncturing the Great India story.

He cautions that we need to act fast. Under recoveries by oil marketing companies have increased from Rs 201 billion (1 billion = Rs 100 crore) in 2004-05 to Rs 773 billion (estimated) in 2007-08; a stunning 285 per cent surge. The state-run oil companies continue to report a daily loss of Rs 5.8 billion per day on account of under recoveries on sensitive petroleum products.

Given the problems, Mr Chaudhri feels that hiking the prices, as a standalone option, is also not a workable solution given the political compulsions, especially in an election-filled year. Lets hear more from the expert

Excerpts.

There are a lot of subsidies given to oil and related products. So what is Government shelling out actually?

Motor spirit (MS) is currently subsidised at about Rs 16 per litre. High speed diesel (HSD) at Rs 24 per litre, kerosene at Rs 29 per litre and LPG at Rs 400 per cylinder.

Thats a lot. Tell us how we can fix this problem.

One option is rationalise the rates of excise duty on MS and HSD. Excise and customs duty cascade the prices, barring domestic LPG and PDS kerosene which are excluded from these indirect taxes. If one glances at the break up of retail price of unbranded motor spirit (MS) in Delhi, excise duty accounts for 33 per cent, customs duty accounts 4 per cent and sales tax accounts for 17 per cent of the total selling price. In short, price without duties account for 46 per cent and the balance 54 per cent is on account of duties.

With regards the retail selling price of high speed diesel (HSD) in Delhi, excise duty accounts for 15 per cent, customs duty accounts 7 per cent and sales tax accounts for 12 per cent of the total selling price. In short, price without duties account for 66 per cent and the balance 34 per cent is on account of duties.

Revenue impact, therefore, is massive

Yes. Back of the envelope calculation based on the annual consumption pattern of MS and HSD for FY 2007-08 suggests that the Government would generate revenues (i.e. tax) of Rs 278 billion on MS and Rs 571 billion on account of HSD. Cumulatively the total revenue on MS and HSD is approximately 117 per cent of the under recoveries estimated for 2007-08 and 39 per cent of the estimated under recoveries for 2008-09.

Rationalisation of the tax build up, by way of re-setting the absolute tax cost to the benchmark $60 dollar oil prices, can provide the much-needed cushion for the cascading crude prices. This may not by itself be the only measure given the revenue consideration of the Government. However, no other measure can be meaningful to bridge the gap without the duty rationalisation.

What can be an alternative measure? Cess?

To bail out the oil companies from the under recoveries, the Government is considering a cess or surcharge on income-tax and corporate tax. The revenue generated by levy of cess on income tax / corporate tax is not expected be significant. A meagre 1 per cent levy of cess would generate a single digit impact to the estimated under recoveries. Over 90 per cent of the under recoveries would still remain unaddressed.

Therefore as all tax payers, including corporate India, face the brunt of accelerating commodity prices and enhanced cost of capital, with slow down in the global economy, tampering with the tax rates can be counterproductive certainly not a progressive solution!

If cess is not a progressive solution, this leaves with price increase only. Is it not? Should it combined with other measures?

The Ministry of Petroleum and Natural Gas has proposed a hike in the price of MS by Rs 10 per litre, HSD by Rs 5 per litre and that of LPG by Rs 50 per cylinder to bring down the revenue losses suffered by the oil companies. Market determined prices which are in line with the international prices are always a right step in the wake of rising oil prices. Deregulating prices would mean that prices would move in tandem with global prices.

But given the high duty rates of MS and HSD, a price rise would only alleviate the pain of the oil companies and increase the revenues of the exchequer. The mass consumers and the economy would be shaken badly by this move; inflation which is currently ruling at 7 per cent could surpass 10 per cent mark there by destabilising interest rates and impact economic growth. Price rise, as a standalone option, is also not a workable solution given the political compulsions, especially in an election filled year.

What would be the way forward with this price issue? Is there anything we can do without having to face grave repercussions?

The way forward for the fuel policy is to achieve a fiscal rationalisation at both the Central and State level by reduction in the custom, excise and sales tax and then allowing free market forces to apply to MS and HSD, with subsidies from the budgetary allocation for PDS based kerosene and domestic LPG. This way the blow is cushioned between all the stakeholders the Government of India, the state governments and the consumers.

 
 
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