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How best to tackle the fuel price
June, 02nd 2008

Market determined prices which are in line with the international prices are always a right step in the wake of rising oil prices.

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 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 20,100 crore in 2004-05 to Rs 77,300 crore (estimated) in 2007-08; a stunning 285 per cent surge. The state-run oil companies continue to report a daily loss of Rs 580 crore 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 from the interview:

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 looks at the break-up of retail price of unbranded motor spirit in Delhi, excise duty accounts for 33 per cent, customs duty 4 per cent and sales tax 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.

As regards the retail selling price of HSD in Delhi, excise duty accounts for 15 per cent, customs duty 7 per cent and sales tax 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 (that is, tax) of Rs 27,800 crore on MS and Rs 57,100 crore 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 to the cascading effect of 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 this is not expected be significant.

A 1 per cent levy of cess would generate a single digit impact on the estimated under-recoveries. Over 90 per cent of the under-recoveries would still remain unaddressed.

Therefore as all taxpayers, including corporate India, face the brunt of accelerating commodity prices and enhanced cost of capital, with slowdown 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 a litre, HSD by Rs 5 a 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 on 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 over 8 per cent could surpass the 10 per cent-mark, there by destabilising interest rates and impacting economic growth.

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 as regards the fuel policy is to achieve fiscal rationalisation at both the Central and State levels, by reduction in the custom, excise and sales tax rates 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 softened as it is shared among all the stakeholders the Central Government, the State governments and the consumers.

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