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M Govinda Rao: Policy inaction and looming crisis
June, 03rd 2008

The international price of oil is a national problem and the parties should collectively deal with it.

Normally, the announcement by the Union Finance Minister of the economy registering 9 per cent growth during 2007-08 should have brought much cheer. Averaging 8.9 per cent growth during the last five years is no mean achievement. Yet, neither the markets nor the observers did exhibit any buoyancy or optimism. The mood seems to be one of despondency. It is only a couple of months ago that the success in adhering to the fiscal deficit target as prescribed in the Fiscal Responsibility and Budget Management Act (FRBMA) was highlighted even as some observers warned that underestimated subsidies and off-budget liabilities are likely to spoil the party.

Unfortunately, the government seems to be walking from one difficult situation to another. Hardly have the noises of increases in food prices have faded when the problem of uncovered oil deficit has come to haunt. At $135 a barrel, the price of crude oil has increased by over 35 per cent this year alone and this is nothing short of an international crisis. The sharp increase in global prices can be ignored at our own peril.

There is an old adage "A stitch in time saves nine". The inability to make periodic revisions in oil prices commensurate with international prices is now pinching. The government recently issued oil bonds of Rs 35,000 crore, estimated at only half the payable for 2007-08. Continued inaction is estimated to cost oil bonds worth Rs 200,000 crore to the oil companies in 2008-09. In addition, there are unpaid subsidies to food and fertiliser companies, farm loan waiver, and pay revision cost, which could aggregate another Rs 100,000 crore. All these constitute almost 6 per cent of GDP and we seem to be approaching a crisis situation. Although on the foodgrains front building up comfortable stocks can help to ease inflationary expectations, the continued inaction on oil prices could precipitate a fiscal crisis of a magnitude higher than even the one seen in 1991. The solution is nothing short of sharp increase in prices, and in the medium term the government should even rethink the administered pricing scheme itself. Hopefully, we will not wait for a crisis to boil over.

The calculations show that the price of petrol should increase by at least Rs 20 to deal with the situation if the prevailing price of crude and structure of pricing distillates is continued. Artificially suppressing the prices will only culminate in real shortages that beyond a point the government cannot support. The government cannot afford to postpone a revision of prices of petroleum products any longer, for, hidden inflation has huge economic costs. Besides unaffordable subsidies, suppressing the prices of petroleum products will continue the high demand, will not show the true scarcity value, and will prevent the required response and adjustment.

The response of the government to the impending crisis has been inadequate and inappropriate. Inadequacy is mainly due to lack of determined action. Surely, increase in prices of petroleum products is necessary for the reasons mentioned above even if it means increase in the wholesale price index in the short term. The recent proposal to increase the prices of petrol by Rs 5 and those of diesel by Rs 2 is clearly an inadequate response to the impending crisis. The proposal to levy cesses to augment revenue is inappropriate, as is cutting customs and excise duties. Such measures will merely shift the burden to the Budget as lower revenues will only increase the fiscal deficit. These measures will not help to contain the guzzling demand for petroleum products.

The unfortunate fact is that the subsidy from the petroleum products, including kerosene, does not accrue to the poor by any stretch of imagination but only causes excess demand, adulteration and distortions in resource allocation. One wonders whose interests they are really serving when the Left Parties oppose the price increase. This is the time to rally round the government to find a solution to the looming crisis. The unprecedented international price of oil is a national problem and the parties should collectively deal with it.

There has been a suggestion to levy the windfall tax. While there is a case for the government to take a portion of the rent accruing to private oil mining companies due to increase in the price of crude and this should be explored, this can only be a supplementary measure. The private sector company has closed down its retail outlets to avoid selling petrol and diesel at the administered price and exports the entire production from the refinery. Thus, while only ONGC is made to bear a part of the subsidy to the consumers by paying lower than the international market price for the crude it extracts, the private sector company enjoys the full benefit by entirely exporting its production. Ironically, when over two-thirds of the oil demand have to be met from imports, India exports petrol and diesel. As the private sector reaps huge rent from its extraction of mineral oil, there is no reason why a part of this cannot be taxed through the windfall tax.

The example of a country successfully levying such a windfall tax is Mongolia. It has started levying the windfall tax from 2006 to reap a part of the rent from sharply rising international prices of copper and gold. The decision was taken by Parliament. It fixed the reference price of copper and gold and the mining companies are required to pay the tax at 68 per cent on the price increase above the reference price. The government of Mongolia has garnered significant resources (over 7 per cent of GDP in 2007). Surely, the private sector company can share a part of the rent it gets due to increase in the international price of crude oil. This can however be only a supplementary measure. This is really a serious national problem and if we do not act immediately, the country will plunge into a crisis. This is the time for the political parties to act in the interest of the country and hopefully, they will rise above petty party politics.

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