Thursday, September 15, 2011

Petrol price hike is not against the aam aadmi…..

Petrol prices went up again. TV channels went on a mindless frenzy of emotional outburst reflecting the angst of their middle class audiences. Sense gave way to non-sense. Emotions to rational analysis. And of course, politics sat squarely in the middle of every debate as always!

Let me just take some of the issues involved in this matter:

Petrol price hike will stoke inflation: Wrong. The impact of a price increase in petrol does not run through the entire economy, as the impact of a diesel price hike does. Most of the petrol is used by the urban middle class in running their two and four wheelers for transport. This section gets hit hard and directly. But it does not affect the prices of other goods which depend on diesel for transportation across the country. Inflation does not rise much because of petrol price hikes.

Crude prices had touched $145 in July 2008. Now the prices are much lower at $115 or so. Yet petrol prices are higher by at least 50% now since then. Why? There are two reasons for this. 1) In 2008, when the crude prices went up to $145, and the retail prices were comparatively low, the government was picking up a huge amount of subsidy on petrol (in addition to the subsidy on diesel and LPG). Every litre of petrol it sold led to a loss to the oil PSUs. Those losses were funded by the government. Today, the government is bearing a lower burden by passing on much (not all) of the burden to the people. The petrol subsidy alone this year would have been more than Rs 5000 crores if this price hike had not been taken. That’s why the retail petrol prices are higher today than in 2008. This trend will continue. Every now and then (especially around election times!) the government may reduce the retail petrol prices…..but in the long run petrol prices would keep increasing till subsidies on petrol become zero. The government will have to continue subsidies on diesel, LPG and kerosene though 2) In 2008, the Re was quoting at Rs 42.7 against the dollar. Today, the Re has fallen to Rs 47 odd. The impact of this on crude prices in rupee terms is obvious. Some would argue that the rupee having fallen so much reflects how poor our economic condition is. Not true! But this post cannot cover that subject.

Government makes huge tax revenues on crude and refined fuels. Why can’t it cut those taxes to benefit the people? This is right. The central government does indeed make a lot of money on excise, customs, VAT etc and the state governments make monies on sales tax on fuels. All of those higher taxes that the government will make will go on to increase the revenues of the government. The government deploys those revenues behind pro-poor programmes (NREGA, fertilizer subsidy, PDS etc etc). If the government cut taxes on fuels, only the urban middle classes would benefit. If it increases prices, the urban middle class is hit, but the rural poor are benefited because the pro-poor programs get higher funding. So the urban middle (and upper class) pays for the rural poor. That’s only fair, isn’t it? Besides, let’s not forget that the government’s revenues are much lower than its expenses. This gap is broadly called the fiscal deficit. A high fiscal deficit causes inflation which affects every citizen. The petrol price hike will cut the fiscal deficit a wee bit and help (indirectly) the fight against inflation. Inflation for the urban middle class will surely rise, but for the entire country may actually fall. But all this is true only in case of petrol price hikes. If diesel price hikes happen, then the whole economy is hurt. If LPG prices increase, then again all sections suffer. That’s why the government freed up petrol prices but kept its control over diesel and LPG prices.

So will petrol prices keep increasing in the future? You bet! Nomura has predicted that crude prices could touch $230 in the future. We can imagine what that will do to petrol prices.

But why don’t diesel prices increase? Today, so many cars are based on diesel. Isn’t that subsidizing the urban rich? Yes indeed. The government has to look at a way of separating urban diesel pricing from rural and commercial diesel pricing. There is no reason for rich people driving diesel-guzzling SUVs to get subsidies from the government. The price of diesel for the transport sector and rural areas must remain subsidized for longer though.

What about LPG prices? According to one TV channel, the government plans to reduce subsidies here too? Well, there is much abuse of LPG subsidies today. Instead of the subsidies reaching the middle classes, they are being usurped by commercial establishment (restaurants etc) who consume gas cylinders in bulk by bribing the local delivery boy. So the government pays money for the restaurant’s gas bill! If only the government could stop this corruption, it could direct its subsidies much better and maybe then, the prices needn’t increase so much. So while LPG prices have to rise very significantly, it would be foolish to increase it in one step. The pain has to be spread over many years. There is an obvious political problem here. Economics may dictate that prices be increased in one step, but politics will put the brakes on such a plan. I would be surprised if the government increased LPG prices steeply today. I am in favor of reducing the number of subsidized gas cylinders…..but the price on non-subsidized LPG cylinders should increase slowly.

So the urban middle class keeps suffering? While it appears so, that’s not true really. Much of the economic gains the country has made in the last 20 years has benefited the urban middle classes. Just look at the salary levels of people today v/s just 5 years back. On average, pay hikes are between 15-20% per annum (in the developed West, they are not more than 2-3% per annum). So even if inflation is 10%, we are getting more in our hands in real terms. Many people are confused with our economic growth of 8-9% per annum. They think it’s less than our inflation of 10%. Wrong! The economic growth is over and above the inflation number. That’s why it’s called real growth. The growth after considering the impact of inflation is about 18-19%. That’s called nominal growth. In short, middle classes have enjoyed much of the benefits of economic liberalization. Now its time we share the spoils with the poor.

Why should Income Tax payers be singled out to the brunt of LPG subsidy reduction? Well, the principle is that the rich pay for the poor. What other method is there to identify the rich from the poor except for Income Tax returns? The problem of course is that many rich businessmen (and bulk of Indians do business; not jobs) don’t pay Income tax at all. They would escape any impact of withdrawal of subsidies. This is a larger problem…..but again, that’s the subject matter of another post.

What’s the long term solution to the fuel pricing problem? Well clearly, we have to move away from crude-based fuels. A bulk of crude is used in the transport sector and the power-generation sector. The solution is simple really. 1) We must move towards more electricity based transport systems. The metro is a prime example of how electricity can substitute petrol/diesel. Electric cars are starting to enter the Indian market, though they are still expensive. 2) We must generate electricity using nuclear power. Nuclear power is clean….much cleaner than coal power plants. Also the health hazards are actually much lesser than the exaggerated reports we hear on TV. We remember Chernobyl and Fukushima, because they are spectacular tragedies. But we don’t remember the slow deaths that coal based power plants are causing us every single day. Most activists who complain against nuclear power don’t have any solutions to offer. If we use more coal, they have a problem with that. There is only a limited power we can generate from hydro power. Solar, Tidal, Wind, biogas etc are still not commercially viable to produce on large scale. That’s why we must support Jaitapur whole heartedly. Let’s not get politics into everything.

If only we removed corruption, we wouldn’t need so much subsidies? That’s indeed true! In fact, it’s the story of most problems in India. If only we could eliminate corruption in the PDS, we would save a lot of wastage of resources. That’s why Nandan Nilekani’s UID project is so crucial. If this were implemented to cover all poor people, then the entire PDS system (where corruption abounds) could be scrapped. Poor people would get the dole (subsidy) directly into their bank accounts. Say the government wants to give the poor 20 litres of kerosene per month at Rs 10 per litre. So the poor pays only Rs 200 per month for this. Let’s say the real price of kerosene is Rs 50 per litre. So the government bears the subsidy of Rs 40 x 20 litres = Rs 800 per month on its account. Unfortunately, most of this kerosene is not delivered to the poor, but is siphoned off by the PDS shop owner for unfair gains. If however, the government simply gave Rs 800 into the bank accounts of the poor, then that money cannot be looted by the PDS network. The poor would add their Rs 200 and go to the market and buy their 20 litres of kerosene by paying Rs 1000. This is why the UID project is so crucial. It cuts out corruption totally (of course, there are some other problems attached to UID….). So we should support the UID project.

There are many other things we need to do to protect our future. For that, we need an intelligent debate. Unfortunately, the passion of the country is politics; not economics!

The real truth is that the petrol price hike will hurt PLUs (people like us)…..but it won’t hurt anyone else. Clearly, the government seems to be more focused on the poor (and that’s alright with me). To be fair, the government did announce a 7% increase in the DA for urban middle-class government employees before announcing the petrol price increase……


  1. Hi Prashant..that is indeed a good piece of information for cribsters like us.


  2. Just a query, if petrol prices are following market pricing should it not be reduce when the crude price goes down or the rupee strengthens against the dollar???

  3. very true & informative..thank u.

  4. @Hari: Yes prices will come down but only when the global crude oil prices come down for a significant period of time. Prices have come down in the past....only we don't remember that! Prashant