For price, subsidy reform in oil

"There are pervasive rigidities in market design, product taxation and subsidy levels and the express policy purpose must be to reduce the extant distortions. The open-ended subsidies can make budgetary figures go completely haywire and send entirely wrong price signals. We need independent retailers to fully integrate petro-goods with retail industry."

The price of inaction, it has been wisely said, is far greater than the cost of making a mistake. Consider, for instance, the warped pricing regime for the main petroleum products. What’s clear is that open-ended consumption subsidies, in ascenario of rising import prices, are unsustainable and without path-breaking reform, would make totally unacceptable demands on the fisc. Which is why the recommendations of the expert group (EG) ‘on a viable and sustainable system of pricing’ of petro-products, submitted to the Centre last week, needs to be deliberated upon for prompt policy implementation. The EG calls for an open, competitive market for petro-goods like petrol and diesel and effective targeting of price subsidies for household fuels for the greater good, which is unexceptionable.

However, while the EG’s broad suggestions on market design, pricing and subsidy reform in the vexed oil economy makes perfect sense, its proposal for an additional excise duty of Rs 80,000 on diesel cars is wholly questionable and seems ill-advised. The committee has justified the additional excise on the grounds that ‘higher excise duty on petrol compared to diesel encourages use of diesel cars’. But the presence of one set of rigidities in petro-products pricing can hardly justify another, and especially so when there is already a panoply of distortions in the oil sector. The fact is that there are pervasive rigidities in market design, product taxation and subsidy levels — and the express policy purpose must be to reduce the extant distortions, not add to them.

As the EG rightly says in para 2.10, ‘price control, subsidies and taxes can introduce distortions which may not be desirable’. Note that the higher excise on petrol, plus attendant indirect taxes, add up to almost half the retail price, which is clearly much too high as per international practice. And since our indirect tax regime on petrogoods is of the old-fashioned cascading type along the production value-chain, and not ‘vatable’ (read offsetable) by taxes paid earlier — as is the norm abroad in high-tax regimes — it is perverse incentive for untoward activities like fuel adulteration. 

The point is to reduce the distortions in oil, so as to incentivise routine efficiency in logistics and supply for market-determined prices. And yet, the EG does suggest precisely the opposite: a steep additional excise on diesel-driven vehicles (4.14), for the spurious reason of ‘balance’ given the higher excise on petrol. In any case, the latter levy in petrol prices is supposed to be a cross-subsidy, so as to cover the subsidy on kerosene (SKO) and cooking gas (LPG). The rationale was that the car-owning higher-income groups can well help meet the subvention requirement for SKO and LPG. But the fact is that under-recoveries on subsidised SKO now add up to over Rs 20,000 crore per annum, and that for LPG amounts to over Rs 16,000 crore. The open-ended subsidies can make budgetary figures go completely haywire and send entirely wrong price signals. Also, as various studies show, the bulk of the subsidised SKO is diverted for fuel adulteration or smuggled across porous borders — where the price is usually much higher. Besides, adulterated fuels mean faster engine wear and tear which has its costs. The subsidy on LPG is anyway largely appropriated by the non-poor. 

Hence, the necessity of better targeting the subventions on SKO and LPG, as the EG has well suggested, with ‘smart’ cards, rural electrification and the diffusion of solar lamps, etc. It has also called for price revision of subsidised SKO — the price has not been changed for a decade. It makes no sense to have consumption subsidy levels amounting to almost half a percentage of national income on one head alone, SKO, and especially when there’s massive leakage and diversion. The EG has also called for price revision of LPG, so as to stem runaway subsidies. Also welcome is the recommendation to revise LPG prices in line with the growth in average incomes, as also price decontrol of petrol and diesel. 

The retail prices of automotive fuel do need to be linked to import costs and scarcity value. But in parallel, we need reform of the taxation regime for oil products and reasonable rates. There’s a case for cess on petro-goods to provide for pollution control and the like, but we must widen the indirect tax base and not levy disproportionate duty on oil. Also, streamlining the subsidy regime for SKO and LPG would remove the logic for higher excise on petrol. It is distortionary and needs to be dropped. In tandem, the proposed additional excise on diesel cars makes no sense and needs to be nipped in the bud. Further, it is notable that the EG has implied opening up of the effective ring-fencing of retail sales of oil-products, and doing away with the monopoly rents it entails (4.53). We need independent retailers so that petro-goods are fully integrated with the larger retail industry, to shore up productivity gains and deliver competitive and efficiency prices.

Source: Economic Times

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