With
international oil prices rising rapidly, crossing the
$135-a-barrel mark and heading, according to some predictions,
towards even $200-a-barrel, the oil economy has become
a prime cause of concern for the government. The weighted
average price of the basket of crudes imported by India
has risen to $125.28 a barrel as compared with $30 plus-a-barrel
four years back and $60 plus-a-barrel just two years
ago. Such large and quick increases have resulted in
a sharp divergence between the domestic prices of oil
products set by the government and the international
prices at which imports are being made.
This divergence many would argue is unavoidable. The
sheer magnitude of the increase in international prices
makes it foolish to argue that domestic prices should
be adjusted upwards to cover much or all of the increase.
Oil is a universal intermediate and a price increase
of that magnitude would have direct and second-order
effects that would transform the current inflation into
a veritable inflationary crisis.
On the other hand, if prices are not increased and little
else is done the burden of adjustment is transferred
onto the oil companies that receive much less per litre
on sales of petroleum products than the costs they incur
in importing the crude and refining them to obtain those
products. While estimates vary, projections of losses
that would be incurred on this account by the three
oil marketing companies (Indian Oil Corporation, Hindustan
Petroleum Corporation Limited and Bharat Petroleum Corporation
Limited) during the current fiscal year go up to as
much as Rs, 2,00,000 crore, as compared with Rs.77,000
crore last year. If they are not compensated in some
way, their viability is clearly at stake.
It needs to be noted that not all oil companies are
faced with this difficulty. Those that have access to
reserves and are in a position to extract oil for export
before or after refining, would be making substantial
profits as the selling price of oil products soars relative
to their cost of production. Even in India there are
companies that benefit thus in the current situation,
though the fact that India imports much of the oil products
it consumes, makes the divergence between international
and domestic prices more of an issue here. Maintaining
a differential between domestic and international prices
is easy only in countries that are self-sufficient in
oil. On the other hand, in countries that are dependent
on imports of oil the real issue is the way in which
the gap between domestic and international prices can
be financed.
This conundrum indicates that in import-dependent contexts
policies relating to the oil economy must be innovative.
In fact, recent trends in global oil prices make clear
that given the array of factors, economic and geopolitical,
that influence these prices, no country can adopt the
simplistic view that domestic oil prices must be aligned
with international prices. Put differently, the domestic
price of oil cannot be set at levels that recover the
costs of import, since those costs are too volatile
and rising. Rather the domestic price should be set
on the premise that it is one element in a tax-cum-subsidy
framework, with the price serving as part tax when international
oil prices are unduly low, and part subsidy when international
oil prices are as high as they are today.
It is the refusal of the government to adopt this position
that partly accounts for the current crisis. That attitude
stems from two sources, with contradictory motivations.
The first is the ideologically-driven and ill-advised
decision to move away from a regime of administered
prices to one in which prices are aligned to those signalled
by international markets. The decision to opt out of
the administered price mechanism for oil was adopted
as part of the reform, but the government has been hard
put to implement that decision in practice. All it has
managed to do is to transfer the burden or benefit of
differentials between the international and domestic
price of oil from a specialised facility to the oil
marketing companies themselves.
The second reason why the government has been unwilling
to treat the oil price as an instrument of its tax-cum-subsidy
regime, is that the Finance Ministry has gained much
from treating the prices of oil products as values on
which indirect taxes of various kinds can be levied.
This has made the petroleum sector a cash cow that yields
large revenues in the form of customs duties and excise
duties. What is more since these duties were specified
as ad valorem rates proportional to the value of the
commodity being taxed, revenues garnered from taxation
rose along with the increase in the international and
domestic prices of the commodity. (It is only in the
the last budget that the Finance Ministry partly replaced
the ad valorem duty with specific rates of duty on “unbranded”
petrol and diesel whose share in total consumption is
on the decline.)
The use of oil, especially autofuels, as a source of
tax revenues has meant that the retail price of petrol
and diesel includes a substantial duty component. Petrol
and diesel imports are subject to a customs duty of
7.5 per cent and the tax component in the retail selling
price of these two commodities is placed at 53 and 34
per cent respectively. As a result in 2006-07, out of
the proceeds from sales of petroleum products at the
retail level, as much as Rs.10,043 crore accrued to
the government as revenues from customs duty and another
Rs.58,821 crore as revenue from excise duty. If the
government had chosen to forego this revenue, but the
retail price had been kept at its earlier tax-inclusive
level, the “underecoveries” of the oil marketing companies
would have been much less. Small upward adjustments
of price would have been adequate to fully compensate
the oil marketing companies. Further, in the long run,
since there would be periods when the oil marketing
companies would earn large surpluses because international
prices rule low but domestic prices are held stable,
part of the adjustment could come from inter-temporal
transfers of past surpluses to finance current deficits.
Finally, even if increases in global oil prices are
persistent as they have been in recent times, the government,
if it treats oil prices as one instrument in its tax-cum-subsidy
regime, could choose to mobilise revenues from taxes
imposed elsewhere in the system and compensate the oil
marketing companies, so as to ensure their viability
even when retail prices are held constant. One source
of such revenues could be the superprofits garnered
by the upstream oil companies (including private ones)
involved in production and refining of oil. But if the
Finance Ministry chooses to treat the petroleum sector
as a cash cow and exploit increases in prices to garner
additional revenues which it then presents as evidence
of successful resource mobilisation, such a strategy
cannot be pursued.
These conflicts between the interests of the Finance
Ministry, the Oil Marketing Companies, the consumer
and the ideologues of reform was indeed recognised by
the Rangarajan Committee which was set up to examine
the oil pricing conundrum in an environment of liberalised
pricing. Based on its analysis of different stages of
the oil pricing chain, the committee concluded that
the burden resulting from any persistent increase in
international oil prices should be shared by the upstream
oil companies and refineries, which receive prices that
more than compensate for costs; the central government
which garners revenues in the form of customs duties
and excise duties (besides dividends from the oil majors);
the state governments which benefit from sales taxes;
and the consumer, shielded partially from the full impact
of international prices.
The committee had much to say on the principles that
should govern how the burden should be shared. Given
its period of analysis the committee found that the
upstream oil companies (or oil companies other than
the oil marketing companies, such as ONGC, OIL and GAIL)
had recorded profits to the tune of Rs. 15,600 core
in 2004-05 and Rs. 14,600 crore in the first nine months
of 2005-06. That the oil industry’s contribution to
the central exchequer in terms of duties, taxes, royalty,
dividends etc. rose from Rs. 64,595 crore in 2002-03
to Rs. 77,692 crore in 2004-05. That the petroleum sector
alone contributed around two-fifths of the total net
excise revenues of the Centre. That taking Delhi as
an example, central and state taxes amounted to 38 and
17 per cent respectively of the retail price of petrol
and 23 and 11 per cent respectively of diesel. And that
the incidence of taxes as a proportion of the retail
price in India was, higher than in the US, Canada, Pakistan,
Nepal, Bangladesh and Sri Lanka, though they were lower
than in many countries in Europe known for their higher
average level of prices.
This analysis suggested that there was an adequate buffer
to shield domestic consumers from the effects of the
increase in international prices, so long as segments
that can afford to take a cut in petroleum-related revenues
because they have alternative sources of resource mobilisation
are willing to accept such a reduction. Even though
the recent increase in oil prices is too large for the
burden to be shouldered by any one segment involved,
it is clear that if the Centre is willing to forego
a large part of the revenues it has been milking out
of the petroleum sector, prices need only be marginally
increased if the oil companies are to be adequately
compensated.
Further, if the government is willing to compensate
the oil companies with resources mobilised through taxes
that fall on those who can afford to pay rather than
through an increase in the prices of oil that burden
rich and poor alike, prices can be still held constant
at least till such time as the current inflationary
situation is brought under control. But to do this the
government needs to give up the view that petroleum
product prices should be determined by “market forces”,
on which the Finance Ministry can conveniently impose
taxes for revenue generation purposes. Rather petroleum
prices should be seen as a tax, the use of which should
be gauged relative to other options that are available.
But that may require taxing precisely those well-to-do
sections that the Finance Ministry has protected for
long in the name of incentivising private savings and
investment.
There is, however, some hope. The fact that this is
an election year at both state and central levels, that
inflation is already a major problem confronting the
government, and that both the government’s allies and
the opposition have hardened their stand, is forcing
a rethink. Some right decisions may be made, even if
not out of conviction.
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