Is the fuel pricing policy problematic?

News: India officially has a deregulated pricing regime for fuel prices. However, there has been a practice to put prices on hold during election campaigns. Experts have raised concerns with this fuel pricing policy.

How has India’s fuel pricing regime evolved in recent years?

The dismantling of oil prices started gradually in 1997, according to the recommendations made by the Nirmal Singh Committee. From 75% in the first year to 100% by April 2002.

From 2004, oil prices started moving up. Hence, the government restored the cost-plus pricing system to protect the consumers. The government did not pass the entire price burden to consumers.

It subsidized prices for transport fuels, LPG, and kerosene through mechanisms to provide for oil marketing companies. Till 2009-10, the government issued oil bonds, but it provided cash subsidies thereafter till 2014-15.

The oil prices came down again in 2015, hence, the NDA government started implementing market price mechanism, without any burden on the consumers.  

The current high prices are due to two factors. First is the high level of excise and VAT. Second is external factors such as depreciation of rupee and Russia-Ukraine war.

There is a stop-and-start approach to price changes despite  a free pricing regime. As soon as the elections in critical States are announced, fuel prices are frozen despite global price trends.

This policy is definitely a red flag because investors closely study governments’ behavioural responses to various kinds of shocks that emanate from the world economy. Investors also look at the prospect of Indian economy and capacity utilization.

How does the deregulation affect the economy?

There are political and economic reasons for the government to deviate from the stated policy either temporarily or in a regular way.

The Indian economy is vulnerable to global crude price pressures. If these prices are passed fully to customers and industries, they will have major economic effects. High retail inflation now will lead to subdued economic recovery, especially after COVID-19.

Hence, India is not able to manage a meaningful de-administered price over a long period of time and makes short-term compromises again and again.

In the short term , the quick solution could be a reduction in excise duties or taxes, which will have a fiscal cost. The government has had healthy tax revenues this year. Hence, the tax buoyancy can provide legroom to the government to absorb a reduction on excise duty on petroleum products.

Fiscal dilemma faced by the government

The tax-to-GDP ratio particularly of the Central Government has not touched the old peak after GST reforms, personal income tax reforms, corporate tax reforms. Therefore the capacity of government becomes limited.

Oil bonds are an inefficient intervention as they only tend to postpone the problem. From 2002 onwards, India’s strategy for dealing with global crude price rise vulnerability has been myopic. The governments tend to develop short-term measures when there is a sharp rise. There is a need to develop long-term measures given the import dependency on crude is 85%.

Source: This post is created based on the article “Is the fuel pricing policy problematic?” Published on 1^st April 2022 in The Hindu.