ANALYSIS: Will the govt solve the oil subsidy problem?

The finance minister has proposed a three-pronged strategy to deal with oil subsidies

The government finally seems to have a solution to the oil subsidy crisis. The finance minister in his speech in the parliament on May 8, 2012 proposed a three-pronged strategy to deal with the oil marketing companies that are severely affected due to rising crude oil prices in the international market and a weakening rupee.

The finance minister has proposed lowering of taxes by both, the state and central government as well as passing on part of the burden to consumers by way of fuel price increases.

What seems to have prompted such a solution is the colossal under-recoveries which have risen to Rs 1,39,000 crore. Under-recoveries in diesel stand at Rs 14.50 per litre, in kerosene at Rs 31.85 per litre, while cooking gas is at Rs 412 per cylinder.

The finance minister fears that if world economies improve, oil prices will shoot up to $150 per barrel at which point it will be very difficult to manage the subsidies as the country imports over 100 million tonne of crude oil.

His fears may not be unfounded since crude oil has taken a strong support around the $100 per barrel mark, despite the fact that nearly half of Europe is under recession, China is showing signs of a slowdown and the US economy is barely growing.

The proposal by the FM seems to be temporary in nature as it takes into consideration only the current under-recoveries levels. While deficit can come down temporarily, it can rebound as the move will result in higher inflation and lower tax to GDP ratio. There is no solution for a rise in crude oil prices. Even after the proposed measures are implemented, deficits will rise sharply in line with oil prices and falling rupee.

In an article title ‘The great fuel subsidy hoax’ in Business Line, CP Chandrasekhar and Jayati Ghosh have pointed out that tax collection from the oil sector is higher than the subsidies enjoyed by it. Nearly half the current price of fuel is on account of taxes. India’s petrol prices are 42 per cent higher than those in US and 26 per cent higher than in China.

These findings were based on data between 2006 and 2009. While tax collection was relatively stable at around Rs 1,45,000 crore, subsidy increased from Rs 52,000 crore to Rs 1,06,000 crore. Assuming that the tax collection is at the same level, excluding any growth, subsidies currently are at Rs 1,39,000 crore.

In other words, the tax collected from the petroleum sector is given back as subsidy. So why collect taxes?

This is probably the best time to remove taxes on fuels and subsidies at the same time. The government of Goa has already shown the way by removing state taxes on petrol. Consumers too will benefit as the removal of taxes will bring down the price substantially. The government can then peg its prices to global prices.

This biggest disadvantage of this move will be the political gains of raising and reducing fuel prices. But that’s another story.