Fuel price distortions

Diesel prices cannot remain out of line for too long

It is a shame that even a member of the Union Council of Ministers, Railways Minister Mamata Banerjee, has protested against the recent hike in petrol prices. Ms Banerjee is unfortunately engaged in a “race to the bottom” kind of political one-upmanship with the populist Left Front government in West Bengal that she hopes to defeat in this year’s assembly elections. But, for even the generally more responsible Bharatiya Janata Party to blame the government for the petrol price hike, when, in fact, the responsibility for petrol pricing has been placed firmly in the hands of oil marketing companies, is unpardonable populism. Indeed, it is precisely because petrol prices have been deregulated that the oil companies are able to increase them in response to rising global crude oil prices. Many other countries have also been forced to increase fuel prices at home in response to global trends. Hopefully, however, the government of Prime Minister Manmohan Singh will show greater resolve resisting opposition to the price hike than has been the case in neighbouring Pakistan where Prime Minister Yousaf Raza Gilani has wilted under similar opposition pressure and withdrawn the price hike announced last week.

If there is one criticism that can, in fact, be made of the government’s policy, it is a criticism that no political party is willing to make. This is that this weekend’s round of petrol price increase could have been avoided if the government had allowed the oil marketing companies to increase diesel prices, which the government still controls and refused to increase the last time petrol prices were hiked. Having failed to touch diesel prices for a second time, the government has allowed the price differential between petrol and diesel to further widen. It would appear that one important reason for the government allowing oil marketing companies to increase petrol prices while not allowing them to increase diesel prices has to do with the varying inflationary impact of the two options. A diesel price hike would have a greater impact on the general price level because of the nature of the product and its market. Higher diesel prices tend to get passed on to consumers by the transport and power sectors, which use this fuel as a raw material. Petrol is more of a final consumption good and the ability of petrol consumers to pass on higher petrol prices to others is limited. Moreover, petrol accounts for only 20 per cent of total fuel consumption in India whereas diesel accounts for over 50 per cent. Thus, a hike in diesel prices has a greater impact on wholesale prices than an equivalent hike in petrol prices.

While the inflation argument is a credible one to make, no country can afford to keep domestic inflation under the lid ignoring global trends in energy prices. Moreover, the fact that petrol consumption in India is still not getting tempered despite recent price hikes suggests that the Indian consumer is willing to bear the additional burden. India cannot afford to see a runaway increase in petrol consumption at a time when the trade and current account deficits are rising. If the emerging distortions in fuel consumption has to be corrected, the government will have to consider an increase in diesel, kerosene and LPG prices sooner or later.