Cracking the oil subsidy puzzle

A Kotak Securities report finds some innovative solutions to solve the oil subsidy problem

News reports say that the government is considering increasing prices of diesel, kerosene and LPG (liquefied petroleum gas) immediately after the monsoon session of the Parliament. Both finance and oil ministries are lobbying for a Rs 3-5 per litre hike in diesel prices and substantial hikes in the other two fuels. There’s a shortfall of almost Rs 50,000 crore that will be needed if diesel prices are not hiked now, to plug the deficit at 6% for the current year.

There is little doubt that there will be a public and political outcry followed by demands of rolling back the hike. But the ground reality is that unless the deficit is roped in, the country may face chances of a rating downgrade, which will deteriorate the condition further.

 

There is a way, however, that the government can adopt to rope in the deficit. Kotak Securities’ analysts Sanjeev Prasad, Taurun Lakhotia and Vinay Kumar have pointed out some innovative solutions to solve the oil subsidy problem in a report on the energy deficit scenario.

The report says that the government can align retail prices to market levels and give sufficient compensation to consumers by giving higher income tax exemption for general consumers to offset the impact of inflation and higher minimum support prices to farmers. Nearly 20% of diesel consumers, automobile owners and industrial users do not deserve a subsidy says the report.

As for LPG, the much talked about proposal of capping consumption to six cylinders per household and charging full prices for the remaining will result in savings to the tune of Rs 10,800 crore.

In case of kerosene, the pilot project of direct cash transfer to consumers in Alwar is cited as a role-model for the sector. Since the implementation of the project Alwar, consumption has fallen by a mind-boggling 88%, indicating the level of pilferage in kerosene. 

Raising prices, especially of diesel, will naturally impact inflation. The report says that price rise will mainly be on account of higher cost of transportation; however, it is likely to be only marginal. For a household with an annual spending of Rs 1 lakh, the impact will be around Rs 1,000 a year for every 1% rise.

Given diesel’s weight of 4.69% in the wholesale price inflation index and a 40-50% increase in diesel prices, the direct impact on inflation will be two% while the indirect impact will be 1%.