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Why government's decision to keep diesel, petrol prices high is good economics but bad politics

Political rivals along with a section of economists are up to get goat of Finance Minister Arun Jaitley and Petroleum Minister Dharmendra Pradhan, blaming them for keeping the prices of petrol and diesel high to make up for the revenue deficit and 'looting' people at large.

twitter-logo Anilesh S Mahajan        Last Updated: September 15, 2017  | 18:55 IST
Why government's decision to keep diesel, petrol prices high is good economics but bad politics

Political rivals along with a section of economists are up to get goat of Finance Minister Arun Jaitley and Petroleum Minister Dharmendra Pradhan, blaming them for keeping the prices of petrol and diesel high to make up for the revenue deficit and 'looting' people at large. On the contrary, this is an unpopular decision, but full credit needs to be given to the NDA regime for sticking to this decision and believing in the economic benefits. It is good economics to keep the prices of petrol and diesel higher, especially when country is reforming the energy usage pattern and is dependent on the imports of oil to suffice demand.

But it is obviously bad politics, as it is creating unrest among urban voters, who are paying through their nose to buy these fuels. But is this good economics to keep oil prices high via taxes, in days of subdued crude oil prices globally. The answer is yes. Most of the economists, believe that it is much wiser to pay tax upfront than let inflation and other means squeeze this money from our pockets. Consumers of petrol and diesel are facing heavy taxation, but they also reaped the benefits when the prices were controlled. But this also defeats the argument of decontrol, where consumer gets benefit of low prices and pays hefty when prices are higher.
 
But there is a weight in high taxation, at least at a bigger picture. The biggest argument that backs Jaitley and Pradhan duo's decision of heavy taxation is, despite the artificially higher petrol and diesel prices the demand for these products is growing. Not exponentially as earlier, but growth is still healthy.

In FY 2016/17, India consumed 194.2 million tonne, roughly 5 per cent higher than FY 2015/16 numbers of 184.6 million tonne. But the growth from 2014/15 numbers was 11.5 per cent. Although India has substantial 230 million metric tonnes of refining capacity, yet requires importing 78 per cent of the raw material crude oil. Last year, India paid $70 billion (despite soft crude oil prices) to import crude oil. The jump in demand from world's third largest consumer of oil, would not only jack up the crude oil prices globally, but will also impact the currency rate. Indian rupee appreciated by more than 5 per cent in the last one year, would have gone for a toss. More purchase of crude oil obviously will impact the current account deficit, especially when the exports from India are down. This could have snowballed into higher inflation economy. In an era of slower growth, higher rate of inflation would have created more problems.

Along with this, heavier taxation is allowing government some extra money to push infrastructure spending. In this year's budget Jaitley promised spending of Rs 3,96,135 crore in upgrading and creating new infrastructure in the country. This includes roads, railways, ports, transmission facilities et al. Some of the money is been generated internally, but much of it is coming from the state's coffers.

From August 1, India has already moved towards daily correction of prices for both petrol and diesel. This practice is globally accepted practice. The US market is much more liberal, and allows the retailers to decide the price, unlike India where oil marketing companies decide price based on international prices of petroleum products.

On Friday, the price of a liter of petrol at any Indian Oil outlet was priced at Rs Rs 70.43. Out of this, the dealers pay Rs 30.41 (without taxes) to Indian Oil and keep Rs 3.57 as their margins. Out of rest Rs 36.43, Rs 14.97 go to Delhi government and rest Rs 21.48 goes to union government. Delhi again gets nearly Rs 11.59 out of collection of union government. This is true for all the states in the country.

Petroleum products, along with sales of alcohol, real estate and electricity are kept out of GST. These products make most for the state exchequer. For example: Delhi government pockets Rs 26.56 in sale of every liter of petrol. During the discussion on GST, many states shared their apprehensions of losing the revenues these items are brought into GST ambit. If the taxes come down, especially, when the state governments are finding it difficult to match the expenditures for the social development programmes, it would be nightmare for the centre to achieve structural changes in the Indian economy.

The second argument, which supports high taxation on petrol and diesel during the low crude oil prices is that it allows to control the demand for these products. India, along with other major economies is moving towards use of renewable energy and to replace petrol & diesel with electricity as transportation fuel. The soft oil prices are here to stay. Most of the global oil analysts feel, maximum oil could touch is $60 a barrel. In pockets, India has decent density of utilization of natural gas as transport fuel, but a better network of gas supplies would have made this phase much smoother. Recently, Pradhan argued that nearly a dozen countries have petrol and diesel prices higher than India. But what he didn't tell us, that why they have higher prices. Many of these countries are pushing their consumer towards cleaner fuels. India is still far from seeing this infrastructure. In comparison to more than 57,000 petrol or diesel outlets, there are only 1094 CNG outlets. Moreover, there are only 32.8 lakh consumers of piped gas, than 18 crore LPG consumers.

But since India is jumping this age, and is moving with renewable wave, there is a massive push to rooftop solar and solar parks to replace the peak load. It is inevitably replacing the diesel based generation units. This is coupled with the drop in prices of solar panels and stagnant (or higher prices) of diesel. As per CEA's estimates, country has 90 GW of such capacity. Back of the book calculations suggest that the DG units generate 5 units of electricity on consumption of one liter of diesel. This fuel is priced at Rs 59.08 in Gurugram, and a unit of electricity produced with it will cost Rs 11.82 and power from solar rooftop on an average will cost around Rs 5 a unit. Diesel there is taxed around Rs 26.29 (Haryana + Centre taxes). This advantage is also gauged in the country's biggest transporter Indian Railways.

The higher price of diesel and cheaper electricity makes the case for railways to increase the speed of electrification from 1000 KM annually to around 3500 KM, and it makes the efforts to outsource this to Power Grid and EESL more lucrative. India consume half of diesel for transportation, nearly all petrol consumption goes in cars and bikes. The benefit of renewable being more eco-friendly and more stable comes in bundle.

In this debate, both sides have solid arguments, hope at the end the country wins.

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