Respond, But Intelligently: The government must look at innovative ways to soften the fuel price hike

The recent hike in prices of diesel and petrol had been anticipated for weeks. By the time it happened, the public was, to some extent, conditioned to accept the decision. However, a single move such as this cannot remove the politics embedded in oil product prices. It is, thus, hardly surprising that the political parties of the Left and others have taken to the streets, protesting the move. The Centre has countered this by convincing some of the Congress-led governments, Maharashtra and Delhi, or allies in Andhra Pradesh and Tamil Nadu, to reduce state sales tax and soften the blow. Others are set to take similar steps, allowing the Centre to not roll back the increase it announced and yet show responsiveness to the consumers' interests. The average consumer would no doubt find the increase inconvenient, but the government had no choice, given that global oil prices have been hovering in excess of $70 per barrel in recent weeks.

To assess the recent step, it would be necessary to look at developments in recent years relating to deregulation and reform in the hydrocarbon sector. Prior to April 1998, prices were set under the Administered Pricing Mechanism (APM). This system was incapable of fostering innovation or providing incentives for efficiency improvements. It involved an elaborate system of cross-subsidies of product prices, which had inbuilt inefficiencies. Consequently, the Centre issued the 1997 notification for phased dismantling of the APM beginning 1998, culminating in total deregulation by 2002. Unfortunately, the subsequent governments tossed this plan by the wayside, and prices continued to be fixed by the cabinet.

But a key feature of the June 2006 decision is the intent to give oil companies the freedom to change prices of motor and kitchen fuels periodically if crude rises beyond a specified limit. The firms will be expected to review prices on a monthly basis, or on a quarterly basis. The problem of continuing with prices below global levels is that the burden of providing these subsidies would essentially be borne by the oil firms. In an era when the market for oil products is expanding, and the need for technological improvements even in the retail segment of the trade is becoming more important, continuing losses by the oil firms would limit their ability to bring about efficiency improvements and even maintain existing levels of service.

While no one can, with any reasonable certainty, predict the future of global prices, there are reasons to believe that the days of low oil prices are over, unlike the aftermath of the oil price shocks of 1973-74 and 1979-80, when there was substantial reserve capacity available with major oil producers, particularly Saudi Arabia. At present, the reserve capacity has all but vanished. The global demand for oil continues to grow, though at a somewhat lower rate than projected a year ago. The pressure on the oil market is, thus, likely to remain unabated, and current political developments involving Iran and Iraq and the situation in Nigeria add to the existing uncertainties. It would, therefore, be inappropriate for India to continue determining the price of petroleum products, a decision that should really be taken by the market.

The inevitability of higher oil prices is something the Indian consumer will have to accept, and this would hopefully lead to eliminating inefficiencies through the introduction of more fuel-efficient vehicles and greater investments in public transport. One reason why global oil prices crashed in 1985 was the worldwide effort to improve energy efficiency in response to the sudden price hikes of the first two oil price shocks. It is no surprise, therefore, that a Republican President in the US, Richard Nixon, actually imposed automobile standards as a regulatory measure on the automobile industry, with significant impact on the demand for gasoline.

The Indian government should accept the major challenge of helping poor consumers, but it should target subsidies in a focused manner to benefit only those below the poverty line. This can be achieved by identifying BPL households and providing them with smart cards allowing the purchase of pre-specified quantities of kerosene for the month. Subsidising kerosene only encourages large-scale adulteration of several products, with harmful consequences through diversion of resources, damage to automobile engines, higher pollution. Estimates of the extent of diversion of kerosene for adulteration are as high as 45 per cent. Further, since kerosene is meant for lighting purposes in rural households, the government can subsidise solar lanterns, which would provide pollution-free superior lighting in rural homes rather than kerosene lamps. All of this is possible, of course, if pricing of oil products can be rationalised, as indeed the government's recent step makes possible now.