Financial Daily from THE HINDU group of publications
Wednesday, Aug 25, 2004
Insulating economy against surging oil prices Timely duty cuts, targeted subsidies called for
C. J. Punnathara
But this is just a temporary solution expected to provide but a respite to the soaring prices. This recurring problem needs a more fundamental and long-term solution. And the answer lies in the Customs duties levied on crude imports.
Going by recent trends, the Government was expected to mop up as much as Rs 12,500 crore from Customs imposts on petroleum, oil and lubricant imports this year substantially higher than the Rs 8,500 crore it would have mobilised last year.
A neat tool to hold the fiscal deficit in check, without effecting a steep and politically sensitive slash on subsidies. But was this bloating revenue surge from Customs duties on crude and petroleum products at the cost of the common consumer warranted?
The government would not be the loser, even when it cuts Customs imposts on crude. In fact, the government will neither be a loser nor a gainer just a good referee, doing the right thing at the right moment. Last year, the total imports of petroleum, oil and lubricants into the country totalled Rs 85,000 crore.
With hardly any import of petrol or diesel, the bulk of these imports would have been crude. At 10 per cent Customs duty, the receipts to the government would have been around Rs 8,500 crore.
If the figures for April-July 2004 are anything to go by, the value of petroleum imports this year could go up by an average 50 per cent, thanks to an unprecedented price spiral from $26 per barrel of 2002 to $44 per barrel, as of August 2004.
The prices have soared to their current level both through cost-push and demand-pull factors. And with the hardening prices refusing to ease, it would not be far off the mark to estimate Customs revenue of Rs 12,500 crore from petroleum imports for the current year.
But that is only one side of the picture. It is an irony that the government has been reaping windfalls from two ends of the oil spectrum: Surge in oil prices and an equally sharp rise in the volume of imports. Petroleum imports have almost doubled, from 48 million tonnes in 1995-96 to 90 million tonnes in 2002-03. After the demise of the administered pricing regime and oil pool account, even the subsidy burden was passed on to the public sector oil marketing companies.
Through a system of cross subsidies, the marketing companies were charging higher rates for petrol, while subsidising the prices of LPG and kerosene. So the government hardly had to bear the subsidy burden. And the public sector marketing companies were doing the good deed until recently, when international crude prices spun out of control.
As for the government, all it had to do was to keep the oil taps open and the cash flow just continued to tick. But that does not mean the government was not concerned about the common consumer. It was just more concerned about keeping its economic account books in balance and ensuring that the Budget deficit remained under control.
But as the international oil prices continued to harden without respite, the public sector marketing companies were forced to increase petroleum product prices beyond the critical levels.
The flow into the government coffers still continued, but the inflationary spiral went out of control, mainly triggered by the inherent cascading impact of petroleum prices over every other facet of the economy. This has forced the government to sit up and take notice.
It now has to weigh its options between the chances of a dwindling revenue flow and bloating fiscal deficit, on the one hand, and checking the inflationary spiral, on the other. But these are not mutually exclusive facets of the economy. Both are complementary in nature and often trigger each other.
Surging inflation means hardening interest rates, rising cost of production and reducing export competitiveness in an increasingly globalised market, which eventually raises the spectre of a Budget deficit. The reverse is equally true. A rising deficit often means greater borrowing by the government, strengthening interest rates, rise in cost of production and a resultant inflationary spiral.
The Government is taking the judicious step of intervening at the right stage and should shackle the price surge by cutting the Customs and other duties. But is that all the government can do to protect the interests of the consumer and retain the interest of the economy?
To prevent such eventualities from recurring, the Government should also bring a system into position, which recognises when the international prices spiral out of control, triggering a breach in domestic prices beyond critical levels and call for an automatic re-think to cut duties and keep the prices and inflation under check.
And the process should be directly linked to the Customs duty on crude imposts as well. Say, reduction in Customs duty when the international price breach $40 level and further reduction when it breaches $45 level per barrel.
Despite this reduction, the government would earn substantially more than in earlier years. This is all the more essential because such international price surges are not likely to remain uncommon in future.
That is not to say that the Government should sacrifice the proceeds from the international price surges unilaterally. The burden should be shouldered by all the stakeholders the Government, the refineries, the petroleum marketing companies and the consumer.
Under the conventional neo-classical economic doctrines, the price was seen as the principal moderator to reduce or enhance consumption levels. When prices go up, consumption comes down; and when prices come down, consumption goes up.
This basic doctrine has not been fully enforced into the petroleum sector. That is not to say that when the price of crude virtually doubled in the last three years, the prices of LPG and kerosene should also have risen correspondingly. More realistic pricing could have reduced consumption and removed wasteful use of scarce resources.
If this is done, the government would not be subsidising items such as kerosene to fuel office gensets and shops in fancy malls. And the penetration level of LPG is still quite skewed in favour of the metros and urban centres.
And here, again, the principal consumers are those in the middle-class. The question here is not of taxing them exorbitantly, but more realistically so that price-led reduction in consumption could become a reality.
Last year proved that price was not much of a leveraging factor in consumption. The value of petroleum imports last year went up close to 30 per cent, mainly on account of the price spiral. This did not seem to have much of an impact on the volume of imports; in fact, it showed a marginal rise.
Cross-subsidies have cushioned the price impact on LPG and kerosene and their consumption could have grown. Like the targeted Public Distribution System, it might be time the government contemplated better targeting of its petroleum subsidies.
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