‘Nudge’ pricing

In what is an example of this year’s economics Nobel prize winner Richard Thaler’s nudge theory at work, some States have cut value added tax on petrol and diesel following the Centre’s reduction of excise duty on the two fuels by ₹2 a litre each. While announcing the cut last week, the Centre urged States to reduce their levies on the fuels. While Maharashtra, Gujarat and Himachal Pradesh — the last two poll-bound — were quick off the block in cutting VAT, Madhya Pradesh joined the bandwagon on Friday. More States are bound to cut rates as they feel the ‘nudge’ from these four. Bihar’s chief minister, Nitish Kumar, however, has chosen to “appeal” to the Centre to reduce the base price of petrol and diesel, pointing out that VAT on the two products in his State was among the lowest. Kumar’s argument shifts the focus to the pricing policy followed by the oil companies for the two fuels.

He has a point. The oil companies still follow policies dating back to the controlled pricing era which ended during the UPA II regime in the case of petrol and in the first year of the current government for diesel. According to this formula, retail prices are linked to imported landed cost and export parity price of the two fuels in the ratio 80:20. This is despite the fact that petrol and diesel are not imported but refined within the country. While the trade parity pricing may have been needed in the control era, in the free pricing regime that prevails now, the policy only results in offering undue protection to domestic refineries. The prices of petrol, diesel and indeed all fuels refined from crude oil should be linked to the cost of crude plus refining and transportation costs and margins. The anomaly of the current system will be evident from the fact that the basic price (excluding taxes) of fuel is the same across the country. Ideally, coastal States and those with refineries in their vicinity should be paying a lower price than those in the hinterland where transportation costs will be higher. It is time the Centre gets oil companies to review their pricing strategies and aligns them with the free market approach that ushered in daily changes in fuel prices.

Meanwhile, the momentum from the current debate on fuel prices should be used to reach an agreement on the inclusion of petrol, diesel and ATF under the GST umbrella. Some States have already made favourable noises and the least that the Centre could do is set off discussions in the GST Council. Inclusion of these fuels will help large sections of industry that are not able to avail of input tax credit on these products despite being big consumers. The oil companies will also stand to benefit and, hopefully, it will set off a reform of fuel pricing as a whole.

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