Lifting diesel subsidy: good idea, terrible timing

With car sales skidding lately, in July it fell 10 percent, sacking the diesel subsidy is going to hurt the auto sector even more.

FP Editors August 05, 2011 09:28:04 IST
Lifting diesel subsidy: good idea, terrible timing

There's little doubt that the idea of removing the subsidy on diesel used for passenger cars is a good one, but the timing may be a little off right now.

Car sales have been skidding lately - in July, sales plunged 10 percent from a year ago, the worst performance in about two-and-a-half years.

Increasing interest rates are not going to make things any easier.

That's why car makers have given a muted reception to the idea of lifting the diesel subsidy. General Motors India president Karl Slym told The Economic Times that while the company was supportive of market-driven diesel prices, it was worried about the impact on passenger car sales. "Already the sales of car and passenger vehicles are sluggish in the domestic market and any change in policy will further impact it," he added.

Lifting diesel subsidy good idea terrible timing

Because the fuel is used by some economically sensitive segments, diesel prices have continued to be subsidised even after price controls on petrol were lifted in June 2010.Danish Siddiqui/Reuters

Diesel cars account for 35 percent of all passenger vehicles sold in India. Sales of this segment have climbed recently on the back of the difference between diesel and petrol prices.In a city like Mumbai, diesel is cheaper than petrol by about Rs 23. It's a similar story in other cities. Petrol prices are higher because they are not subsidised, and linked directly to international oil prices.

Ever since price controls on this fuel were lifted in June 2010, prices have soared by more than 30 percent, leading to a surge in demand for diesel passenger cars.

Passenger cars account for 15 percent of diesel consumption in India, making this segment the second-largest consumer of the fuel. Trucks are the largest consumer, accounting for 37 percent. Industry accounts for another 10 percent; buses, another 12 percent; and the Railways, about six percent.

Because the fuel is used by some economically sensitive segments, diesel prices have continued to be subsidised even after price controls on petrol were lifted in June 2010.

The government provides a subsidy of Rs 6.08 per litre for diesel, which contributes to a fuel subsidy bill of Rs 1,22,000 crore for the year ending March 2012. Diesel accounts for 40 percent of the government's subsidy bill.

Watch video: Finance Minister Pranab Mukherjee is planning to do away with diesel subsidy for passenger cars.

For the government, lifting the subsidy on passenger cars is a step in the right direction in easing the payment burden, especially at a time when the economy is slowing down and there are some doubts about full-year tax revenues.

Besides, diesel passenger car owners don't really need the subsidy - they can afford to pay the full price. Diesel cars, which start from Rs 3.5 lakh and include high-end, large sports utility vehicles, are more expensive than petrol cars, so any buyer who opts to buy a diesel car can certainly afford to pay for subsidy-free fuel.

Nevertheless, for the economy, making diesel prices more market-driven will have an unwelcome effect: higher inflation.

High food and fuel prices have been plaguing the economy for a while - the benchmark wholesale-price index (WPI) climbed by 9.44 percent in June from a year earlier and has remained above 9 percent for seven straight months.

Higher diesel prices will only make it more difficult for an under-attack government to lower prices to more reasonable levels.

According to one estimate, an increase of two rupees in diesel prices lead to a 30 basis point direct rise in the WPI, and another 30 basis points by an indirect effect.

That's not the only issue. Some finance ministry officials have expressed concerns about the implementation of a system under which passenger car owners pay market-driven prices, while other users pay government-controlled prices.

"It is desirable but not doable," said an official.

The system could create a parallel economy. "If a dual pricing structure is in place, people would come in tractors, fill up drums with diesel and then sell it to car owners at a premium, but below the market price for passenger cars," said an official.

However, that might not deter the government from implementing a much-required reform in the fuel market to fix what is seen as an unnecessary price distortion. Politically, it will not be a problem either, because the suggestion was, in fact, made by the Opposition.

That means car makersmight just have to get used to the idea, no matter how unhappy they feel.

As a recent Business Today article noted: "..an absurd subsidy on diesel is skewing the Indian car market and creating a scenario where the government robs Peter, the owner of a petrol-driven 100 cc motorcycle, to pay Paul, who drives a massive SUV. Look at it any way you want, but it is just not fair."

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