Petrol bomb is a dud: If only Dr Singh had listened...

In 1991, Manmohan Singh talked about the power of an idea whose time has come. But is raising petrol prices steeply one such idea?

Vivek Kaul May 24, 2012 11:23:35 IST
Petrol bomb is a dud: If only Dr Singh had listened...

The Congress-led United Progressive Alliance (UPA) government finally acted hoping to halt the fall of the rupee by raising petrol prices by Rs 6.28 per litre, before taxes. The actual increase is closer to Rs 7.50-Rs 8 in various cities. Let us try and understand what the implications of this move will be.

Is this a bold move that will finally redeem the reform credentials of the UPA and Manmohan Singh? Given the strong political reaction to it, it seems like Singh's government has finally bitten the bullet. But has it? Consider the actual impact.

Some relief for oil companies: Oil marketing companies (OMCs) like Indian Oil Corporation (IOC), Bharat Petroleum (BP) and Hindustan Petroleum(HP) had been selling petrol at a loss since the last hike in December. That loss will probably now be eliminated with this increase in prices. The oil companies have lost $830 million on selling petrol below cost in the last six months. The companies had lost around Rs 4,860 crore in the financial year 2011-2012. If the increase in price stays and is not withdrawn, the oil companies will not face any further losses on selling petrol, unless the price of oil goes up and the increase is not passed on to the consumers.

No impact on fiscal deficit: The government compensates the OMCs for selling diesel, LPG gas and kerosene at a loss. Petrol losses are not reimbursed by the government. Hence the move will have no impact on the projected fiscal deficit of Rs 5,13,590 crore. The losses on selling diesel, LPG and kerosene below cost are much higher at Rs 512 crore a day. For this the companies are compensated by the government. The companies had lost Rs 1,38,541 crore during the last financial year. Of this, the government had borne around Rs 83,000 crore and the remaining Rs 55,000 crore came from government-owned oil and gas producing companies like ONGC, Oil India Ltd and GAIL.

When the finance minister Pranab Mukherjee presented the budget in March, oil subsidies for 2011-2012 had been projected at Rs 68,481 crore. The final bill has turned out to be Rs 83,000 crore, and this after the oil producing companies owned by the government were forced to pick up around 40 percent of the bill.

Petrol bomb is a dud If only Dr Singh had listened

Is this a bold move that will finally redeem the reform credentials of the UPA and Manmohan Singh? AP

For the current year the expected losses of oil companies on selling kerosene, LPG and diesel below cost is expected to be around Rs 190,000 crore. In the budget, the oil subsidy for 2012-2013 has been assumed to be Rs 43,580 crore. If the government picks up 60 percent of this bill, like it did in the last financial year, it works out to around Rs 1,14,000 crore. This is around Rs 70,000 crore more than the oil subsidy that the government has budgeted for. The only caveat is global oil prices. If they fall significantly, the subsidy bill would be lower.

Interest rates will continue to remain high: The difference between what the government earns and what it spends is referred to as the fiscal deficit. The government finances this difference by borrowing. The fiscal deficit for 2012-2013 is expected to be Rs 5,13,590 crore. This, when we assume Rs 43,580 crore as oil subsidy. But the way things currently are, the government might end up paying Rs 70,000 crore more for oil subsidy, unless oil prices crash. The amount of Rs 70,000 crore will have to be borrowed from financial markets. This extra borrowing will "crowd-out" the private borrowers in the market even further, leading to higher interest rates.

At the retail level, this means two things. One, your loan EMIs will stay high or even go up. And two, with interest rates being high, investors will prefer to invest in safe instruments like fixed deposits, corporate bonds and fixed maturity plans from mutual funds. This, in other terms, will mean that the money will stay away from the stock market.

The trade deficit: One dollar is worth around Rs 56 now, the reason being that India imports more than it exports. When the difference between exports and imports is negative, the situation is referred to as a trade deficit. This trade deficit is largely on two accounts. We import 80 percent of our oil requirements and, at the same time, we have a great fascination for gold. During the last financial year India imported $150 billion worth of oil and $60 billion worth of gold. This meant that India ran up a huge trade deficit of $185 billion during the course of the last financial year. The trend has continued in this financial year. The imports for April 2012 were at $37.9 billion, nearly 54.7 percent more than the exports which stood at $24.5 billion.

These imports have to be paid for in dollars. When payments are to be made, importers buy dollars and sell rupees. When this happens, the foreign exchange market has an excess supply of rupees and a shortfall of dollars. This leads to the rupee losing value against the dollar. In case our exports matched our imports, then exporters who brought in dollars would be converting them to rupees, and thus there would be a balance in the market.

What has also not helped is the fact that foreign institutional investors (FIIs) have been selling stocks as well as bonds in the market. Since 1 April, the FIIs have sold around $ 758 million worth of stocks and bonds. When the FIIs repatriate this money they sell rupees and buy dollars, putting further pressure on the rupee. The impact of this is marginal because $758 million over a period of more than 50 days is not a huge amount.

When it comes to foreign investors, a falling rupee feeds on itself. Let us try and understand this through an example. When the dollar was worth Rs 50, a foreign investor wanting to repatriate Rs 50 crore would have got $10 million. If he wants to repatriate the same amount now he would get only $8.33 million. So the fear of the rupee falling further gets foreign investors to sell out, which in turn pushes the rupee down even further.

What could have helped is dollars coming into India through the foreign direct investment route, where multinational companies bring money into India to establish businesses here. But for that the government will have to open up sectors like retail, print media and insurance (from the current 26 percent cap) more. That hasn't happened and the way the government is operating currently, it is unlikely to happen.

The Reserve Bank of India does intervene at times to stem the fall of the rupee. This it does by selling dollars and buying rupee to ensure that there is adequate supply of dollars in the market and the excess supply of rupee is sucked out. But the RBI does not have an unlimited supply of dollars and hence cannot keep intervening indefinitely.

What about the trade deficit? The trade deficit might come down a little if the increase in the price of petrol leads to people consuming less petrol. This in turn would mean lesser import of oil and hence a slightly lower trade deficit and lower pressure on the rupee. But the fact of the matter is that even if the consumption of petrol comes down, its overall impact on the import of oil would not be that much. For the trade deficit to come down the government has to increase prices of kerosene, LPG and diesel. That would have a major impact on oil imports and thus would push down the demand for the dollar.

It would also mean a lower fiscal deficit, which in turn will lead to lower interest rates. Lower interest rates might lead to businesses looking to expand and people borrowing and spending that money, leading to a better economic growth rate. It might also motivate multinational companies (MNCs) to increase their investments in India, bringing in more dollars and thus lightening the pressure on the rupee. In the short run, an increase in the prices of diesel particularly will lead to higher inflation because transportation costs will increase.

Freeing the price: The government had last increased the price of petrol in December 2011. For nearly six months it did not do anything and now has gone ahead and increased the price by a hefty 10 percent. It need not be said that such a stupendous increase at one go makes it very difficult for consumers to handle. In a normal market (like it is with vegetables, where prices change everyday), the price of oil would have risen gradually from December to May and consumers would have adjusted their consumption of petrol at the same pace. By raising the price suddenly the last person on the mind of the government is the aam aadmi, a term which the UPAwallahs do not stop using time and again.

The other option, of course, is to continue to subsidise diesel, LPG and kerosene. As a known stock bull said on a television show a couple of months back, even Saudi Arabia doesn't sell kerosene at the price at which we do. And that is why a lot of kerosene gets smuggled into neighbouring countries and is used to adulterate diesel and petrol.

If the subsidies continue, it is likely that the consumption of various oil products will not fall. And that in turn would mean oil imports would remain at their current level, and the trade deficit will continue to remain high. The economy will stagnate.

Manmohan Singh as the finance minister started India's reform process. On 24 July 1991, he backed his "then" revolutionary proposals of opening up India's economy by paraphrasing Victor Hugo: "No power on Earth can stop an idea whose time has come."

Good economics is also good politics. That is an idea whose time has come. Now only if Mr Singh were listening to his own words. Or should we say be allowed to listen..

Vivek Kaul is a writer and can be reached at vivek.kaul@gmail.com

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