Oil pricing constraints presage growth stagnation

R K Roy

It is unlikely that America’s mobilisation against terrorism will end in a quick, short operation in Afghanistan. Besides, the threat of reprisals looms large over West Asia. This means that oil prices will tend to be volatile. The September 12 fears of the price of crude crossing $31 per barrel have abated. However, the current price of $28 per barrel is on the high side (against $25 per barrel for imports in the first half of the year).

India prices oil products on the basis of a crude price of around $18. That means prices of kerosene, diesel and cooking gas need to be upped. The administered pricing mechanism (APM) is slated to make way for market- determined prices. But the kind of increase that will be required in select (subsidised) products—kerosene and diesel, for example,—may deter the government.

Two mitigating factors, however, need to be taken into account. One, the import duty on crude (valued in depreciated rupees) could be pared. Two, faced with competition (the country has excess refining capacity), the oil companies will have to reduce their fat marketing margins.

Even so, consumer prices of products will have to bear a stiff increase. Fear of unpopularity—elections in Uttar Pradesh are close at hand—may tempt the government to continue with the APM. The trouble is that procrastination (or marginal upward revisions in product prices) will burgeon the deficit in the oil pool account (already Rs 14,000 crore); the deficit is the amount the central government owes the oil companies.

Consider the policy dilemma. If oil prices are freed, the rising cost of fuel, a consumer essential, will pre-empt a larger proportion of the household budget; there will be less to spend on FMCG, for example. Demand compression will follow, an ominous prospect in the on-going domestic recession. (In the past, rise in oil prices have slowed non-oil domestic inflation).

This time round, hikes in oil product prices will take place in a milieu of rupee depreciation; that is, the rupee cost of imported inputs (as producers of FMCG have pointed out) will add to costs at the margin. Industries other than FMCG too face this predicament of cost escalation along with demand compression. Thus, the scenario is hardly one in which the industrial slowdown will abate.

But there seems to be no alternative to a hike in oil product prices. A top public finance analyst, M Govinda Rao, reckons that including the oil pool deficit, the fiscal (deficit) imbalance situation in 2001-02 will turn out to be worse than it was a decade ago (when reform was introduced)!

There are two issues here. The uncertainty about how dear crude will become (India imports 70 per cent of its requirement) makes it necessary to reform domestic oil product prices. Whether it will be politically feasible to reduce the oil pool deficit through price reform is, however, open to doubt.

Second, the fiscal deficit is so large that it cannot absorb the oil price deficit. The fiscal (largely revenue) deficit must be cut. This need has surfaced precisely when public investment (hitherto squeezed) requires to be stepped up (to make up for flagging private investment). Since the fisc has no room for manoeuvre, public investment will take a back seat.

Thus, the stagnation of India’s growth is on the cards.