The across-the-board increase in all state-controlled oil prices and a promise to largely withdraw the governments role from the sector, are expected to pose a tough political challenge to Prime Minister Manmohan Singhs Cabinet. The announcement immediately pushed up stock prices of oil retailers, especially the public sector ones. The BSE Oil & Gas Index advanced 2.88 % to close at 10,604.07, while the benchmark 30-share Sensex fell 0.88%.
The decontrol of petrol price at both the refinery level and at the retail level also paves the way for private players like Reliance Industries and Essar Oil to return to fuel retailing. Thanks to subsidies available only for government-controlled oil marketers, private players so far did not have a level playing field to compete with state-owned companies on the retail front.
However, the move drew predictable opposition from Trinamool Congress chief Mamata Banerjee who abstained from Fridays meeting of the empowered group of ministers which made the critical decision. Due to political sensitivities, kerosene prices have not been revised since April 2002, artificially making it the cheapest among all neighbouring countries.
This has created a huge black market for the product, with pilferage of about 35%, finds a study by National Council for Applied Economic Research.
The changes will be the biggest shake-up in the oil subsidy bill run by the government on its budget and partially offset by public sector oil marketing companies which pick up the tab. Despite the increase, the companies would still lose Rs 53,000 crore, petroleum secretary S Sundareshan told reporters. He said a new burden-sharing formula among the government, upstream oil producers and retailers would now be worked out to deal with the actual under-recoveries of this fiscal.
Petroleum minister Murli Deora said the governments options were getting limited. The under-recoveries of over Rs one lakh crore last year were unsustainable and affected the budget available for governments other welfare projects. Finance minister Pranab Mukherjee is attempting to limit fiscal deficit to 5.5% of GDP, while increasing government expenditure on social sector by at least 5% in 2010-11.
The decisions approved by the ministerial panel headed by Mukherjee include pricing freedom for state-owned retailers on petrol, paving the way for an immediate price increase of Rs 3.50 a litre and subsequent changes in price depending on global crude oil price movements. The price of diesel goes up by Rs 2 a litre, kerosene by Rs 3 a litre and LPG used as cooking gas by most of middle class India by Rs 35 a litre. Some of the changes were recommended by the Kirit Parikh committee which submitted its report to the government this year.
Former Planning Commission member Kirit Parikh, whose report on sustainable pricing of fuel forms the basis for the governments decision, said it was a step in the right direction. He said diesel consumption is five times that of petrol and therefore, it is important for diesel to reflect the international price more than petrol.
Sundareshan said the group of ministers also decided that the price of diesel should be eventually market-driven, but for the present, only Rs 2 should be increased per litre. At the current price of diesel, retailers lose about Rs 23,000 crore. However, to reduce the full impact, the EGoM decided that at present, the price need to be raised by only Rs 2, he said.
Finance ministry officials and economists said the decision would have an immediate impact on wholesale price-based inflation which touched 10.16% in May as per provisional figures. Crisil director DK Joshi said that WPI-based inflation could go up by 100 basis points because of the fuel price increase.
Kaushik Basu, chief economic advisor in the finance ministry, conceded the changes coupled with the price increase for LPG and kerosene will have an immediate impact on inflation. I expect an increase of 0.9 percentage points in monthly WPI inflation. But he was hopeful the changes will cause the fiscal and revenue deficits to decline and exert a downward pressure on prices.
The government had allocated only a marginal subsidy of Rs 3,108 crore in the 2010-11 budget for LPG and kerosene, assuming oil prices may come down or extra subsidy could be provided in the supplementary demands for grants. (Upstream companies ONGC, OIL and Gail India foot the bill for selling petrol and diesel at government-fixed prices.) Crude oil price at $60-70 is comfortable for state-owned oil companies and beyond $75 is unmanageable. Crude oil is ruling at around $77-78 a barrel in global markets. The decision eases financial strain for the government and upstream oil companies like ONGC, OIL and Gail India. While the government subsidises kerosene and LPG, upstream oil companies bear the losses on account of selling petrol and diesel below cost. ONGC CMD RS Sharma told FE that upstream companies would indirectly benefit from the decision, while downstream retailers like IOC, BPCL and HPCL would benefit more directly.
Last fiscal, fuel retailers had to absorb a loss of over Rs 5,000 crore after the government gave a financial assistance of Rs 26,000 crore and upstream oil PSUs contributed Rs.14,430 crore.