With crude at $70, time to start taking action.
It wasn’t just the fall in oil prices, significant as they were, that helped reduce the government’s oil subsidy burden over the years. When oil was at $108 per barrel in FY14, under-recoveries were R1,40,000 crore, so when oil prices fell around 19% in FY15, subsidies should have fallen by that amount—instead, at R76,000 crore, they fell 46%. And while oil prices were projected at $65 in FY16—a 26% fall—subsidies are projected to fall 55%. The reason behind the dramatically higher fall in under-recoveries is the UPA’s policy on diesel subsidies—diesel has traditionally been the highest item of under-recoveries and accounted for 57% of the total in FY13. Instead of cutting the diesel subsidy by a big amount—it was R9.6 per litre in January 2013—the UPA decided to raise prices by 45-50 paise per month; by May that year, it almost looked as if the battle had been won since diesel under-recoveries were down to just R3.8 per litre. That didn’t happen since crude prices rose, but it was this policy—continued by the NDA when it came to power—that allowed diesel prices to be freed up last year in December.
While it is foolhardy to predict where oil prices are headed, with them rising 41% from the January 2015 lows of $49, it is important for the government to keep in mind the possible impact and act upon this. At R35,000 crore, the likely FY16 subsidies on LPG and kerosene don’t look that high. But just imagine what they would have been had the UPA not started its process of cutting diesel subsidies. And even these subsidies are very sensitive to the prices of both the rupee as well as oil. According to the government, every $1 hike in crude oil prices raises the subsidy by R1,100 crore —on a full year basis, that means the $20 hike in crude oil prices since January has raised subsidy costs by R22,000 crore. The fall in the value of the rupee also raises the under-recovery. If oil prices continue to rise the way they have in recent months, or if the rupee continues to depreciate, the under-recovery bill could shoot up so fast the government will not know what to do about it. It would be a good idea if the government took a leaf out of the UPA’s book and started raising LPG/kerosene prices by a small amount every month.