Politics vs Economics: Why fuel price cuts should be reversed

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New Delhi | Updated: November 26, 2018 6:46:08 AM

Oil PSUs, at least, must not bear a Rs 1 per litre subsidy

While auto fuels must never be subsidised, one could have justified the cut since, at that time, crude was close to four-year highs at per barrel.

With Brent falling to $60.73 per barrel on Friday and the rupee retracing much of its losses, the price cuts on auto fuels must be reversed. On October 5, the government cut the excise duty on petrol and diesel by Rs 1.5 per litre to lower retail prices; in addition, oil PSUs were told to absorb another Rs 1. States were exhorted to match the Rs 2.5 cut, and several BJP states did this.

While auto fuels must never be subsidised, one could have justified the cut since, at that time, crude was close to four-year highs at $86 per barrel. But at current levels, neither the Centre nor the oil PSUs should be subsidising fuel costs. Some argue that the fall in crude oil prices has boosted oil-PSU margins and so they can absorb the Rs 1 per litre cut. However, since PSUs are accountable to shareholders, prices at the pump must reflect the market price of petrol and diesel. Once PSUs start absorbing costs, it distorts the market, making private sector retailers less competitive and, if they absorb the cost, they become less profitable. Either way, the impact on the market is large. A few decades back, LPG marketing was opened to the private sector, but with PSUs offering huge subsidies, private sector firms soon folded up. And when the Vajpayee government decided to free prices by dismantling the Administered Pricing Mechanism in 2003, private retailers like Reliance and Essar set up a network of petrol pumps. However, with the government going back to a subsidy regime, the private sector players had no option but to start mothballing their retail outlets.

An additional problem is that investors become wary of OMCs when the government starts forcing them to give subsidies; it may be Rs 1 right now, but there is always the possibility of this doubling or trebling as oil prices rise. As a result, valuations of oil PSU stocks are usually lower than those for their private sector counterparts. Given the government owns most of the PSU stock, it stands to lose the most when this happens. Reversing the price cuts will raise oil PSU valuations.

It is a slightly different story for state governments because they impose duties on auto fuels on an ad valorem basis unlike the Centre’s specific duties. As a result, the state revenues see a quantum jump when prices go up. For example, a rise in prices of petrol and diesel on September 3—by 12% and 15%, respectively, as compared to the levels on April 1—resulted in Maharashtra collecting Rs 5.49 crore more per day from sales tax . Such extra daily receipts for Tamil Nadu were Rs 3.69 crore while, for West Bengal, they were Rs 2.06 crore. Delhi raked in extra daily revenue of about Rs 1 crore. Rajasthan, Andhra Pradesh and West Bengal were among the first to trim VAT on auto fuels when Jaitley exhorted the states to follow the Centre’s lead; on September 9, Rajasthan lowered the VAT on petrol to 26% from 30% and on diesel from 22% to 18%. So, even if the states don’t reverse the duty cuts, there is a case for the Centre and, most certainly, the oil PSUs need to do this.

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