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“automotive fuel pump reading at 242 pesos” by Gab Pili on Unsplash

Indian Politics and the Economics of Petroleum Product Pricing

In the summer of 1998, India conducted its second nuclear test, nationalist sentiments were running high all over the country. BJP led government at the center was hailed for the bold step, it was natural to assume that the party’s popularity was at all-time high. However, within 6 months from the day “Buddha smiled”, they lost the crucial Delhi state elections. The reason for the loss was primarily attributed to the rising prices of essential commodities, specifically the price of onion. In the largest democracy of the world, with median annual household income of USD 3168 and the median per capita income of USD 616, the prices of essential commodities is a very sensitive political and policy matter, it poses an exceptional challenge in terms of achieving equilibrium between good economics and good politics.

With 2019 being the election year, the ruling political party can’t afford to garner negative media coverage on the issue of price rise. The print and TV media, catering to the common citizens, confines the analysis and discussion on how taxes are contributing to the petrol and diesel prices. The TRP race doesn’t incentivize them to decipher the complex economics of petroleum pricing and its long-term impact on the country’s economy. Eventually, it builds a strong narrative against the government. However, instead of getting sucked into the cacophony, the responsible and educated citizens must try to understand the rationale behind government’s decision before supporting or opposing the policy stand. For the purpose of simplicity, I would limit my argument to the following three factors while unambiguously supporting the central government’s stand on oil pricing:

  1. Good economics, though not so good politics: One may have many complaints against the current central government, but there is a broad consensus about the good job done in managing the Fiscal Deficit. To continue on the path of fiscal prudence, reducing taxes on petrol and diesel is not a viable option, specially when GST implementation is far from stabilized. Tax cut will be a tempting political proposition, considering the upcoming elections, but it will have adverse cascading effect in long term e.g. higher fiscal deficit would lead to more borrowing from the government which would ultimately result into higher interest rate. Further, effect of the high crude oil price has already started showing up in the increasing current account deficit (CAD) numbers. Any populist reduction in oil prices, by reducing taxes, would indirectly contribute to higher consumption of petrol and diesel and thereby it would further widen the CAD. Given that the government has virtually no control over the crude prices, high petrol and diesel prices acts as an indirect lever to control the consumption.
  2. Paying for the wrong policies of the previous government: Past constraints the future. The current government has inherited 1 lakh 30 thousand crores of oil bond, in form of unpaid bills of oil companies from 2009–2014. In simple terms, the burden of the price of oil consumed has been passed on to the future generations. In such a situation there is limited room for the current government to reduce taxes. Ultimately we need to pay for what we consumed.
  3. Things will stabilize: There are many factors contributing to the high crude price viz. geopolitical risks, OPEC production drop, Iran factor etc. As per May’18 “Short-term Energy Outlook” provided by the USA Energy Information Administration, the crude oil prices will average USD 63 per barrel in 2018 and 2019. If this forecast holds good, the situation is likely to be well under control. Knee jerk reaction should be avoided, the best approach would be to watch and be nimble in adjusting the course.

So far, the political leadership has shown courage to carry on the reformist agenda by avoiding the easy populist route. But, at the same time they must recognize that patience is running out for the common citizens on the road. The impact of increasing crude oil price has started showing up in the inflation numbers, which is inching towards 5%. After 4 years, RBI had to increase the repo rate twice in 2018, it would mean higher EMI for the borrowers, which is again a negative from politics and economy point of view.

Broadly, not much can be done to reduce the oil price, though some level of structural reform in taxation of petroleum products is inevitable, it remains to be seen is how the balance between good economics and good politics will be maintained while doing so. One line of though is to bring petrol and diesel under GST, but it would translate into major revenue loss for the center as well as for the states. It would result in 35% drop in petrol prices and 22% drop in diesel prices, with potential to propel oil consumption; eventually a net negative for the economy and environment. It can be safely assumed that this proposition is not even on the table of GST council.

With state elections due towards the end of 2018, and the opposition ready to up the ante, petrol and diesel pricing policy will be a major challenge for the policy makers. It will be an interesting space to watch out for the policy analysts and political observers. Any major policy shift is unlikely, the game will be played in political arena.

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Public Policy, Politics, Education, Science and Technology

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