Request you to kindly drop in all your mails/queries to support@infraline.com or call us at
+91-120-6799125 (D); +91-120-6799100 (B)

An SIP approach for Reducing Petroleum Subsidy, Shri V S Laghate, Vice President (Strategic Planning), Deepak Fertilisers and Petrochemicals Corporation Limited

The Finance Minister, Shri Pranab Mukherjee, has recently acknowledged that the Fiscal Deficit target of 4.6% of GDP is not likely to be met this year. This is much above Government’s own target of 3% that was to be achieved by 2008 under the Fiscal Responsibility and Budget Management Act.

An important contributor to the fiscal deficit is the burgeoning burden of subsidy on petroleum products. In the first nine months of this financial year 2011-12, the under recoveries for national Oil Marketing Companies were Rs 97,313 crores, on account of diesel, PDS kerosene and LPG, as per a press note from the Ministry of Petroleum & Natural Gas dated 01 Feb 2012. On annualised basis, this is about Rs 1.3 lakh crores, or just around 1.5% of the national GDP, which is about Rs 90 lakh crores at current market prices. Had this subsidy not been there, the Fiscal Deficit would have been much closer to the target level mentioned above.

It is clearly in the national interest to find a solution, preferably by tackling the problem of petroleum subsidies at the root.

The harsh reality is that the Government of India, like almost all other Governments in the world, does not have any control on the international price of crude oil, which is the principal determinant of the price of the petroleum products. Global lifestyles are now so dependent on energy that the demand for crude oil will continue its inexorable climb. The manifold increase in crude prices in past ten years from $25 in 2001 to $109/barrel in 2011 should have drastically reduced consumption, but instead global demand increased in this period from 77 to 88 million barrels/day. The price increase did encourage tremendous investment in exploration and production, but total world Reserves have remained stagnant at the level of about 45 times annual world consumption for the past fifteen years. Thus there is no room for hope that supply will exceed demand in future, and reduce prices. The International Energy Agency has pithily concluded that both the demand and supply of crude oil are no longer price elastic.

As all forecasts show that the price of crude oil will keep on increasing, the problem of under recoveries will only increase as time progresses. It will not go away. Under these unforgiving conditions, the only tenable long term solution is to allow the prices of petroleum products to be closely aligned with crude prices. After all, the Government of India cannot afford to pay a permanent and ever increasing subsidy on items that represent a large portion of its expenditure.

The present policy response is that prices are increased in ad hoc manner - in terms of both quantum and timing. As these increases are small as compared to the requirements, the affected organisations have to be bailed out by diverting large sums of money, which could otherwise be used for developmental activities. Clearly there is a crying need to correct this unhealthy situation that is incorrigibly undermining the economy.

A solution is proposed here, which will hopefully be found acceptable to all concerned.

In the field of personal investment, the concept of Systematic Investment Plans are well known. Can this concept be adapted for dealing with the mounting subsidy problem?

The SIP method encourages small regular investments in order to accumulate a large sum. In the same way, the government could consider making small regular increases in the prices of diesel and other subsidised items such as LPG, kerosene, etc, so that over a period of a few months the backlog is covered.

At present, the under recovery in diesel is about Rs 11.35 per litre, as per MoPNG’s Petroleum Planning & Analysis Cell report of 01 Feb 2012. If a price increase of Rs 0.95 per litre is applied every month for 12 months, then the entire under recovery will be covered. As the present price of diesel is about Rs 45 per litre, the percentage increase every month will be about 2%.

There are many advantages of this method.

  • Since each increase will come in small amounts, public reaction is likely to be muted.

  • The impact on the price index will be small every month, making it easier to manage.

  • When prices are compared to the previous month, then the inflation effect will keep reducing as the base will have risen.

  • As all will be aware of the impending increase every month, it will be easier for households, organisations, institutions, and commercial establishments, to plan their expenses and adjust to the revised prices.

Hopefully, politicians will find it acceptable, since the much required medicine is being administered in small doses that the economy will have minimum difficulty in absorbing successfully.

In the case of an investment SIP, experts advise that the investment should be continued irrespective of whether the stock market rises or falls. In the same way, a Systematic Price Rationalisation Plan should be implemented every month regardless of external factors. In other words, it is important to build in safeguards to prevent the scheme from getting derailed by any of the multitude of factors that affect government decision making processes.

Thus, a critical aspect is that the timing of the next increase is fixed in advance and should not be open to change. This is exactly in line with an SIP where the investor gives standing instructions to the banker to remit a fixed amount of his money on the due date; the investor does not have the luxury of changing his mind! In the same way, there should not be an option to the government to modify either the date or quantum of the price increase mandated in advance.

The model can be adjusted in a few ways:

  • The amount to be neutralised may be set at say 80% of the subsidy level, for example at Rs 9 instead of Rs 11.35. This would be acceptable only if it is felt that crude prices may reduce next year due to the gloomy global economic forecasts. But if crude prices continue to rise, then the scheme would have to be extended.

  • The period of neutralisation may be longer or shorter, for example 9 months or 18 months.

  • The frequency of neutralisation may be at intervals other than a month, for example two weeks or 6 weeks

  • However, all these adjustments should be decided once for all at the start, and implemented without change, in the long term interest of the people and the economy.

There may be an apprehension that people will tend to stock up one or two days prior to scheduled date of increase. However, this tendency should not be significant after people get used to the idea, which may take say three months. In order to further reduce this tendency, the increase in initial months may be moderated to say 50% of the standard increase in the first month, 75% in second month, and reach the full level in the third month.

The application of the scheme to other products may also be considered. The above mentioned report of the MoPNG states that the under recovery in PDS Kerosene is Rs 28.77 /Litre, and in Domestic LPG Rs 378 /Cylinder. Considering the sensitivity of these items, the SIP period may be longer. If it is 24 months, then the monthly increase would be about Rs 1.2 per litre for kerosene, and Rs 15.75 per LPG cylinder.

The proposed approach provides a simple way forward to resolve the thorny problem of petroleum subsidy.

Rating agencies are likely to view the scheme favourably, since they will see a time bound plan of action to reduce the subsidy levels and the fiscal deficit. An improvement in rating will, in due course, translate to more investments into the country, as well as lower interest rates, both of which will help to further reduce the fiscal deficit.

All companies and organisations operating in, and providing funds to, the Petroleum sector are likely to support the proposal since it would provide long term clarity. They will be able to draw up their growth plans with enthusiasm, and approach financial agencies for funds with a great deal of confidence. That will enable them to create the long lasting solutions that the country needs for tackling the Energy Security issues, without which economic growth cannot be sustained.

The success of such a program depends strongly on ensuring that the people understand why these inherently unpopular steps have to be taken. A public awareness campaign should be conducted in order to educate people at all strata of society. It is of course absolutely essential that all political parties arrive at a consensus that petroleum subsidies have to be done away with in the larger national interest.

___________________________________________
(The views expressed by the author are personal.)