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Why the Petrol Price Hike is a Good Thing

I write at Yahoo: Why the petrol price hike is a good thing

Petrol prices were raised again recently, by Rs. 7.5 and the hike leaves the country seething, except those that drive diesel cars. And to make the diesel owners wince a little, the government will decide the fate of that fuel too, in a meeting soon. While there is outrage about this "unprecedented" price hike, let me play devil’s advocate and temper down some of the most vehement arguments against this increase.

Why the Petrol Price Hike is a Good ThingPetrol Prices

With a tax of Rs. 26 per litre, can they not reduce taxes? Goa, for instance, has cut state taxes to zero; this gives the Goan petrol pump the ability to sell petrol at Rs. 61, a good Rs. 12 less than the Delhi price of Rs. 73. How, though did the brand new Chief Minister, Mr. Manohar Parrikar do it?

He replaced the lost revenue on petrol by increasing taxes and fees everywhere else. After the monsoon session, you will have pay a toll tax just to enter Goa. Alcohol will be more expensive. A power of attorney that used to cost Rs. 25 will now cost Rs. 500. A 10% luxury tax now applies to beauty parlours. Cars get more expensive with entry taxes, VAT increases and higher road taxes.

So do you really want that, fellow Indians? That the government cuts taxes on petrol and diesel, and instead makes it more expensive for you to do anything else? Goa made the grade, and has not yet seen the impact — of lower consumption due to the higher taxes. Other states, which are more dependent on the fuel revenue than Goa, might not be able to comply. Regardless, it is highly unlikely that we’ll stay wedded to a low petrol price if it means higher taxes and prices elsewhere.

State VAT is only one part of the tax problem — a larger chunk is the centre’s "excise duty" which adds Rs. 14.78 to the petrol price, and which if brought down could make life a little easier for those of us that travel in petrol vehicles. So why can’t the states and centre cut taxes together?

The central government isn’t earning much more than it did, and if you take away some tax revenue, the gap between income and expenditure — a wide one already — will widen further.

The second argument then is: the government needs to spend less. That it does. It spends a lot of money just paying the oil companies for their taking losses on diesel and kerosene. In effect, a portion of what it collects as tax on that fuel goes back into paying for the losses incurred on these fuels. Yes, the government could cancel them out — reducing the subsidy while at the same time cutting taxes on diesel. But that won’t touch the petrol price — which isn’t subsidized, and the losses due to a cut in taxes won’t be nullified in any other way.

Why can’t the government cut taxes anyhow? Cutting government revenues is a problem of optics. Imagine being told that you must take a cut in salary, because the government just cut your income tax rate by 20% and inflation is only 10%. This is not acceptable to most people, although they might universally agree that a tax cut puts more in their pocket than earlier. A drop in revenue, for the government, is unthinkable, even if they did manage to cut expenses.

And there’s the political problem of austerity. Spending lesser means cutting government employee salaries, cutting farmer subsidies like fertilizers, reducing the wages paid in the NREGA scheme or otherwise spending lesser on infrastructure. All these solutions have political problems, and the government will do all it can to prevent a backlash in these high-voter areas; petrol users are simply those that have enough money to avoid public transport, but not enough to buy a diesel guzzler, a population that is, by and large, not inclined to vote either. Most unrelated expense items have been cut already, even as the fiscal deficit — a measure of how much more the government needs to borrow to match expenses with revenues — ended up over 5% of GDP.

Prices also give a signal. If you raise prices, you lower demand. And undoubtedly, we need to reduce our reliance on petrol and diesel, which come from crude oil, our largest import. We import around $150 billion worth of crude oil every year, a figure that only increases as crude oil reaches new heights. This increases our trade deficit, and reduces the value of the rupee in dollar terms, which, in the end, makes our petrol more expensive in rupees. Our consumption hasn’t slowed, mainly because we prefer, as a country, to not pass on market prices to our consumers. Effectively, without a price signal, consumption patterns don’t change. Freeing prices may make them volatile, but we have lived with volatile necessities for years — no one, for instance, calls for potato prices to be regulated. Even the search for alternative fuels or the encouraging of cheaper ones like natural gas will not happen as long as prices for current fuels remain subsidized.

On that vein, diesel prices must be increased as well, and LPG. The oil companies lost nearly 140,000 crores (Rs. 1.4 trillion) in diesel, LPG and Kerosene last year, half of which the government must bear.

Petrol prices may come down anyhow. The calculations above reflect a crude price of $124 in April, which has since fallen to $105 recently, even as the rupee touches Rs. 56 versus Rs. 53 earlier. Net of the above, petrol prices can fall to nearly Rs. 64 per litre, without any changes in state or central taxes. But that shouldn’t change the view that prices need to stay deregulated. After all, when international prices go down, we won’t like the argument that they can’t cut prices until they make up for past losses.

  • Shripad says:

    Dear Mr. Shenoy,
    I agree with your point of view in a very marginal way. I have read your other articles (about the Greek Crisis- The Dranchma Drama) but I do not agree on the Goverment stand on increasing petrol prices.
    There is a higher need for the government to understand where most of its spending is going. Agriculture, Infrastructure, Telecom, Sports, Defense, Railways, you name a sector where it has not been proven that expenditures have been fraudulent. IT IS THE LACK OF POLITICAL WILL TO CONTROL & EXERCISE ITS CONTROL OVER BAD & CORRUPT GOVERNANCE. Can there be any explanation for the President of a nation & Speaker of the Assembly taking over 22 international trips with their families? Little has been done to understand where the problem lies & what exactly needs to be done.
    Yes, if the rise is fuel price is due to depreciating rupee is acceptable & in that case expected to come down as-well. In case of our country, the trend is usually upwards only. By terming inflation, the prices of groceries (et all take onions for eg) were increased, would you expect the prices to come down in the same drastic manner once the inflation normalizes.
    In my point of view, The Indian Goverment has become a spoilt kid which the people are allowing to grow & create bigger mess in the coming years (if it continues with the same attitude of governance).
    Thanks & Regards

  • Mahesh says:

    Hike in petrol price will lead to increases on other essential goods & services prices – which inturn not adjusted when rollback-ed.

  • Kshitij says:

    The fuel hike SHOULD BE MORE !
    I will explain why:
    This country exports little compared to imports. The rupee has come down by multiples over decades…… who will take accountability for the tremendous loss of wealth? Measure your savings over the last 30 years in dollar terms. You are poorer.
    Check the value of your property in dollar terms over the last 30 years. There is NO supergain.
    Would you like to sell petrol for Rs 20 or Rs 25 per litre? Who will go bankrupt ? Your neighbour’s national currency? Would you know how much diesel / electricity, farmers waste when you give it to them for free? Well, they never shut the supply ! ! ! THEY NEVER SHUT IT ! GET IT? No? There are several more interest groups and their political power. Each of these interest groups WASTES energy. This is well known to sector experts.
    Now imagine the deficit climbing. The country gets downgraded. The rupee is Rs 100 to a dollar thanks to this. Will you get low inflation then ? Will petro cost Rs 78 then? Who will pay for it?Tooth fairy?
    Those familiar with the sector propose that states cut their taxes rather than donate public funds to politician’s Swiss bank accounts and that of their side kicks. They would also propose to break all these interest groups. Besides the refining cos are said to have huge corruption issues and one of the high courts recently summoned them.
    Where will cheap energy come from? By magic ? Look at some of the above solutions. And yeah…cut your consumption and save.
    There are more headaches ahead. Even if oil price reduces the rupee may yet weaken further. So buckle up.

  • feltra says:

    I totally agree with you that prices should be de-controlled… And you are on the dot about why petrol is fair game while diesel is not… I think most people are misled into thinking that essential prices will rise due to petrol rise… they are thinking of transportation. But all bulk goods transportation is diesel isn’t it? Of course, the rise in petrol will be “an excuse” to raise the prices of other essential commodities…
    Full decontrol or even diesel decontrol is never going to happen. If it does, GOI / parties cannot play favorites for vote-catching – which has become the full time occupation of the current set.
    One other thing which the people crying hoarse about price rise is this: Has the usage really come down because of the rise? If not, then what are we crying about? But then, the Govt “servants” will simply get inflation adjusted earnings, unionised private sectors will do likewise by agitations etc. Its only the non unionised, non govt “servants” who would be affected by this – as they would have lesser and lesser money for savings / discretionary expenses. And as you rightly said, they are certainly the ones who don’t care to vote and therefore get ignored as a vote bank totally…
    What to say! Mera Bharat Mahan!! 🙂

  • jogesh bohra says:

    while this article is giving a complete view on the tax part of the fuel from the state and central govt, i feel that its again leaving us in afix of what is the solution to the problem and i feel the unilateral thinking is required in this aspect.
    according to my view, the govt must zeroise the taxes and calculate the total amount of losses due to loss in tax collection.
    against which the governemt has to calculate where will people lut their disposable income that is saved due to taxes.
    2 ways, either by spending on capital good or consumer goods.
    or by savings in to debt or equity.
    In both ways the beneficiary will be the government.
    Through the spending the coompanies will get more revenues and will pass the additional taxes to the government.
    Through capital good investment also the customer receives taxes and investment stability for long term.
    Through savings in debt or equity will also raise the investable surplus and boos the investor confidence with the company and hence country. further making the nation more stronger in terms of growth prospects.
    I am sure with this thinking in these tough scenerios, (ofcourse in a calculative manner) will bring the undisputed solution which will be suitable to all.
    Else, we will end up giving more from our pockets to the corrupt governments so that they get more to eat, because no one really knows how many holes are there in the national treasre and hence it can never be filled, especially not with you and me paying from our pocket.
    POlicy makers can afford even 1000 rs a ltr.

  • Well written. While the whole country is complaining of the hike in petrol prices and holding agitations in protest , your article provides a very analytical & rational contra view.

  • The demand for diesel engines has been rising, and the petrol price hike is expected to only accelerate that rush.