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A praiseworthy pricing policy

International crude oil prices have fallen from a high of $110 per barrel in March 2014 to a low of around $30 per barrel in early February this year (see Graph-1). This decrease of 72 per cent was hardly predicted by oil pundits.

A praiseworthy  pricing policy

Now the trillion dollar questions are: Have we reached the bottom? How long will low crude oil prices prevail? When it goes up, as it should, where would it head? Will we see $100/b oil price any time soon?

While there are various forecasts, the general view is that we will not see oil price above $100/b for a long time to come. This is what happened when oil prices fell below double digit in 1986. For almost 18 years oil prices remained at a low level. Will history repeat? Based on the present supply and demand situation, such a low price scenario looks unlikely. Prices are likely to recover much and sooner than in 1986.  

Creditable moves of Modi government...

It is to the credit of Modi government that when international oil prices crashed, petrol prices in India have fallen by just 18 per cent. This is because the NDA government increased Central excise taxes on petrol by Rs 11.86 per litre and on diesel by Rs. 13.68 per litre ten times during this two year period.

Some of the state governments ruled by Opposition have protested against such justifiable increases. There was no compelling need to share the windfall of oil price decline with the consumers of these products.

In a country where 20 per cent of the population live under starvation poverty line ($1.90 per person per day) any responsible government needs additional revenues to take up welfare projects in health, education, water, rural development... There is no better way to raise resources than to tap petroleum products. Of course these steps of additional resource mobilization are justified only if the government succeeds in spending the money to alleviate poverty with minimum level of corruption and leakage.

The NDA government also deserves credit for adapting aadhaar to distribute residential LPG subsidy directly to the beneficiaries. This has resulted in reducing the misuse of subsidised LPG for other uses.  

Subsidy with unmet benefits...

However NDA’s policy of asking people to voluntarily give up LPG subsidy is not a success. Out of 16 crore LPG consumers, only 75 lakh have agreed to forego the subsidy. A new policy which has become effective from first of January this year of eliminating subsidised LPG to families with more than ten lakh annual taxable income will also not help much in reducing subsidy burden. A more progressive step would have been to eliminate sale of subsidised LPG completely.

The subsidy amount has fallen drastically from about Rs 850 per LPG cylinder in early 2014 to less than Rs 100 today as a result of the fall in oil prices. The poor can always be assisted through direct benefit transfer system.

The UPA government had made a mockery of reducing LPG subsidy first by limiting number of cylinders to six and then to nine and finally twelve when average number of cylinders used by a family was less than nine. Only about 3 per cent families use more than 12 cylinders in a year.

Fall in oil prices will help India to save foreign exchange of Rs. 500,000 crore ($ 74 billions) in a year. Through increase in excise taxes on petrol and diesel the government should be able to mobilise additional revenue of Rs. 145,000 crore per year. While the former should help improve the trade balance, the latter should help reduce the budget deficit. Will these twin developments lead to the strengthening of the rupee?

Fall in oil prices has helped the NDA to increase excise taxes on petrol and diesel with minimal loss in political goodwill. Now is the time for it to eliminate residential LPG subsidy. After all more than 90 per cent of the beneficiaries are the middle income and rich families. Since more than 80 per cent of LPG is imported, the country has to pay for it at the international market rate. It is only fair that those who use LPG pay for it. Such a market based price policy reduces corruption since there is no subsidy to be exploited by the dealers many of whom are politicians.

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