Unjustified Petrol price hike
The Central Government announced an unprecedented hike of 7½ rupees in petrol prices with effect from May 24, 2012. The government could not have chosen a better time to announce the fuel price hike: A birthday gift for the aam aadmi on the completion of three years of UPA-II. When a government compounds bad economics with worse politics, it isn’t very difficult to predict what might happen over the next few days. The Central Government will direct states to cut taxes on petrol. Congress-ruled states will readily agree to the proposal. States ruled by the opposition parties will resist the proposal. The Congress will go to town proclaiming itself as the most genuine defender of the common man. Allies of the Congress will blow hot and cold but to no avail.
The economics behind the fuel price hike can be traced in part at least to international crude prices, a rupee which seems to have fallen into an abyss, a massive cobweb of taxes levied on crude products and a regime of subsidies which has been unfairly represented as serving no purpose other than to decrease profits among oil marketing companies (OMCs). The government’s problems begin with its failure to identify and resolve these issues collectively and correspondingly, with its propensity to engage in knee-jerk policymaking. This government has been accused of “policy paralysis” for weeks. With policy announcements such as the latest fuel price hike, they make it too easy for critics!
Admittedly, the economic issues surrounding the fuel hike are complex and deserve to be understood through a considerable amount of reading. For now, it is proposed to merely put these issues in context with a view to offer a quick perspective of how this government has wrecked the Indian economy. The rupee has depreciated significantly against most major currencies and notably against the dollar. The immediate implication for fuel prices is that since crude oil is purchased in dollars, the price (in rupees) per barrel of oil would increase. Given that crude oil is purchased in dollars, the government might have calculated that an increase in petrol prices would deter domestic consumption and thereby result in fewer dollars being spent to procure the supply necessary to meet domestic demand.
It is true that appreciating the rupee (against the dollar) would have favourably influenced domestic petrol prices. It is however laughable that the Union Government could presume to significantly influence exchange rates through a petrol price hike. The reason for this is that a currency’s exchange rate is a function of a number of factors including volume of foreign investment and balance of trade (net imports/exports). India has a trade deficit. In other words, it is a net importing economy. Under the circumstances, India will spend more dollars on imports than it earns through exports (notwithstanding that a weaker rupee means that Indian commodities are comparatively less expensive in international markets). India thus looks to other sources of foreign exchange. One of these sources is foreign investment. The trouble is that when foreign institutional investors (FIIs) spot a trend where the rupee is continuously weakening against the dollar, they become apprehensive that they will earn fewer dollars when they book profits and are thus eager to withdraw their investments.
The RBI did try and defend the rupee against the dollar. But owing to depleted foreign exchange reserves, even these efforts were not sufficient to reverse the slide of the rupee. In 2006, noted commentator, S. Gurumurthy, made a convincing case for a deliberate appreciation of the rupee. (“Petrol at Rs. 30 a litre? Possible, but …” The New Indian Express. 22.6.2006). But let’s put aside a major policy rethink on the currency regime for now. This government is clearly incapable of any positive revision. The real shocker is that the steepest hike in domestic petrol price history comes at a time when international crude prices have fallen! Why then would this government announce a price hike?
Government and Congress spokespersons tell us that oil marketing companies (OMCs) have been selling petroleum products at a loss for a long time. “Loss” is really a deception employed by the government to refer to what is known among OMCs as “under recovery”. An under-recovery refers to the difference between the retail price of petroleum products and the trade-parity price which includes a number of unincurred and inflated costs. The fact is that both the retail price and the trade-parity price are nothing but facades which conceal innumerable taxes levied by the Centre and the States including excise duty, additional duty, cess, additional cess and sales tax. Now, this is where governance gives way to naked politics.
Last year, when diesel prices were hiked, the Centre directed states to cut taxes on diesel. Congress-ruled states happily complied. This time, the Congress has directed state governments run by the party to cut taxes. Kerala and Uttarakhand have already complied. In states where the Congress is not in power, such as Madhya Pradesh, the Ajay Singhs and the Kantilal Bhurias will cry hoarse on how the BJP government is anti-poor and responsible for price rise. This is hogwash!
Cutting taxes is not a bad idea at all. But it needs to be seen in the context of state-specific economics, state government schemes, Central Government grants and sources of revenue. Last year, Organiser Weekly explained how the directive issued by the Central Government to cut taxes on fuel products was misplaced in the context of Madhya Pradesh. (‘Fuel Price Hike Bad Economics, Worse Politics’. Organiser. 31.07.2011). We demonstrated how the majority of revenue at Madhya Pradesh’s disposal was generated by Madhya Pradesh itself! We further explained that cutting taxes would impair the state government’s ability to undertake hugely popular schemes such as the Ladli Laxmi Yojana.
Nothing has changed since last year. The same state Congress leaders will demand that the BJP government must reduce taxes on fuel products, knowing full well that the Congress-led Central Government does not offer a sufficient share of the tax revenue to Madhya Pradesh and that cutting state taxes would result in lesser funds for social empowerment schemes. But the UPA government at the Centre cannot even think of cutting taxes on fuel products because that would mean that there will be fewer funds to spend on schemes such as NREGA, RTE and possibly the Food Security Act. So the Congress in the Centre is allowed to retain taxes on petroleum. But all state governments are expected to cut taxes. Consequently, the Congress in the Centre can indulge in massive social spending. But the BJP governments (and even humble state Congress governments) must not be allowed to undertake any social spending at the state level!
This is a gross violation of the spirit of federalism at two levels. First, the Centre has no business in telling States how to manage its finances, especially when the Centre’s recommendations pertain to revenue generated out of constitutionally-prescribed state taxes. Second, it is unethical for the Centre to refrain from cutting central taxes on fuel so that it can fund its expensive flagship schemes but expect the state governments to cut state taxes on fuel, thereby impairing the state’s ability to engage in social welfare schemes. This is exactly the kind of attitude that irritates independent regional leaders such as Jayalalithaa and Naveen Patnaik as well as UPA allies such as Mamata Bannerji, besides BJP leaders such as Narendra Modi who have staunchly defended federalism.
Whenever the argument is made that the Central Government ought to cut taxes on fuel products before asking states to do the same, the Centre is quick to hide under the cloak of subsidies. According to this defence, while both the Centre and the States impose taxes on fuel products, it is only the Centre which has to foot the subsidy burden and thus it is unreasonable to expect the Centre to cut taxes. But how does this explain the skewed distribution of Central tax revenue among states? And how does this explain the uncontrolled weakening of the rupee under the Central Government’s watch? Under the present constitutional framework, where the Centre has far greater avenues of revenue than the states, distribution of tax revenues to the States must be fair and equitable, failing which, the States will be hard-pressed to raise its own revenues.
There are some important lessons for the BJP which is the principal national opposition. On 31 May, 2012, the NDA organised a large-scale protests against the petrol price hike across the country. The magnitude of the hike as well as the general public disenchantment with the UPA government the protests received a good response all over India. The question then will be whether the BJP will seize the opportunity and demonstrate to the public that it is not only a rallying point for people who have been affected by the ill-fated policies of the UPA but also the rallying point for workable solutions to solve the problems created by the UPA. Will BJP leaders sit down and deliberate upon the economics of the fuel price crisis? Will they evolve an economic policy that will offer a comprehensive solution to not only the fuel price crisis but also the weakening rupee and the deterioration of economic federalism in this country? On May 31, the multitude of citizens supporting the NDA protest re-assured that the principal opposition has determined a method to solve the problem that they are protesting against.
As far as the Congress-led Central Government is concerned, the less said the better. With each passing day, the ill-effects of the economic disaster produced by the UPA frustrate new sections of the populace. Each passing day begins to expose the myth of “inclusive growth”. The people of India have begun to understand how the promise of “inclusive development” is inherently flawed by the high-tax, high-spend regime of the UPA. The regret has set in. It will soon be followed by anger. In a democracy, regret combined with anger can only have one logical conclusion. Does Manmohan Singh see the writing on the wall?