Reforming Price of Diesel in India

1. Reforming Price of Diesel in India Mukesh Anand, mukesh_anand@hotmail.com NIPFP August 28, 2012 Full Report at http://www.nipfp.org.in/newweb/sites/default/files/Diesel%20Price%20Reform.pdf

2. Outline of the Presentation • Diesel in Indian economy • Pricing policy and prices • Revenue from petroleum sector • Macroeconomic impact • Microeconomic impacts

3. Consumption of Diesel and Petroleum Products in India, 1974-5 to 2010-1

4. Share in Consumption of Petroleum Products (Per Cent)

5. Sector-Wise Share of GDP and Total Diesel Consumed (per cent)

6. Share of Different Modes of Transport in GDP (Percent of GDP at Factor Cost at Constant Prices)

7. Pricing of Diesel: Chronology • Import Parity Pricing (IPP) - pre-1975 era • Oil Prices Committee (1974, OPC, Krishnaswamy)) – Cost Plus Basis (also called APM) crude oil cost + refining cost + 15 % RoCE • Oil Cost Review Committee (1984, OCRC, Iyer) – revised the ‘return’ element to weighted average of (a) cost of borrowing and (b) 12 % post-tax return on Net-Worth • Oil Pool Accounts maintained by Oil Co-ordination Committee (OCC): Crude Oil Price Equalisation Account (COPE), Cost and Freight Account (C&F), Product Price Adjustment Account (PPA)

8. Pricing of Diesel: Chronology …..contd. • Dismantling of APM, Closure of Oil Pool Accounts – Issue of Special Bonds to Oil Companies (Recommended by Strategic R-Group) • Market Determined Pricing Mechanism (MDPM) – From April 1, 1998, moved to Adjusted Import Parity Pricing for controlled (MS, HSD, SKO, ATF, LPG) products. Markets decontrolled (Naphtha, FO, LSHS, Bitumen, Paraffin) for industrial products • MS and HSD deregulated in 2002 • Trade Parity Pricing (Rangarajan, 2006) for MS and HSD (80 % IPP and 20 % Export Parity Price (EPP)) • Continue with TPP (Parikh Committee, 2010) for HSD, market determined pricing for MS – Government takes an in-principle decision to move to market determined pricing both at refinery gate and retail level for HSD at an appropriate time

9. Trend in Price of Crude (Indian Basket) and Retail Selling Price of Motor Spirit, Diesel (Delhi)

11. Price Build-up of Diesel in Delhi (Effective 16th Nov, 2011)

12. Federal and Provincial Taxes in Retail Sale Price at Delhi

13. Under-recovery of Oil Companies and Fiscal Subsidy on Sale of Sensitive Petroleum Products (billion INR)

14. Federal and Provincial Revenue from Taxation and Quasi-Taxation of Petroleum Products (billion INR)

15. Cost of Inputs (CoI), Value of Output (VoO) and Gross Value Added (GVA) in Refining of Petroleum Products, (value in billion INR)

16. Weight in WPI of Major Groups (per cent)

17. Input Cost of Diesel / Petroleum Products Rail Transport Public Passenger Road Transport

18. Input Cost of Diesel / Petroleum Products Op. Cost of Machine Labour, % Tot. Cost Per Hectare Industry Agriculture #1: 13 Provinces; #2: 7 Provinces

19. Conclusions • Petroleum products, especially diesel consumption has grown significantly faster than real GDP over the last three decades • Petroleum products are a major source of government tax revenue both at federal (15 per cent) and provincial (20 per cent) levels. • Indirect tax yield (federal plus provincial, May-June 2012) per litre of diesel (INR 7.66) is less than 30 per cent on petrol (INR 26.64) • Under-recovery (November 16: INR 10.17; May 16: INR 13.64; July 1: INR 9.13) on diesel is higher than tax realised from it. Sale of diesel accounted for close to 59 per cent of total under-recovery in 2011-2. On a per litre basis, extant under-recovery on diesel is about 25 per cent of RSP in Delhi.

20. Conclusions • FOB price or EPP is the appropriate benchmark for setting basic prices. • Thermal efficiency and combustion emission / residues should be the principle parameters for taxation. • Wide divergence in total price between different (but jointly produced) petroleum products is undesirable. • Given the extant weight of diesel in WPI, a 10 per cent increase in its price would raise the price level by 0.47 per cent. A 25 per cent increase would therefore be commensurate with a price level rise of 1.2 per cent. • But, a simple exercise to estimate input of diesel and the impact of a 25 per cent increase in its price suggests, that ceteris paribus total costs would rise by 8, 10, 3 and 0.25 per cent respectively for (i) passenger transport in public sector, (ii) freight transport by road, (iii) railway transportation service, and (iv) industry.

21. Conclusions • Under very broad assumptions for use of diesel in agriculture, a 25 per cent increase in its price would raise cost of cultivation of wheat and sugarcane respectively by 2.75 and 0.75 per cent. • Governments in India would be ill-advised to completely insulate domestic consumers from the vagaries of international prices. The net effect of an attempt to hold domestic prices may cause (i) a decline in revenue yield (if taxes and duties are reduced to dampen the impact) or, (ii) a rise in expenditure on account of under-recovery. • This, in the short run, would result in a rise in fiscal deficit. But more importantly, misallocation of resources may adversely impact prospects for growth and employment in the medium to long-term. • Indian economy is characterised by large informal sector and increase in diesel price may result in disproportionately higher inflation. • Insights from economic theory are useful, but often derived under assumptions that appear to diverge from reality. Some political influence in pricing, then is expedient.