The price of petroleum products in India, though high compared to international levels does not move as much as what international crude prices would dictate. This artificial inertia induced by Government control has its costs. As per the International Energy Agency (IEA), India ranks fourth after Iran, Saudi Arabia and Russia in terms of consumption subsides for fossil fuels (including electricity). If energy exporters are excluded, India is estimated to take the first spot with fossil fuel subsidies worth over $ 22 billion dispensed per annum. This may not seem obscene for those who have come across gross subsidy outgo figures for India but it is still high enough to put India on the top spot. The IEA argues that when subsidies are removed, the price of fossil fuels would increase and consequently carbon emissions will decrease. As per calculations by the IEA, a complete removal of fossil fuel subsidies will reduce total global primary energy consumption by 5 percent or 738 million tonnes of oil equivalent and that the reduction will be equal to the current energy consumption of Japan, Korea and New Zealand combined. While the fairy tale optimism of the IEA must be applauded, the assumptions implied must be questioned, especially in the context of petroleum products in India.

There are no net subsides for petroleum products in India as the total tax take on petroleum products far exceed subsidy outgo. ’Subsides’ are largely cross subsides where consumers of certain products which are presumed to be used by the poor such as Kerosene for lighting and LPG for cooking is subsidized by consumers of petrol. Even consumers of petrol for which the price, in theory, is decontrolled, are ’subsidized’ in the sense that crude price increases in the global market are not passed through to the consumer which reduces the price elasticity of demand. However this is not the only reason for the malaise in the petroleum sector.

In 2009-10, when the Indian basket of crude averaged $ 70 per barrel, the total tax contribution to the Central and State exchequer from the petroleum sector was ` 1,83,860 crore (~ $ 36 billion at current exchange rate) or about 30 percent of total government tax revenue. If we make the irrational assumption that the all things remained the same even as crude prices increased to $ 150 per barrel, the government tax revenue would have increased to ` 3,93,986 crore (~ $ 78 billion) or 64 percent of tax revenue in 2009-10. Despite the simplistic assumption on which this calculation is based, the direction of causation is clear - an increase in international crude price substantially increases revenue for the Government. The revenue not only funds subsidy component petroleum products but also underwrites its larger social programme both of which are critical to its electoral prospects. Clearly there is no incentive for the Government to reduce the price of energy.

As a nation with inadequate rate payers (for energy) and tax payers the Government is probably justified in becoming addicted to oil to raise revenue. However the easy availability of price inelastic indirect tax revenue that entails little or no transaction cost (collected at the pump at the retail end) precludes social, economic and governance reforms which are required for increasing overall economic prosperity and thus the direct tax revenue. While Iran, Saudi Arabia and Russia keep energy prices low to appease social discontent, India as an energy importer keeps energy prices high to conceal its own inefficiency.

A simulation study carried out at the Observer Research Foundation found that if taxes on petroleum products were reduced by 10 percent, the price of petroleum products will decrease as a result of which consumption of petroleum products will increase. Increase in the consumption of energy will increase manufacturing output by 0.2-5 percent and transport and construction sectors by 2 percent. The overall impact on GDP will be positive with a small improvement in India’s trade deficit. The reduction in the price of energy will reduce inflation by about 1 percent in the first year of tax decrease. With regard to carbon emission there will be an increase of at least 2.4 percent as overall energy consumption will increase. While the assumptions on which the simulation studies are based can be questioned what is important is the direction of the impact. A shift in petroleum tax policy will increase overall economic activity and raise GDP although it will contribute to an increase in carbon emissions.

(The issue of subsidies and under-recoveries will be covered in Part II of this article).

to be continued...

Views are those of the authors