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India’s fuel pricing policies becoming stable
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Many different factors behind fuel pricing in India and Sri Lanka
According to Minister of Energy Udaya Gammanpila and State Minister of Money, Capital Market, State Enterprise Reforms Ajith Nivard Cabraal, who spoke to The Morning earlier this month, the fuel price hike is a temporary measure, and the Government has long-term, sustainable plans as far as lessening fuel price-related burdens on the people are concerned.
In the debate over how reasonable and timely the price hike is, some also compared Sri Lanka’s situation to other countries. This included both who support and oppose the price hike, and while the Government said that Sri Lanka’s fuel prices are one of the lowest even after the price hike, those against the move claimed that Sri Lanka’s domestic issues, such as the Ceylon Petroleum Corporation (CPC) being an inefficient, loss-making institution, were a reason behind the price hike.
To look into how Sri Lanka’s neighbour, India, handles fuel prices, a webinar was held last week, titled “Pricing Fuel and Energy: Lessons From India”, where Advocata Institute Chairman and economist Murtaza Jafferjee and former Indian Finance Ministry Secretary and former Economic Adviser to the Indian Prime Minister Dr. S. Narayan spoke extensively of the political, economic, and social factors affecting fuel prices.
Status quo of fuel prices: Sri Lanka vs. India
The webinar included a lot of analysis between the status of the two countries; according to Jafferjee, gross fuel imports is Sri Lanka’s single largest import, and in the seven consecutive years starting from 2014, gross fuel imports as a percentage of goods imports was 22.9%, 13.4%, 11.9%, 15.1%, 17.6%, 18.4%, and 14.5%, respectively. In the same seven years, gross fuel exports amounted to 5.6%, 3.2%, 2.8%, 3.6%, 4.5%, 4.4%, and 2.9%, respectively, of the country’s gross domestic product (GDP).
Sri Lanka currently has a tax subsidy for fuel, which refers to the reduction in the tax burden borne by the producers of goods and services that generate a positive externality to society. According to the World Bank, the non-poor are the largest consumers of fuel and electricity (the top 30% of society consumes 70% of fuel, well ahead of the direct and indirect consumption of fuel by the bottom 40% through the use of public transport), and that therefore the administered fuel prices are an effective subsidy to the non-poor, funded indirectly by fiscal resources.
However, when compared to several other countries in the South Asian region, namely, India (New Delhi), Pakistan, Bangladesh, and Nepal, most of the absolute and relative prices of fuel – namely, petrol, diesel, and kerosene – are cheaper in Sri Lanka.
When the factors or components of the fuel pricing formula in determining the fuel prices of India and Sri Lanka are considered, there are many similarities, even though the figures were significantly different.
The fuel prices in Sri Lanka’s domestic market are determined by many factors, including the Platts price (price of a barrel in dollars terms in the world market), insurance and freight charges, import price, exchange rate, landed rate, customs duty/net customs duty, excise duty, terminal charges, transport costs, storage costs, dealer margin, and profits. However, as per the current prices, only petrol is sold at a profit of Rs. 4.31, while diesel is sold at a loss of Rs. 12.48.
Factors determining India’s fuel prices include international prices of Brent crude oil, the currency exchange rate, refinery processing, refinery margins, freight costs, logistics, excise duty, road cess (charged by the Central Government), commission to petrol pump dealers, and additional Value-Added Tax (VAT).
When comparing the corrective taxes of the two countries (according to International Monetary Fund [IMF] estimates in 2010), according to Jafferjee, they are determined by carbon emissions, congestion on the road, accidents, and road damages.
India’s Corrective Tax for a litre of petrol is around $ 0.78, while in Sri Lanka it is around $ 0.63 (Rs. 126). When it comes to a litre of diesel, India had imposed a total of $ 0.54, while Sri Lanka had imposed $ 0.42 (Rs. 84).
Corrective Tax is a market-based policy option used by the government to address negative externalities (the results of an individual’s, household’s, or firm’s decision to consume, produce, or invest that is imposed on an unrelated third party which is not involved in the transactions). This tax adjusts the cost of production of the good or service that is creating the externality, and discourages the production and consumption of the good or service.
India’s fuel pricing policies and history
When queried about India’s behaviour regarding fuel-related policies, especially those relating to taxes and the prices of fuel, Dr. Narayan added that understanding India’s fuel pricing as it stands today requires looking at the history of fuel pricing in India, which goes back to the time of India’s independence in the 1950s.
“India was largely an agrarian economy and India also had a food deficit. It was not producing enough food for its own population. So the earliest governments, especially those between the 1950s and the 1960s, focused on increasing agricultural productivity. They gave too big subsidies, including for agriculture. They came in many forms, including subsidies for seeds, fertilisers, and most importantly, subsidies for fuel, both for petroleum and for electricity. At that particular time, most of the country was not electrified and there was a lot of irrigation requirement, and since there was no electricity, oil engine pumps came in,” he explained.
He noted that in that context, the high use of diesel in vehicles used in agriculture began, which he referred to as the “dieselisation” of the Indian economy. “This dieselisation of the economy somehow extended to a lot of other sectors and diesel-powered equipment became more prevalent than petrol-powered equipment in India,” he said, noting that consequently, the need for the production of diesel increased rapidly. This situation had made petrol, which was predominantly used for vehicles such as cars, become a “fuel of the elite”.
The differential between petrol and diesel prices reflected, in a way, the political philosophy of the government, which says that “we will subsidise the poor man’s fuel and we will charge more for the rich man’s fuel”, according to Dr. Narayan. This philosophy has continued until today and is the reason diesel continues to get subsidised and petrol prices are on the rise. The “poor man’s fuel” concept is also the reason kerosene continuously gets subsidies in India.
Dr. Narayan added that this system (which he described as dieselisation), which began five to six decades ago, has had enormous consequences as far as India’s fuel utilisation is concerned.
He further explained: “The engineering industry started producing more diesel pumps than diesel engines. When looking back, there is often this question as to whether it was the right way to go, because diesel is not such an efficient fuel as petrol in terms of combustion and environmental aspects. Until the first oil shock in 1971, diesel continued to be heavily subsidised and the government had all the refining capacity. In fact, refineries produced more diesel, and even now, refineries are constructed in such a way that 55% of the total production is diesel, which is very different from the refineries in the modern world. There was another oil shock in 1973 and another one in 1991, and we realised that the fuel prices had suddenly doubled and tripled. This situation led the Indian Government to take a policy decision.”
He also noted that India was not out of the woods in terms of its agriculture production, even though cereal production had led to a surplus.
“Even though today’s situation is such, at that particular time, when the first oil shock occurred, India was not self-sufficient. The diesel subsidy had to continue in a context where there was no sufficient electricity. Therefore, the kerosene subsidy also had to continue. It is this situation that caused petrol and aviation fuel prices to keep going up, although oil companies continued to make losses,” he added.
When Jafferjee raised a question as to the reason why oil companies continued to suffer losses despite price hikes, Dr. Narayan noted that this too was a result of the dieselisation of the Indian economy. He clarified that even though the prices of petrol and aviation fuel increased, since oil companies had to sell diesel, which constituted the lion’s share of the total production, for subsidised prices, they made losses. In addition to the production of subsidised fuel, another reason oil companies suffered losses was the fact that pump prices were fixed, even though taxes were also part of the prices of petrol and aviation fuel, and it was oil companies that paid these taxes.
According to Dr. Narayan, as the fuel consumption started growing, the ability of oil companies to manage their balance sheets as well as the ability of the government to provide continuous subsidies to oil companies declined. To address this situation, the Indian Government had introduced a system called “administered price mechanism” (APM). This system pooled together the refining capacity of all refineries and the costs of imported oil as well as imported products, and came up with an equated price in terms of each of the products and decided the kind of subsidies that would be given to the products. The balance generated through APM was put into what was called the APM Fund. This funds oil companies, so these companies could issue bonds in the market. These bonds were long-duration bonds – they were 10 to 20-year bonds.
Moreover, he explained: “Even though these bonds were not sovereign, these oil companies were sovereign entities by themselves. So the bonds got traded in the market and the oil companies got money, and a lot of these long-duration bonds maturity will take place between 2021 and 2026. So the government will shell out the money – so they are actually paying in the next five years for the kind of subsidies that they did not pay 20, 30 years back. This mechanism caused a simultaneous, gradual increase of the prices of fuel, including diesel and petrol. However, since most villages were being electrified by this time and state governments gave free electricity for villages, it relieved a lot of pressure on kerosene, which made it easy to increase the price of kerosene. These changes happened between 1990 and 2000.”
By around 2002, when the international oil prices fell substantially, the Indian Government freed up the market and said oil companies can charge the market price for all the products, according to Dr. Narayan. The Indian Government too started raking in quite a bit of money in terms of taxes and Central Excise. Central Excise, which came into existence in the early 1990s at a rate of just 2%, had gone up to about 16-18% by 2010, according to him.
“The Government started making money out of oil companies because the oil prices were low for a substantial period of time,” he observed.
He added that today, the situation has completely changed, and that India has a surplus of refining capacity. A lot of crude oil import costs are being balanced out by oil product exports, and as a matter of fact, oil product exports have become a major export commodity.
When Jafferjee questioned as to whether India has moved away from the fuel prices being used as a tool of equity and distribution to cash transfers or direct transfers to the needy, and what happened in the subsidy scheme, Dr. Narayan responded that as of now, India does not grant subsidies for petroleum or petroleum products.
“In fact, the government keeps increasing excise levies on petroleum, especially in the last two years. They said that we have to bear a huge expenditure for medical costs and Covid-19 vaccines. Since there was also a huge contraction on the GDP growth, we are putting it back on fuel,” he emphasised.
During the discussion on fuel (mainly cooking gas cylinders) subsidies given to those in need, including those declared below the poverty line and receive fuel for free, it was stated that even though the subsidised amount is an immediate transaction between the distributor, the oil company, and other stakeholders, at the end of the day, it is included in the fuel prices paid by those who do not receive subsidies, which is more or less a social cost. In this context, as far as oil companies are concerned, they recover the full cost for all the fuel they supply.
When questioned about the mechanism involving the government paying for the subsidies, Dr. Narayan noted that subsidies are budgetary transfers. However, since the Indian Government postpones transferring these funds, there are concerns and complaints among the companies receiving them, including in the food and fertiliser sectors, regarding the subsidy.
Speaking of the importance of the VAT on fuel as a percentage of total state taxes in India, Dr. Narayan responded, saying: “I cannot give you a number right away, because most states rely on taxes. However, it is significant in terms of welfare and other distribution requirements being on the rise. In fact, states cannot lower their taxes at the moment.”
During the discussion, Jafferjee questioned about the context where India has liberalised its oil industry, as to when exactly did that reform take place in the entire petroleum sector to allow private players to operate freely, and whether it created competition and what it in turn meant for the entire industry. Dr. Narayan explained: “It happened from 1991 onwards when the reform process started. Private companies were allowed to come into the refinery market even towards the end of the 1980s. However, retailing, or the marketing of oil products, started later in the late 1990s. Since the retail price was a fixed one, most private companies thought it was not worth it. However, when the retail prices were freed up after 2004 and again after 2012, a large number of private companies emerged.”
Jafferjee stated: “In Sri Lanka, we tax fuel at a very low level, but we tax cars at very high levels which are in the hundreds in terms of percentages. Also, since diesel is sold at a lower price, we try to do some correction by taxing diesel engines at even higher prices.”
Expressing his opinions as to how India taxes vehicles and what has been the thought process behind it, Dr. Narayan noted: “This is one of the good things that happened in the last few years. The differential between diesel and petrol has gradually reduced, and today it is very minimal. I feel that in terms of actual combustion and efficiency, petrol engines have much better combustion and efficiency than diesel engines. Therefore, slowly going away from this overwhelming dependence on diesel has been a very good thing for the economy, and refineries are also slowly adjusting to this new increasing demand.”
Adding that this is the direction Sri Lanka should also take, Dr. Narayan further noted: “Fuel is fuel. Once you make all fuels similar, then you can concentrate on fuel efficiency from the combustion from the engineering and mechanical engineering side, rather than purely from the fuel injection side. You can change this nature, and also you can improve emission standards. I think that price liberalisation will have a lot of improvements and benefits in the economy, especially on the manufacturing side.”
When the matter of Indians having relatively low taxes on vehicles and high taxes on fuel was brought up, he added that over 90% of the vehicles used in India are locally produced, and that imported vehicles, which are usually high-end vehicles, are taxed. He agreed that this is a move by India to keep vehicle prices affordable in order to stimulate the domestic industry, or the production side.
“India has a substantial manufacturing and also a consumption demand base. Both supply and demand are indigenous. So, the pressure of externalities for an economy like India is considerably less than for a country like Sri Lanka,” he elaborated.
Sri Lanka’s fuel pricing formula has been debated over the past few years, both because of the controversial nature of the formula introduced by the previous United National Front (UNF)-led Government and the current Government’s decision to do away with it. However, all parties including consumers agree that whatever the formula used by the Government, it should not put an excessive burden on the public, especially during the pandemic the country is going through.
Price hikes and cuts are a common element of any form of economy, and at a time when the Government is struggling to prevent an economic collapse, which some critics say is imminent, increasing fuel prices is an understandable move.
However, the importance of making price-related decisions based on economic factors is something Sri Lanka has overlooked in the past few decades, and this situation has to be addressed for smooth price changes that cause minimal impact on the consumers.