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The political economy of petroleum prices-Vikram S Mehta

Desired outcomes can be reached through a series of ‘imperfect’ small initiatives

What is to be done? How can we untie the Gordian knot that has so entangled the political economy of petroleum product prices? This is the question that now exercises our most experienced politicians and our ablest economists.

Most well informed people know that a country that imports 80 per cent of its oil requirements cannot de-link itself from the international market; and that if it did the supplies would eventually dry up; industry would sputter to a slowdown and the macro-economy would hit the skids. But what they do not know is how to keep this linkage and at the same time reconcile the different and often conflicting demands of the multiple stakeholders impacted by it. Politicians, for instance, want to be elected and are unconcerned about the economic logic. They want the oil companies to shield their electorate from high prices. The government wants to contain the fiscal deficit and to create a pricing mechanism that minimises the subsidy outgo. The oil companies want the autonomy to run their business on commercial principles and the consumers want security of supply, quality, access and low prices. These demands are varied and it is not easy therefore to get the stakeholders onto the same page.

So “what is to be done”. How can the demands of these interest groups be made to converge onto a point of equilibrium. Several eminent public servants, such as Vijay Kelkar, C. Rangarajan, B.K. Chaturvedi and Kirit Parekh have provided a catalogue of sensible suggestions that flow from “good economics” but do not ignore “good politics”. They have recommended that the price of diesel and petrol should be aligned to the international market but also that the low-income consumers should continue to receive subsidies. These subsidies should not be channelled through the oil companies but transferred directly from the budget. They have accepted that subsidised LPG should not be totally withdrawn because of politics, but they have suggested that an upper limit be placed on the number of cylinders that can be purchased at concessional rates. They have urged the government to unshackle the oil companies from the bureaucracy and to allow the management operational autonomy. They have argued for a simplified customs and tax duty structure and the inclusion of petroleum products within the ambit of GST. These recommendations are notable for their pragmatism; notwithstanding they have not passed political muster. The reports containing the recommendations are gathering dust in various government offices.

Paradoxically, the cynics have taken the rejection of these reports to suggest an alternative answer. “Let the situation spiral out of control and use the opportunity created by the ensuing crisis to reform the system.” It is their view that an “oil supply” crisis could provide the trigger for catalysing a radical overhaul. They may well be right. The severity of the recent petrol price hike is in part because there was no alternative. The oil companies were looking into a cash abyss. The point however that should not be forgotten is that change induced through crisis can be extremely painful. We all remember and applaud the reforms of 1991. But we forget that these reforms were preceded by years of inflation, unemployment, foreign exchange restrictions and general economic hardship. The government was compelled to reform because of the consequences of bad policy that caused great unhappiness. Crisis should never be sought as the point of departure for policy change. But if and when it strikes, the opportunity to reinvigorate and recreate should not be foregone.

So is it that the answer to the above question distils down to essentially two policy options. One generated by the experts after careful thought and the other compelled through financial and economic mismanagement. I do not think so. I think conceptually there is a third middle-of-the-road answer.

A stumbling block to change is the tendency to overlook what is good in the hope of securing the perfect. A first step is often not taken until and unless the aspired destination is in sight. This hesitancy can be counter-productive. It perpetuates the status quo and dilutes the significance of incrementalism. A small initial step can often lead to a larger next step and thereon. It is not necessary that only policies that swing the needle 360 degrees should be pursued. Less ambitious initiatives that move it say 5 degrees should also be considered. Such initiatives can trigger movements that eventually push it full circle. The mistake that we might be making today regarding petroleum deregulation is that suggestions to initiate incremental albeit imperfect small steps are being stalled because they are imperfect and small. The idea of dual pricing for the two grades of diesel has for instance been blocked because of the concern that it will lead to black marketing, smuggling and diversions. These are valid concerns. Dual pricing is complex to administer and it is distortionary. But relative to current conditions the proposal should be considered. At a minimum it should be studied whether in view of the severity of the subsidy burden and the consequent imperative to deregulate diesel prices, the cost of continued inaction might not be greater than the cost of taking a small albeit “imperfect” first step. Especially if by doing so the ground work for a larger second step is laid.

The Gordian knot will not be easily or quickly untied. There are too many fingers involved and not all are working to loosen it. It has to however be untangled. The issue is how. The economists have chalked out one route. The balance of power between the stakeholders is however such that this has not been preferred. The other alternatives are operationally imperfect. They have therefore not been considered. Should they be? It is not obvious that they should but it should be acknowledged that the desired outcome can sometimes be reached through a sequence of “imperfect” small initiatives.

The author is Chairman of the Shell Group in India. Views expressed are personal