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Is this the right time for an oil price cut?
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January 19, 2009

It is strange that the government should be working on a fuel price cut at a time when crude oil prices are inching up again -- albeit gradually -- from the $40-a-barrel level. It is too early to say if this is a fundamental change in the direction of oil prices, resulting from the announced cuts in production by the oil-exporting countries, or a blip in a falling market. The government seems to be assuming (or hoping that it is) the latter and is rushing ahead with its price cut plan, which is ill-advised when viewed from any of many angles.

Yes, there has been a dramatic decline in oil prices from the high of $147 a barrel in July, to less than a third of that today. This has ensured that the country's three state-owned oil marketing companies -- Indian Oil [Get Quote], Bharat Petroleum and Hindustan Petroleum -- are not talking about under-recoveries any more and are reporting positive margins of about Rs 20-25 crore (Rs 200-Rs 250 million) a day. In other words, they are earning enough money on the sale of petrol and diesel to more than offset the continuing under-recovery on the sale of kerosene and cooking gas.

This is a sharp recovery after the combined losses of Rs 14,431 crore (Rs 144.31 billion) in the first half of this fiscal year, but depending on the size of the price cut and/ or the extent of the upswing in global prices, the companies could be pushed into negative margins again. That would only add to the existing under-recovery bill of about Rs 110,000 crore (Rs 1,100 billion) estimated for the year, of which only a little over Rs 90,000 crore (Rs 900 billion) have been properly funded so far.

In other words, it needs to be asked whether this is the right time for price cuts. The government has what may amount to an additional fiscal hole of 1 per cent of GDP, because of two or three specific factors. One is the requirement of fresh oil bonds of Rs 20,000 crore (Rs 200 billion).

The second is the slowdown in the economy, which has inevitably affected tax revenue. Against the Budget estimate of indirect tax collection of Rs 320,000 crore (Rs 3,200 billion), the actual collection is likely to be less than Rs 300,000 crore (Rs 3,000 billion), in part because of the tax cuts announced as a part of the stimulus packages.

The government is also likely to fall short of its direct tax collection target of Rs 365,000 crore (Rs 3,650 billion) this year. This fiscal hole of about 1 per cent of GDP is over and above the 3 per cent budgeted (taking into account the Pay Commission award), and the fiscal impact of the loan write-offs and the oil and fertiliser bonds that have been issued, all of which take the deficit to the region of 7 per cent or more of GDP.

Against this backdrop, when fortuitous market movements have given the government a price cushion, it should use it to make up the leeway and only then announce a roadmap towards market-linked pricing. It should also work on a plan to target subsidies better (that on cooking gas is the least justified, especially when large-scale leakage from supposedly household demand to commercial use is an open secret).

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