While hike in diesel prices will help lower losses of OMCs and fiscal deficit, the timing is important for inflation and rate cuts
The move to partially deregulate diesel prices has had an important announcement effect with the market spooking upwards. There can be nothing fundamentally incorrect about this move to make the price market-oriented, and the two questions that need to be asked are whether companies will increase prices and to what extent? With the fiscal deficit under strain and the next Union Budget to be critical in terms of providing future direction to the economy, this move is quite appropriate, as something seriously needs to be done to control the petroleum subsidy bill and hence the viability of the OMCs. The issues here are three-fold: pricing per se, fiscal deficit and inflation.
The current under-recovery on diesel is quite high at R9.6/litre. This needs to be brought down. The overall under-recovery on this bill has been around R53,000 crore for the first half of the year, which is around 60% of the total under-recovery on the fuel account. The justification of providing a subsidy is based on the use of this fuel by farmers. With the direct cash transfer concept catching on, it would be easier to charge market rates for diesel, and subsidise farmers directly through cash transfer. As the other users can afford to pay the market price, vehicle owners as well as power generators can be made to get market-oriented, though the issue of inflation would still have to be addressed.
The related question is how will prices move up? Will it be a big increase of, say, R5/litre, as was done last time, or a gradual one? Ideally, a gradual increase makes sense as it is easier to absorb and does not come as a shock. Therefore, incremental prices of, say, R0.5-1 would be easier to take in on a more frequent basis until such time that the gap is closed.
The fiscal deficit is the second element which is being addressed here. For this year, the petroleum subsidy has been targeted at around R45,000 crore. Last year, out of the total under-recovery of close to R1.38 lakh crore, around 60% was taken on by the government through the subsidy while the rest was borne by the upstream companies. Assuming that the current level of R85,000 crore of under-recovery for the first half of the year doubles to