Saturday, June 7, 2008

Oil Pricing in India

The Govt. of India increased the price of gasoline and diesel by 10%. This was met with protests across the country that hampered the normal life. The Government controls the price of oil in India as a means to control the inflation in the economy (which currently stands close to 8%).

The Govt. was losing close to Rs.20,000 crores ($50 bil) due to the subsidy in gas prices. The increase of 10% will help cut the loss by Rs.4,000 crores ($10 bil). When the price of gas is set to a certain amount and the global price of oil increases, the subsidy amount rises with it. Hence, the loss incurred by the Govt. fluctuates with the changes in global gas price.

I propose that the Govt. should decide how much it wants to spend in subsidizing oil in a year and stick to that amount. This amount can be adjusted for inflation in a timely manner. Transfer any changes in the global oil prices to the consumers instead of absorbing them. For example, if the Govt. decides to allocate Rs. 15k crores ($40 bil) towards subsidy and the global oil price rises, do not alter this subsidy amount and transfer the hike to the consumers. Do the same when the prices dip. Let this pricing be handled by the oil companies with minimum intervention from the Government at any level. There should be oversight to ensure that the interests of the people are protected, but the intervention should be limited to a minimum. What is the big deal in letting prices fluctuate daily?

I see many advantages in taking up this approach. Firstly, the incentive/ punishment is shifted more closely to where it belongs. After all, it is the consumption by the people that is causing this fluctuation in global price of oil and with this change, they will be the first ones to experience the result of their own habits. It will increase awareness about the global supply of oil in Indian consumers, which I find is sorely lacking. It will reduce the "Bandhs" that are called upon whenever the Govt. increases the oil prices. I could not find the total economic cost of these bandhs, but I would estimate it to be quite high. This approach will curb the losses of the Government and also keep the National deficit in check.

There are some drawbacks to this approach. The Govt. will lose a significant weapon that it uses to control inflation in the economy - price of oil. However, I am convinced that the benefits outweigh the costs.