Columns: Kautilya

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India Today, January 25, 1999
Jan 25, 1999

KAUTILYA
Job Half Done

Reforms have led to lower diesel prices for consumers.

By Jairam Ramesh

Governance is a continuing business. What one regime sows, another reaps. During much of 1995 and early 1996, the Congress government formulated the policy for phasing out the administered price mechanism (APM) in the oil sector that was standing in the way of attracting new investments, had led to unnecessary subsidies and price distortions and was eroding the financial health of the oil-refining and marketing companies like IOC. This was fine-tuned during H.D. Deve Gowda's tenure and in November 1997, it was the Gujral government that actually took the bold and far-reaching decision to phase out the APM. The BJP can now claim credit for slashing diesel prices, which it did a few days ago.

For over two decades, we had a complicated APM. Stripped of its complexity, what it involved was a subsidy for LPG, kerosene and diesel -- the fuels supposedly used by the poor. The subsidy was defined as the difference between the cost of importing the product and its consumer price. The benchmark is import prices since oil and oil products are what economists describe as "tradeables" and India is a major importer anyway. The subsidy bill was met largely by selling aviation fuel and petrol at more than their import parity price. Petrol provided what is called a "cross-subsidy". An oil-pool account that had both an inflow and outflow was created. This compensated the public-sector oil companies for the costs they incurred for refining and marketing oil products.

Cumulatively, the account showed a deficit of a high Rs 5,700 crore by 1995-96. But 1996-97 was a disaster year when the cumulative oil-pool deficit shot up to an astronomical Rs 15,976 crore. The immediate cause for this was the sudden increase in oil prices in the later half of 1996 following skirmishes involving Iraq. But the problem had been building up and P.V. Narasimha Rao's government failed to carry out the necessary price adjustments in 1994. Deve Gowda summoned the courage to increase oil prices in July 1996. But this was insufficient and in January 1997 the cumulative oil-pool deficit for 1997-98 was projected to touch Rs 18,000 crore. The Finance Ministry pushed for another round of price adjustments but this was resisted by the Petroleum Ministry and the United Front's Steering Committee.

As the crisis was building up, Arjun Sengupta, a member of the Planning Commission with close personal ties with the CPI(M) met the finance minister some time in May 1997 and volunteered to find a solution. Finance minister P. Chidambaram was not concerned with the motivation for Sengupta's back-channel activism. Sensing an opening, he set up a three-man committee under Sengupta's chairmanship and comprising the revenue and petroleum secretaries. The group submitted its report by July 1997 and suggested that the money owed by the government to the oil companies be converted into "oil bonds". The government would write out a cheque in favour of the oil companies for the cumulative oil-pool deficit amount. The oil companies would then invest this money in government securities carrying a 10.5 per cent rate of interest and redeemable over five years. The main advantage of this solution to the government was that it avoided an immediate price increase. To the oil companies, the gain was that balance sheets were cleaned up and a huge liability was converted into an asset.

These "oil bonds" would take care of the "stock" of the oil-pool deficit. But what was to be done to stem the "flow", that is control the annual additions? It was here that the Gujral government followed the Rao-Deve Gowda recipe. After announcing the oil bonds in September 1997, the Gujral cabinet in its last act in November 1997 took one of the boldest decisions ever -- to abolish the Rs 1.80 subsidy on a litre of diesel and align Indian diesel prices with global prices. In addition, it announced the phased dismantling of the APM. Inevitably, the finance minister played a key role but an unlikely hero was Mulayam Singh Yadav, without whose backing his Samajwadi Party colleague who was petroleum minister would not come on board.

The Gujral package was comprehensive. A five-year duty structure was finalised. Prices of products like naphtha, fuel oil and bitumen were decontrolled and lowered immediately. By 2002, the 66 per cent subsidy on kerosene was to be brought down to 25 per cent and the 33 per cent for LPG was then to be reduced to 15 per cent. By then, all subsidies would be explicitly provided for in the general budget. Petrol would continue to be priced at well over global prices in order to cross-subsidise kerosene and LPG. However, the present subsidy on LPG of almost Rs 76 per15-kg cylinder is totally unwarranted. Kerosene is consumed by the poor both as cooking and lighting fuel and some subsidy, well targeted, is in order. But the current subsidy of about Rs 5.40 a litre is high and encourages adulteration.

Diesel prices on a full import parity basis should have been reduced by about Rs 2.50-3 a litre. They have been reduced by about a rupee a litre. This is because import parity has to be "adjusted" so that the oil-pool account generates money to amortise the oil bonds. Half of the bond value has already been redeemed in less than nine months, as against the original expectation of about two to three years, thanks to the bonanza that the BJP has got on account of declining oil prices. This windfall should spur it to compress the timetable bequeathed by the Gujral government and complete the APM restructuring by 2000 itself.

The author is secretary of the AICC's Economic Affairs Department.
The views expressed here are his own.

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