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Tuesday, 27 December 2011

Two wrongs do not make a right

Some weeks ago during a social dinner chat, the head of a well known non-banking finance company headquartered in Chennai made an interesting comment. The subject was fuel pricing and the distortions in the economy caused by the widening gap between petrol and diesel prices. This gentleman, seeking to buy an upmarket car, went to one of the dealerships that his group owned but had to return empty handed because all the cars there were diesel models. He wanted to buy a petrol model and the reason he gave was striking: “How is it right for me to buy a luxury diesel car and pay Rs.45 a litre for fuel when the average Indian pays Rs.70 a litre for petrol to fuel his Rs.40,000 two-wheeler?''

Whether this is an extreme definition of ethics or not is another matter but the comment certainly sums up very well the distortions that are being caused in the economy by the government's flawed policy on fuel pricing. On the one hand, the oil companies are wailing over mounting ‘under-recoveries', which by itself is a questionable concept. On the other, the benefit of lower diesel prices is enjoyed by those consumers who can actually afford to pay more.

Petro-diesel price gap

The gulf between petrol and diesel prices that has widened over the last year (see graph) has prompted a mass shift of car buyers to diesel-engine vehicles from petrol. Between 4 and 5 of every ten cars sold in the country today — depending on whose estimate you want to believe — are diesel engine ones. And this is despite the higher price of diesel cars relative to petrol ones. Obviously, people like the gentleman above are a minority!

‘Dieselisation' of the car market is happening slowly but surely and this has consequences for not just the automobile manufacturers and oil companies but also the government.

According to the recent report of a Parliamentary panel on petroleum, diesel cars consume as much as 15 per cent of the total diesel sold in the country.

It is not surprising therefore, that the panel has recommended a cess on all diesel cars to make them more expensive and deter buyers. That the panel's, over-arching interest was to protect the oil companies is evident from its other recommendation that this cess should go to the oil companies to compensate them for their ‘under-recoveries'.

Predictably, there is opposition to any such suggestion of higher duties on diesel cars from the wing of government responsible for the well-being of car companies.

Heavy Industries Minister Mr. Praful Patel is supposed to have opposed it in a letter to the Finance Minister, Pranab Mukherjee. Howsoever tempting it might be for Mr. Mukherjee in the context of raising revenues, such a cess, if imposed, will be akin to correcting one wrong with another.

The basic problem is with the fuel pricing policy of the government and not with the car companies. That cannot be corrected with another flawed policy on taxing automobiles.

A cess on diesel cars will surely put a brake on demand, slowing down sales of such cars. But how fair is it to change policies on such critical issues after car companies have already invested heavily depending on stability of policy? And again, what about the stock of diesel cars that are already on the road? Is it in the interest of the government to mess with an industry that is one of the biggest employers?

There have been suggestions for a dual pricing policy for diesel. Cars will be charged a higher price than goods carriers and tractors. But this is not a workable suggestion; it is not possible to regulate price at the petrol pump based on the vehicle that comes for a refill. Nor is it logistically feasible to separate dispensing outlets based on vehicles.

So, what is the way out then? There is simply no alternative to completely overhauling the fuel pricing policy. We need market-determined, competitive prices for transportation fuels that are based on the cost of production. The present policy of linking domestic prices of petrol and diesel to the landed cost of imports when in reality not a litre is being imported needs to be done away with.

Petrol and diesel cost almost the same to produce but the reason for the wide differential in their prices is taxes. While encouraging the oil companies to compete with each other and basing prices on their cost structures, the government should also take a holistic look at the taxation policies on petroleum products.

Petrol suffers higher excise duty and sales tax compared to diesel. Duties on the two products need to be rationalised and made comparable with each other. In fact, it may be desirable to revisit the taxation policies for all petroleum products and rationalise them.

These are important reform measures that, realistically speaking, are unlikely to happen in the near term. Come the Budget in February and we might well see the government imposing additional taxes on diesel cars. And the wide gap between petrol and diesel prices is not going to disappear any time soon. The likes of the gentleman mentioned in the beginning are unlikely to drive a diesel car in the near future.

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