India Cuts Gasoline Subsidies

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We have discussed the role of fuel subsidies in distorting demand for oil and therefore adding to price pressures. We’ve also noted that as oil prices have spiked, the cost of these subsidies in some countries is becoming untenable. Both Indonesia and Malaysia have raised end user gas prices.

One of the largest countries giving buyers price breaks, India, has been under considerable pressure to cut them, as state-run oil companies (retailers) face insolvency:

There was no diesel for a day at a gas station in north India recently. The public sector oil companies are slowing down the issue of new gas connections to households. The private sector oil companies are closing down petrol pumps and exporting petrol and diesel. Kerosene is not easily available in the public distribution system; the open market rate is around Rs 30 a litre when the official rate is under Rs 10.

If you think these are isolated events, think again. A fuel shortage looms ahead of the nation as the oil companies rapidly head towards bankruptcy.

With international crude oil prices hovering around $129 a barrel, the country’s three oil marketing companies – IndianOil, Bharat Petroleum, and Hindustan Petroleum – are collectively looking at losses of Rs 200,000 crore this year. These losses belong to the budget, but finance minister P Chidambaram doesn’t want his own copybook ruined….

In less than two months from now, some oil companies will be plain and simple broke as they exhaust their borrowing limits of Rs 90,000 crore…By early July, they will simply have no cash to run their business and some of them will find it difficult to pay staff salaries. “It is like a time bomb ticking away. If the prices of petro-products are not increased immediately, they will just sink without a trace,” top industry sources said.

As we predicted, India has decided to cut subsidies. However, even at this lower level, subsidies will account for 3% of India’s GDP. It doesn’t take much imagination to anticipate that more price increases are in the offing. Yet even a small decrease in the price supports appears likely to generate domestic protests. From the Financial Times:

India’s Congress party-led government increased prices at the nation’s fuel pumps on Wednesday, prompting a backlash from rival parties and threats of street protests.

The government raised retail prices of petrol, diesel and liquid petroleum gas by 8-17 per cent to reduce the burden of fuel subsidies expected to jump to $57.8bn this year – more than 3 per cent of gross domestic product…

In a televised address on Wednesday night, Manmohan Singh, Indian prime minister, urged citizens to conserve fuel, saying the price rises were “inevitable” to relieve pressure on the state-run oil companies that have shouldered the burden of the oil price surge with the help of government bonds.

“I know that the price increases we have had to announce today will not be popular, even though they are only modest,” Mr Singh said.

India, which imports more than 70 per cent of its oil needs, has been under pressure to increase fuel prices for months….

The government left the price of kerosene, the most important fuel for the poor, unchanged.

Crisil, a rating agency, estimated the price rises would cause an increase in inflation of nearly 1 per cent.

Economists described the latest price rises, which will reduce the subsidy by less than 10 per cent, as too small to be anything other than a “band-aid” measure.

“You’re not tackling the problem, you’re dealing with the symptoms,” said Rajeev Malik, economist with JP Morgan.

India’s leftist parties, on which the United Progressive Alliance coalition depends for its parliamentary majority, vowed to stage national protests.

Raising oil prices will have a “cascading effect and heap further burdens on the people”, said the Communist Party of India (Marxist), calling for a windfall tax on oil company profits.

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  1. rent_to_own

    I think the term subsidy needs to be somewhat more carefully used, as was the case here, when talking about India.

    But Saudi Arabia does not ‘subsidize’ fuel – it merely sells what it produces internally at a price lower than can be found somewhere else.

    At this point, the term ‘free market’ has frequently come to mean ‘sell me what I want at the price I offer.’ Which traditionally has been the perspective of the well off when competing against the not well off in the market place.

    But countries like Saudi Arabia or Brasil or Venezuela do not have to sell to us at a price we determine – they can simply use it themselves, for their own purposes, while we say they are subsidizing the cost of fuel, mainly because they are forgoing the profit of not selling it to us. In dollars – who says we don’t have a sense of humor?

    That they are using their own oil for reasons which don’t meet our standards is the problem which ‘subsidy’ encompasses – our standard being, we want to burn it first.

  2. Anonymous

    The idea that EM economies could have significant GDP growth while importing large amounts of oil is quickly fading. The impact on growth and standard of living will be severe and long lasting. The spot light will turn to Japan as it’s export market and Asia manufacturing base decline.
    Large importers of oil all face the same issue of lower standard of living for its citizens and the resulting political fall out.

  3. Anonymous

    I wonder how low the salaries in the US should fall for us to be competitive with the EM economies. Our workers have no subsidized oil, health care, child care. We have to comply with the environmental regulations. The salaries should fall 50% below of what they are in EM countries. IS it where we are going?

  4. Anonymous

    Could this potentially increase demand? Your article noted that many gas stations have no gas to sell. So no gas is selling. If the subsidy is lowered, yes, people will pay more. But how much demand has been stiffled due to lack of supply? Seems to me you could see demand increase as availability increases from zero, no? You are selling zero volumes at lower prices and now could sell more because higher prices will create the incentive to supply more.

  5. Lune

    I like how the communists are proposing a windfall profits tax when the oil companies are going bankrupt from the subsidies. With economic reasoning like that, it’s no wonder they don’t like capitalism :-)

    On a more serious note though, India has a difficult problem. While subsidizing diesel for cars/scooters is stupid, there is an economic and social case for subsidizing fuel used for cooking and other tasks (e.g. kerosene), especially for the poor. We in the U.S. do this with, for example, assistance programs for heating oil and natural gas in the winter months.

    Unfortunately, undertaking comprehensive subsidy reform during a crisis like this isn’t politically easy. But perhaps the impending annihilation of their domestic oil industry and destruction of their federal budgets will finally focus their minds…

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