India - Subsidies Vs Supplies

When the government finally acted to raise petroleum prices modestly last month, one provocation was the danger of fuel shortages across the country. A few days before the price hike, the Indian Oil Corporation's chairman had stated that he had no money to import crude oil and his company had stocks to last just two days. When the Prime Minister appeared on TV the night of the price hike, he made the same point — it was a painful decision, but since the oil companies were running out of cash, it was a choice between having marginally more costly petrol/diesel and not having them at all. The problem is that the price hikes addressed only a small part of the "under-recoveries" by the oil marketing companies. And as oil prices have continued to rise, the country is once again faced with the possibility of having no petrol/diesel, as cash-strapped oil companies struggle to keep their operations going. Stray reports of supply shortages have surfaced from places like Punjab and Tamil Nadu. Acting within the maneuvering room that they have, the oil marketing companies have devised a partial solution — reducing supplies of regular petrol/diesel and replacing these with supplies of so-called premium petrol/diesel where the margins are higher (so that the companies lose less per litre sold). Such branded fuel comprised 12 per cent of sales in 2006, rose to 23 per cent in 2007 and is today around 38 per cent. This force-feeding of more expensive fuel is one of the reasons for the strike by truckers last week.

The supply situation would have been much worse, if not critical by now, if the Reserve Bank had not come to the aid of the oil marketing companies a few weeks ago. In an unusual measure, it decided to buy the oil bonds held by these companies without the discount operating on them in the money market, thereby giving the oil companies the liquidity with which to import crude and yet not suffer losses on the bond discounts. That luxury, however, is not available to the fertiliser firms that suffer from the same problem that the oil firms do: subsidies enforced by the government but paid for with bonds that suffer a discount in the money market. Global fertiliser prices have nearly doubled over the last year, as a result of which the fertiliser subsidy is expected to be Rs 95,000 crore this financial year — against a budgeted subsidy pay-out of just Rs 31,000 crore. The bonds issued to the fertiliser companies in lieu of cash trade at a 7.5 per cent discount, large enough to push the industry into the red. Not surprisingly, then, fertiliser production has fallen dramatically short, triggering agitations in Maharashtra and Karnataka — indeed, it has led to a political slanging match in Karnataka with the chief minister alleging default on the part of the UPA government. The simple truth is that the government's approach to the oil and fertiliser markets is not sustainable. Further price increases are ruled out, given the noise about rising inflation and the fact that this is a pre-election year. If the continuing subsidies are paid by issuing even more bonds, the oil and fertiliser companies will either run out of cash or go bust. There is only one thing the government can and must do: pay out cash subsidies so that companies in both industries can keep operating. The finance ministry will be reluctant to do this, since it immediately raises the fiscal deficit by very large sums and will demolish any claims about fiscal adjustment over the last five years. But informed opinion already knows that the bonds are merely disguising the deficit, and have recognised that the underlying picture is rapidly deteriorating. Far better then to make a clean breast of things, for this will have the immediate benefit of allowing companies to function and prevent supply disruptions. It is also worth bearing in mind that the policy of squeezing the oil marketing firms has led to the value of their shares falling dramatically (by about Rs 125,000 crore in the last 6-7 months). The government owns most of those shares, and it is therefore shooting itself in the foot with its present policy.