Under-recoveries on diesel at record Rs 14.50 a litre, price hike inevitable now

light-diesel-oil-250x250Vivek Kaul 

The under-recovery on diesel being sold by oil marketing companies(OMCs) for the fortnight starting September 16, 2013, has shot up to Rs 14.50 per litre. It has gone up by 42% in a period of one month. For the fortnight starting August 16, 2013, the under-recovery had stood at Rs 10.22 per litre.
So what are under-recoveries? The Rangarajan Committee report of 2006 stated that the OMCs are “are currently sourcing their products from the refineries on import parity basis which then becomes their cost price. The difference between the cost price and the realised price represents the under-recoveries of the OMCs.”
The price that OMCs charge dealers who sell diesel is referred to as the realised price or the depot price. If this realised price that is fixed by the government is lower than the import price, then there is an under-recovery. Having said that under-recoveries are different from losses and at best can be defined as notional losses. (For those interested in a detailed treatment of this point,
 can click here).
The OMCs need to be compensated for the under-recoveries. One part of the compensation comes in directly in the form of additional cash assistance from the government. Another part comes by the way of financial assistance from upstream national oil companies. Hence, companies like ONGC and Oil India Ltd, which produce oil, need to compensate the OMCs i.e.
 Indian Oil, Bharat Petroleum and Hindustan Petroleum, for a part of their under-recoveries.
The government has budgeted 
Rs 65,000 crore this financial year for petroleum subsidies. This is for the payment that it makes to the OMCs, for the under-recoveries they incur on the sale of diesel, cooking gas and kerosene. As per the data released by the Ministry of Petroleum and Natural Gas yesterday, the under-recoveries currently stand at Rs 486 crore per day.
The trouble is that a part of the budgeted subsidies have already been utilised for payment of under-recoveries for the last financial year. Also, most finance ministers over the years have under-budgeted for these payments.
Like in the financial year 2012-2013, the petroleum subsidies had been budgeted to be at Rs 43,580 crore. The actual subsidy bill finally came in at Rs 96879.87 crore. A similar trend was observed in the financial year 2011-2012 as well. The government had budgeted Rs 23,640 crore for petroleum subsidies. The final bill came to Rs 68,481 crore.
The Financial Express reports that “At current rate, the three oil PSUs are projected to lose Rs 156,000 crore in revenues in the financial year ending March 31, according to Indian Oil Corp (IOC), the nation’s largest oil firm.”
This number is similar to the total under-recoveries of Rs 
1,61,029 crore last year. Of this the government had paid around Rs 1,00,000 crore to OMCs, the remaining cost was borne by the upstream national oil companies.
So what this means is that the government will have to incur a higher expenditure to compensate the OMCs for the under-recovery than the Rs 65,000 crore it has budgeted for. This would mean a higher fiscal deficit. Fiscal deficit is the difference between what a government earns and what is spends.
Data put out by the Controller General of Accounts shows that as on July 31, 2013, the fiscal deficit for the first four months of the financial year 2013-2014 was at Rs 3,40,609 crore. The fiscal deficit targeted for the financial year is Rs 5,42, 499 crore.
Hence, 62.8% of the targeted fiscal deficit has already been exhausted in the first four months of the year. If the government continues at this rate, by the end of the financial year it will overshoot its fiscal deficit target by a huge mark.
The finance minister P Chidambaram has said over and over again that the government will stick to the fiscal deficit target come what may. The numbers as of now tell a completely different story.
In the last financial year 2011-2012, the government had exhausted 51.5% of the targeted fiscal deficit during the first four months. To meet the fiscal deficit target, the expenditure was slashed majorly in the last few months of the year.
Given this, if the government has to meet its fiscal deficit target, the first thing that it should be doing is to raise diesel prices. Of course, it cannot raise the price of diesel by Rs 14.50 per litre at a single go. But a significant increase of at least Rs 5 per litre is due.
If it is not carried out, the chances of a sovereign downgrade of India by the rating agencies will become extremely high in the months to come. This is because the fiscal deficit of the government will bloat up. A sovereign downgrade will see India’s rating being reduced to ‘junk’ status. This would lead to many foreign investors like pension funds having to sell out of the Indian stock market as well as the bond market, given that they are not allowed to invest in countries which have a “junk” status and that will put further pressure on the rupee, which has recovered nicely over the last few days.
At the same time any increase in the price of diesel pushes up freight and transport costs. This will lead to a higher inflation, especially food inflation. Data released yesterday shows that food inflation currently stands at 18.8%. As Sonal Varma of Nomura pointed out in a note yesterday “
The jump was mainly due to a steep rise in primary food price inflation, which rose to 18.2% year-on-year in August from 11.9% in July from higher inflation of vegetables, fruits and protein-rich food. Vegetable price inflation jumped 78% year-on-year in August from 47% in July, led by a steep increase in the prices of onions (245%).”
Multiple
 state elections are due over the next few months and any further rise in food prices is going to cost the Congress led UPA government dearly. Many an election in India has been lost on spiralling onion prices.
But if the government doesn’t increase diesel prices then there is a considerable threat of being downgraded by the rating agencies to junk status and that will put further pressure on the rupee. So that’s the catch 22 that the government finds itself in. Having said that, its a problem created by the Congress led UPA government by refusing to de-control the prices of oil products. Also, a higher inflation number will make it difficult for Raghuram Rajan, the new RBI governor, to announce any interest rate cuts in the months to come, as the government wants him to.
So what will the government bite the bullet on hiking diesel prices? Oil Secretary Vivek Rane had an answer for this. As he said yesterday”Some burden has to be borne by consuming population. That is the challenge government faces. It is a political challenge, it is an economic challenge. It is a challenge we cannot run away from.”

The article originally appeared on www.firstpost.com on September 17,2013

(Vivek Kaul is a writer. He tweets @kaul_vivek) 

 

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About vivekkaul
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System , the latest book in the trilogy has just been published. The first two books in the trilogy were published in November 2013 and July 2014 respectively. Both the books were bestsellers on Amazon.com and Amazon.in. Currently he works as an economic commentator and writes regular columns for www.firstpost.com. He is also the India editor of The Daily Reckoning newsletter published by www.equitymaster.com. His writing has appeared across various other publications in India. These include The Times of India, Business Standard,Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal, Quartz.com, DailyO.in, Business World, Huffington Post and Wealth Insight. In the past he has also been a regular columnist for www.rediff.com. He has lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore). He has also taught a course titled Indian Economy to the PGPMX batch of IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He can be reached at vivek.kaul@gmail.com

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