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Introduction

The Crude Oil Prices have steadily increased over the past decade.

AGGREGATE DEMAND

AggregateDemand

HouseholdConsumption

(C)

GovernmentConsumption

(G)

Net Exports

(X)

Private

Investment(I)

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In Rupee terms

Imports have increased reducingthe Net Exports (X) component ofaggregate demand.

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Impact on Household Consumption (C)

Affects the Cost of Production

DieselTrucks and Railways, fertilizers and pesticides for

agriculture, plastic-manufacturing

Major Contributor to Cost Push Inflation

Prices of Products are partially increased to Offset production costs

High Inflation with negative sentiments to future prices led

to decrease in household consumption

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Impact on Government Consumption (G) Cushioning effect though fuel price subsidies

Administered Pricing Mechanism

Increases the government expenditure

Partial pass-through of price rise cushions the fall in household disposableincome, which has a positive impact on Aggregate Demand

However this is not sustainable in the long term considering the supply sidebottlenecks and the rising Fiscal Deficit

In Long Term its advisable for the Government to reallocate the money

used for subsidy to more productive channels, like incentivizing the searchfor Crude Oil sources domestically

Government can also attempt Long-term capital formation throughinfrastructure development

Private Investment has reduced due negative business expectations due to

Decreasing Aggregate Demand

Persistently high interest rates

Impact on Private Investment

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Overall Impact and RBIs Monetary Policy stance

Reduction in GDP growth rate -higher unemployment levels

Cost-Push Inflation has hit the BOP hardest

Situation of Stagflation

RBI had hiked the Repo Rate 13 times along with CRR hikes

Fight inflation by sucking the liquidity in the market

Control Demand side

Current inflation is mainly due to supply side and not a demand side inflation , thus

rendering the above measures ineffective

Fuel and Food major contributors to inflation

With supply side constraints, the impact of monetary policy is minimal

Cost-Push policy can be countered as reducing demands will force the manufacturers

to reduce the mark-up to increase the demands

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Transmission of International Oil

Prices to India

The three broad channels through which the international oil prices have a

deep impact on the economy are

a) Import Channel

b) Price Channel

c) Fiscal Channel

Import Channel:

India is a Net Importing Country

Susceptible to foreign bill variations Rise in Oil prices means real growth reduces

The Compression in aggregate Demand dampens the Growth

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Price Channel

Price channel is indicated by the link from international oil prices to

increase in administered prices to WPI inflation

The objectives for regulation of price of oil have been three-fold:

To protect the domestic economy from volatility in international oil

prices

To provide merit goods to all households,

To protect poor consumers so that they may obtain kerosene (through

PDS) and LPG at affordable

If the administered price of crude oil, gas and petroleum increase by 7 per

cent,

The overall WPI increases by 1 per cent (i.e. the total elasticity to be 0.14)

10% increase in Global Prices1 %point increase in WPI and 2% over

time

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Fiscal Channel

Absence of a complete pass-through, an international oil priceincrease will raise the subsidy on oil

Increase the revenue expenditure of the government

Oil prices though subsidized also generate revenue for both stateand centre

A rise in international oil prices affects the tax collected

The Tax Collections should however rise to result into a net addition into

the subsidy

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2.8 % of the GDP

Over 60% of State Exchequer

3 years Tax contribution has been higher than the subsidies provided by the

government

Contribution: Rs 136,000 crore and state 80,000 crore

Subsidy including Oil Bonds Rs.40,000 Crore

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International Comparison ofPetroleum Prices

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The table shows:

Price of all products except kerosene are higher than international market

This is applicable to the subsidized diesel

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The table below compares prices of petrol with other countries

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Break up of Retail Prices

Taxes are close to 50% of retail price

More than 50% of taxes are collected in form of Excise

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Projection of Financial Burden on

India

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The table above shows the projected consumption by 2020-21 and 2030-31

The two assumptions made in Kirit Parekh Report (2010)

The average annual compound growth rates of petrol diesel kerosene LPG during 2002-3 to2008-09 will apply to 2020-21 & 2030-31

The Current Level of prices set by government will continue

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The Figure below represents under-recoveries of OMCs on sale of petrol

diesel LPG and PDS Kerosene

These estimates reveal the share Diesel in Under-Recoveries and is

Projected to Increase from 45% of Crude to 58% at $150/barrel by 2020-21

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Financing the Under-Recoveries Significant impact on oil companies, notably the upstream national oil

companies

They are currently shouldering the majority of the nongovernment burden

On Elimination ,money would allow the companies to be properly andfairly financed

One way to finance part of the under-recoveries is to levy a windfallprofit tax on all upstream companies who were allotted blocks onnomination basis

The Chaturvedi Committee has suggested a special oil tax on domesticproducers of crude oil on pre-NELP leases

100% from a price level of $75/bbl so as to manage the huge under-recoveries

estimated for 2008-09. The tax should be either

(i) annulled

(ii) re-set downwards to equal the fuel subsidies made available only to BPL families for SKO andLPG

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Conclusion & PolicyImplementation

International oil price shock is expected to result in lower growthand higher inflation, via the trade channel, the fiscal channel and the

price channel

More substantial reforms are needed, including full deregulation of

diesel prices, and periodic increases of domestic liquefied petroleum

gasoline (LPG) and Public Distribution System (PDS) keroseneprices

Harmonize petroleum sector taxation with the proposed goods and

services tax (GST) in the framework of a tax on value-added

Reviewing and improving the tax system would yield a range of

benefits for the Indian economy, but can be seen as a medium- tolong-term measure

It is possible to proceed with diesel subsidy reform without changes

to the tax system

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Conclusion

Reforming fuel subsidies would improve Indias fiscal balance

Create fiscal space for increased investment in physical and social

infrastructure or other development-related expenditures

This will remove current market distortions (such as the growing number ofprivate vehicles being manufactured to run on diesel)

Incentivize energy efficiency and clean energy solutions, thereby reducing

pollution levels

Removing fuel subsidies entirely would also remove opportunities for

corruption and selling fuel on the black market

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Thank You