Further escalation in the price of petrol spoils the game for India’s growth story.

“I felt humbled by my achievement and instantly offered a short thanksgiving prayer to Lord Buddha after scaling the peak on May 21,” Jamsenpa said. Jamsenpa is a businesswoman – she runs Himalayan Holidays, a tourism enterprise, atIn November, the Oil Marketing Companies (OMCs like BPCL, HPCL etc.) raised petrol process for the umpteenth time since the pricing was deregulated in June 2010. The petrol prices were deregulated with deregulation of diesel, LPG and kerosene to be done in phases. However, only petrol prices seem to be getting revised and that too just upwards. Prices of other oil products are just raised randomly, when OMCs start making heavy losses.

As always, the hike in oil prices led to furore and discomfort amidst the public. Such moves are always popular with opposition political parties and there were many political statements of withdrawing support and opposing the hikes. However, the government just said the decision to raise oil prices was taken by companies and they had no say in it. Now this is only partly true as OMCs are government companies and even after petrol deregulation, the decision to raise prices is still random and done only when under-recovery (difference between world and domestic oil prices) is high leading to bleeding of balance sheets of OMCs.

This is all politics, which matters the most in India’s oil sector. What about economics?

The first obvious thing is it leads to higher expenditure for the people, which is also reflected in the statistical inflation, as oil prices form part of the Wholesale and Consumer Price Indices (WPI and CPI).The second is indirect inflation, as higher oil prices are transferred from producers to consumers. The third is the role of depreciating rupee in this recent petrol price raise. The RBI, in its analysis, showed though oil prices have declined by 7.9% from a peak in July 2011, the Indian Rupee has depreciated by 10.7% resulting in a net rise in oil bill by 2%. As India imports nearly 70% of its oil demand, depreciation of the rupee always plays a crucial role.

The fourth is the cross-subsidization of petroleum products, which also involves a lot of politics. In order to please the huge agriculture and transportation sector lobbies, the government has traditionally provided higher subsidy on diesel (and LPG to please the aam aadmi) and lower subsidy on petrol. OMCs have milked petrol consumers and let go of diesel consumers. Now petrol has been deregulated but subsidies on diesel and LPG continue. This is called cross-subsidization and makes the whole market inefficient. People prefer diesel vehicles instead of petrol ones and you have much higher carbon emissions, and diesel engines are less efficient. This leads to poor environmental economics as well. What is worse is that none of these subsidies reach the poor as multiple studies have shown, and on the contrary, go to the rich.

These are all short-term issues which India has been grappling with for a while. The larger issue is of energy insecurity in the country. India faces an enormous challenge of developing amidst elevated oil prices. It is true that in real terms (nominal prices minus inflation) oil prices are similar to those seen in the 1980s, but here the challenges are enormous. The other countries developed with oil prices remaining much lower and there was not much upward pressure on oil prices. The oil markets were not as well-integrated with other markets as well. This is not the case now and just one news of better growth in US and other parts of the world pushed oil prices higher.

This century is going to be driven by the emerging and developing economies, most with large populations. Hence, the pressure on oil prices is only going to increase. India, with the second largest population and favorable demographics, will put maximum pressure on world oil markets.

How does India develop without leading to this vicious circle of rising oil prices and inflation? Oil is like grease for growth but could easily be sand in the wheel of growth as well. India clearly faces two policy challenges in this case: Find more energy sources of its own and develop alternative sources of energy other than imported oil.

by Amol Agrawal