Wednesday, April 25, 2012

The right approach to deregulate diesel

The government has in principle agreed to deregulate diesel prices and make them more market linked. We just hope the decision is implemented in spirit and not just in letters. And we have valid grounds to doubt that. As we all know petrol despite being deregulated, continues to be sold below the international prices. The current pricing mechanism has been distorting markets, leading to dieselization of the economy.

While not much can be done regarding food subsidies, the central bank intends to target the fuel subsidies to contain the trade deficit. It is important to note here that petrol prices have been deregulated for more than a year now. However, diesel, which is consumed almost four times more than petrol (diesel forms 43% of the fuel basket while petrol comprises just 10%) is still sold at fixed prices. This makes the sale prices of diesel way off from the international prices. As fiscal deficit seems to be overshooting the target set at 4.6% for FY12 (expected to widen to US $160 bn) on account of rising food and fuel subsidies, the RBI is tightening the noose on government to deregulate diesel prices.

While some may frown on the suggestion as it may lead to inflation, the failure to do so will increase fiscal debt leading to rise in the price levels. However, this is a major policy change that can jeopardize the political interests. Hence to expect the Government to implement it at one go is unrealistic. A more feasible approach will be to segment the diesel consumption market according to the end user. 

For example, diesel can be subsidized for the farm sector but any such benefits to the private car segment should be cancelled. This will not only lay the right foundation, but also prevent the dieselization of the economy (on account of indiscriminate regulation of prices, the diesel consumption is witnessing growth of over 8%). Assuming no policy change, the petroleum subsidies by themselves are estimated to contribute to 0.8% increase in the fiscal deficit for current fiscal year. Thus the move to deregulate diesel prices will not just stabilize the fiscal balance; but also balance the markets in terms of rationalizing diesel demand.

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