THE government decision to stick to the easy solution of subsidising petroleum products to shield people from rising international crude oil prices has caused a perverse situation. While it has destroyed the wealth of shareholders of oil marketing companies (OMC), huge liabilities have been created for future. The oil bonds, which the government has issued and is planning to issue for 2007-08, will create a huge burden of over Rs 60,000 crore to be repaid in future. That’s not all. A policy of cheap oil means less incentive for consumers and industry to conserve energy.
Reeling under mounting losses, the OMCs have turned out to be losers on bourses, when other companies created enormous wealth for their shareholders. By October 2007, the Sensex had gained around 45% during previous 12 months and private oil major Reliance Industries had more than doubled its market capitalisation. In contrast, government-owned OMCs witnessed a fall in their market capitalisation. During the October 2006-October 2007 period Indian Oil’s market capitalisation fell 5.3%, BPCL’s by 16.8% and that of HPCL by 28.4%. However, the situation has marginally improved as IOC’s market capitalisation rose in last two weeks.
It is the government, which has emerged the biggest loser being the largest shareholder in these OMCs while the situation of the retail investors in these companies continues to remain miserable.
And who is responsible for this value destruction? Of course the subsidies of fuels by the government. The government feels it necessary to offer petrol and diesel at lower rates for retail consumption to shield Indian consumers from inflationary pressure of higher oil prices. But there was a better way to achieve this, lower the burden on indirect taxes, Custom duty, excise and sales tax, imposed on these products.
Besides the heavy spurt in international crude oil prices, huge indirect taxes imposed by central, state and local governments are all the same responsible for the over-inflated retail prices of petrol and diesel in India. Indian retail prices of petrol and diesel typically comprise of around 55% of taxes i.e. out of Rs 50 per litre of petrol that a consumer pays around Rs 27.50 goes in form of various taxes.
High level of indirect taxes in itself is not an evil and India consumers are certainly not the highest taxed citizens in this regard. European countries historically have even higher indirect taxes on these transport fuels, which has helped the governments to raise resources while inducing energy conservation. Despite the high level of economic growth, the consumption of petroleum products in the Europe has grown at a CAGR of 1.3% over last 15 years - substantially lower compared to 1.9% in the US, which favours cheap oil policy.
However, the current situation in India is comic where both - high taxes and subsidies - co-exist. While the political leadership wants to offer the fuels at subsidised rates, it is not ready to cut down on its handsome tax income. Oil sector contributes over one-third of Indian government’s gross tax revenues. The issue of oil bonds to the OMCs to finance these subsidies means the government is ‘eating the cake and having it too’ - only it is borrowing its cake from the future. Because, these oil bonds have created liabilities for future.
Except for the illusion of softening inflation thanks to cheaper fuel, the government has achieved little from this financial jugglery. The value destruction has been immense during the entire process. At the average Sensex growth of 45% the trio IOC, HPCL and BPCL could have added over Rs 38,000 crore to their market capitalisation during last 12 months. At the same time, the growth in ONGC’s market capitalisation could have been tremendous, had it not been forced to share the subsidies.
The issue of the oil bonds will have serious long-term ramifications apart from the more visible financial impact. Cheaper fuel will inevitably increase wasteful consumption of petroleum products within the country resulting in higher import bill. At the same time, availability of subsidised fuels will hamper growth of alternatives or better technologies towards conservation of petroleum resources. Lastly, lack of competition from the private sector may lead to higher inefficiencies within the OMCs.
Reeling under mounting losses, the OMCs have turned out to be losers on bourses, when other companies created enormous wealth for their shareholders. By October 2007, the Sensex had gained around 45% during previous 12 months and private oil major Reliance Industries had more than doubled its market capitalisation. In contrast, government-owned OMCs witnessed a fall in their market capitalisation. During the October 2006-October 2007 period Indian Oil’s market capitalisation fell 5.3%, BPCL’s by 16.8% and that of HPCL by 28.4%. However, the situation has marginally improved as IOC’s market capitalisation rose in last two weeks.
It is the government, which has emerged the biggest loser being the largest shareholder in these OMCs while the situation of the retail investors in these companies continues to remain miserable.
And who is responsible for this value destruction? Of course the subsidies of fuels by the government. The government feels it necessary to offer petrol and diesel at lower rates for retail consumption to shield Indian consumers from inflationary pressure of higher oil prices. But there was a better way to achieve this, lower the burden on indirect taxes, Custom duty, excise and sales tax, imposed on these products.
Besides the heavy spurt in international crude oil prices, huge indirect taxes imposed by central, state and local governments are all the same responsible for the over-inflated retail prices of petrol and diesel in India. Indian retail prices of petrol and diesel typically comprise of around 55% of taxes i.e. out of Rs 50 per litre of petrol that a consumer pays around Rs 27.50 goes in form of various taxes.
High level of indirect taxes in itself is not an evil and India consumers are certainly not the highest taxed citizens in this regard. European countries historically have even higher indirect taxes on these transport fuels, which has helped the governments to raise resources while inducing energy conservation. Despite the high level of economic growth, the consumption of petroleum products in the Europe has grown at a CAGR of 1.3% over last 15 years - substantially lower compared to 1.9% in the US, which favours cheap oil policy.
However, the current situation in India is comic where both - high taxes and subsidies - co-exist. While the political leadership wants to offer the fuels at subsidised rates, it is not ready to cut down on its handsome tax income. Oil sector contributes over one-third of Indian government’s gross tax revenues. The issue of oil bonds to the OMCs to finance these subsidies means the government is ‘eating the cake and having it too’ - only it is borrowing its cake from the future. Because, these oil bonds have created liabilities for future.
Except for the illusion of softening inflation thanks to cheaper fuel, the government has achieved little from this financial jugglery. The value destruction has been immense during the entire process. At the average Sensex growth of 45% the trio IOC, HPCL and BPCL could have added over Rs 38,000 crore to their market capitalisation during last 12 months. At the same time, the growth in ONGC’s market capitalisation could have been tremendous, had it not been forced to share the subsidies.
The issue of the oil bonds will have serious long-term ramifications apart from the more visible financial impact. Cheaper fuel will inevitably increase wasteful consumption of petroleum products within the country resulting in higher import bill. At the same time, availability of subsidised fuels will hamper growth of alternatives or better technologies towards conservation of petroleum resources. Lastly, lack of competition from the private sector may lead to higher inefficiencies within the OMCs.
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