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Rashmin Sanghvi & Associates

Chartered Accountants

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Tardeo Road,
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Maharashtra, India.

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Home Articles Economics & Investment         Share :

The Oil pool Deficit

Petrol Price Problem

20th June, 1996

Mr. P. Chidambaram Piloted discussion and Government announced increase in the price of petroleum products by 25% to 30%. Taxi and Rickshaw drivers went on strike. Congress, BJP and CPI criticised the price hike strongly. Share prices crashed. Prime Minister Deve Govda had never imagined such a wide spread protest. Ultimately the Government had to announce a price reduction in diesel.

What is at the root of the whole crisis ?

Petrol Economics

Rupee was devalued from Rs.31.35 per dollar to Rs.35 per dollar. About 11% devaluation. Reserve Bank does not accept the term "devaluation" because they say it is the market forces which decide the price. Fact is that RBI manipulated demand and supply of dollar in such a manner that the rupee value went down.

India imports more than 50% of its petroleum needs. If the rupee is devalued, the cost of petroleum in India, in terms of Indian rupees is bound to increase.

Petroleum price in India would be affected by three broad factors :

1. International price of crude oil and petroleum products in terms of dollars;

2. Rupee - dollar parity ;

3. Inflation within India.

The Indian inflation will affect the cost of mining Indian crude oil, cost of refining all the crude oil (local as well as imported) and distribution of petroleum products.

After the last devaluation, the price of petrol, diesel etc. were not increased for several months. All three factors had accumulated and there was no alternative for the Government but to increase the prices.

Election Politics

Dr. Manmohan Singh and the Congress party knew that they had no alternative but to increase the price of all petroleum products. Any increase in petroleum price would mean a general inflation. And inflation means loss of votes for the ruling party. And election was fast approaching. Why take the blame? Let the elections be over and then take stock of situation. In any case, congress was suspecting that it will loose the elections. Why take any more chances ?

So Congress did not announce price increase. The oil pool account got into a huge deficit. This deficit will be reflected in the budget to be presented in February, 1997.

As expected, Congress got defeated in the elections.

BJP come to power for a few days. It also had the same calculations. Why take any unpopular decisions ?

Then come the U.F. government and Mr. Govda become the Prime Minister. He had no further option to pass the buck. He had to take the hard decision. But probably nobody expected the strong protest from all over the country.

Inflation Economics

Whenever there is a devaluation of rupee, there has to be an inflation in the economy. Because of the administered prices, the exact impact of inflation may be delayed. But at some point of time, there is bound to be an increase in the costs.

This cause - and - effect cycle works in the following manner ;

Because of a devaluation in rupee, the crude oil price in terms of rupee increases. Hence the prices of petrol, diesel, kerosene, LPG (Home cooking gas) and all petroleum products have to be increased.

With the increase in petrol prices the cost to motor car owners and taxi drivers increases. Nobody is bothered if the car owners suffer a cost increase. But the taxi driver can not absorb the increase in petrol costs. He has to increase the taxi fare. And this affects the middle class people. All the bus companies have to increase the bus fares - which affects the middle class as well as the poor.

When the diesel price increases, the entire truck transport industry is affected. They increase the transport - freight rates.

Railways consume diesel. They have to increase railway fares.

The Kerosene price increase directly hurts the poor. So normally, Government does not increase the kerosene price despite devaluation. The cost of subsidy on kerosene is passed on to other products like petrol.

LPG price increase is another direct hit to the housewife.

LPG and Kerosene price increases are direct blows on the common man.

Increase in bus, taxi and railway fares is a secondary blow on the consumers.

Now consider the tertiary blows.

Since freight cost increases, the cost of vegetables increases. This affects the housewife and all the voters in India.

For industries like - converting bauxite into aluminum (Hindalco Nalco etc.), and converting scrap iron into steel (mini-steel plants); electricity cost may be more than raw material costs. They have to increase the price of aluminium and steel. So the cost of aluminium utensils has to go up.

Electricity is generated in two manners - Hydro electricity through dam waters. There is not a significant impact on their cost of electricity generation. Thermal electricity may be generated by using coal or petroleum products. Those dependent upon petroleum products as fuel have to increase the cost of electricity.

Electricity distribution companies take electricity generalted by all kinds of plants. They average out the cost increase and increase the electricity tariffs to the consumers.

In the same manner all industries are affected to a smaller or greater extent. Crude oil is an energy. In this century, it is the most wide spread energy. When the price of energy increases, inflation is bound to follow.

Why devaluation ?

Whenever there is inflation in the country, cost of production within India increases. So an exporter finds it difficult competing in the international market. How can he compensate for the internal inflation ? Entire exporters' lobby clamours for devaluing the rupee. This will make Indian products cheaper in the international market and the exporter can compete.

Somehow, Government and RBI are convinced of this logic. They feel that every devaluation helps increase exports. And in a foreign exchange starved nation, export is a top priority. So they keep devaluing rupee.

However, they forget that they are setting off a vicious cycle.

Because of Indian inflation, exporters want devaluation. Devaluation causes inflation. So they want more devaluation. And the cycle goes on and on. In the process, the Indian public suffers more and more. And when the sufferring goes beyond limits, they protest. And poor Mr. Deva Govda is at a loss - "what happened !"

When all prices increase - industrialists and traders increase the prices of their products. Organised union workers ask for increase in dearness allowance. Unorganised private sector and casual workers suffer. Political parties and general public are protesting against inflation. But once a devaluation of the currency is made, inflation is unavoidable. It is necessary to protest vehemently all devaluations.

Rashmin Sanghvi
Date: 20th June, 1996