**[investwise]** Oil Reforms: Expensive Short Term, Sensible Long Term

 

Oxford Analytica India: Why Should State Subsidise Private Transport?   The Indian government announced May 25 that it was ceasing to subsidize the price of petrol and was cutting its subsidies on diesel, kerosene and liquid petroleum gas (LPG). It intends to move to a system of full market pricing for diesel over coming months. Kerosene and LPG, which are used as popular cooking and heating oils--the latter especially by the poor--may remain subsidized for the foreseeable future.   The decision caused widespread surprise. With headline inflation rates running at more than 10%--and food prices rising by an annual 17%--few expected the government to take steps with further inflationary consequences. The immediate effect of the price hike may add 0.9 percentage points to overall inflation, according to initial estimates.   However, the government may have reasoned that the impact would be less noticeable now than at a later date, as international oil prices are relatively low.   Pricing Reform What is less surprising is the government's wish to float petroleum prices at some point. This has been the official policy of successive governments over the past decade, reinforced by no fewer than four commissions of enquiry.   The principal mode of the subsidies has been for public-sector oil companies to sell their products at loss-making rates. The government would then compensate through the issue of off-budget oil bonds. Last year, despite the fact that global oil prices fell sharply from their 2008 peak, the so-called under-recoveries of these firms amounted to $18 billion. The policy was thus a heavy burden on both the national exchecker and the state oil firms themselves.   Under the new dispensation, under-recoveries should fall dramatically and the government could save as much as $5 billion per year. This will support New Delhi's target of cutting the budget deficit from 6.9% of GDP in fiscal year 2009-2010 (ending March) to 5.5% in 2010-2011 and 4.8% in 2011-2012.   Industry Responses Only five years ago it appeared that private firms would become major players in the petroleum retailing sector. However, as global oil prices soared, the resulting subsidy payments not only exacted a heavy toll on public finances but made private firms unable to compete against their subsidized rivals.   In addition, some Indian auto manufacturers have greeted the news positively, believing that the impact on vehicles sales will be short-term and that there will be wider benefits from increased competitiveness of some home-grown brands. For example, the celebrated Tata Nano is one of the most fuel-efficient cars in the world, and several similar vehicles are being developed by rivals.   Political Resistance Support from industry for the new policy is not matched among politicians, leaving uncertainty over the extent to which the plans--notably, those concerning diesel--will be adhered to. In the past governments have often backed down in the face of public protest. Opposition parties are exercised by the impact on living costs; the transport industry is strongly organized and has a history of launching crippling strikes.   In this context, it is striking that the United Progressive Alliance (UPA) government has got this far. While it contains a core of known economic liberalizers gathered around Prime Minister Manmohan Singh, Finance Minister Pranab Mukherjee and Home Minister Palaniappan Chidambaram, it also depends on the support of coalition partners with more obviously populist agendas.   The 13 months since the UPA was re-elected has seen friction between them, stalling a number of important bills. These include bills to ease the problem of acquiring land for industrial and infrastructure purposes, to open the education sector to foreign competition, to reform the pensions and insurance sector and to tighten intellectual property rights.   Outlook It may be that a brief window currently exists when Singh and his allies will be able to smuggle through, so to speak, more of their reform agenda before the pressure of seeking electoral popularity closes it again. In India the reform agenda has always proceeded more by stealth than by public acclamation. The time could be ripe, over the next few months, for it to make a significant advance--providing the present protests against rising prices do not prove overwhelming. Safe Harbor Statement: Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.   Nothing in this article is, or should be construed as, investment advice.

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