Opinion: How Modi Government Finally Removed the Elephant in the Room

(M K Venu is Executive Editor of Amar Ujala publications group)

The Modi government has done the right thing by decontrolling diesel prices. This single reform will have a huge ripple effect in the rest of the economy. For years, diesel has remained the elephant in the room in any discussion on the massive petroleum subsidy and its deleterious effect on other macro-parameters such as the fiscal deficit, current account deficit, inflation and growth.

Public sector oil companies suffered huge under-recoveries which had a negative impact on their stock prices, impacting lakhs of small investors. We will be rid of this continuing nightmare with the diesel price decontrol.

In the past, year after year, the government would run up oil subsidies of the order of roughly 2 to 2.5 per cent of the GDP. Diesel would account for roughly half of this. This year, for instance, the total oil subsidies at the beginning of the financial year were projected at about Rs.1,30,000 crore. Of this, diesel would have accounted for Rs.65,000 crore. However, with oil prices falling 20 per cent in just a few months, the diesel subsidy has just disappeared. The government will, at one go, knock off over 1 per cent of GDP from its expenditure without doing anything! The good news is many international oil analysts say oil prices will remain around $90 per barrel in 2014 and 2015. If this is to be believed, then the Modi government is indeed in a sweet spot.

This was the right time to decontrol diesel prices. In May this year, the subsidised domestic price of diesel was about Rs.6.50 per litre below the international market price. This situation had prevailed even after the domestic price having been raised 19 times by 50 paise each since January 2013. It may be recalled the UPA government had taken a decision to gradually align the domestic diesel prices to the international market level by hiking the price in small doses of 50 paise per litre every month. That strategy worked to partially mitigate the subsidy levels, but even after these corrections we were way behind the curve.

In these circumstances, the 20 per cent fall in global oil prices has come as a boon. Analysts say for a net importer of oil like India - 80 per cent of our oil is imported - every $10 fall in oil prices can have a positive impact of up to a quarter percentage point in the GDP. This is possible if the government takes decisions in other areas of critical reforms. After diesel, the NDA must now attack the massive wastage in kerosene subsidy. Some say more than 50% of the kerosene subsidy (nearly Rs 30,000 crore per year) is used by the kerosene mafia, which mixes it with diesel.

True governance would require that the Modi government recall the sacrifice of an upright PSU oil company officer like Manjunath and create a new framework for the delivery of kerosene subsidy without compromising the needs of the really poor and needy. I am certain kerosene subsidy can be halved from its present level.

The other good news is that the international price of thermal coal, which had shot up to $135 per tonne at the peak of the global economic boom in 2008, has fallen back to about $60 per tonne. Since India had become a big coal importer over the past decade and more -- coal imports doubled from $8 billion to $18 billion - the fall in coal prices is also beneficial. This could have a positive impact on electricity prices which has become a contentious political issue in North India.

The government must come out with a white paper outlining comprehensive reforms in the energy sector, overall. India can use the currently deepening slowdown in the global economy and the consequent fall in food, oil and other commodity prices to quickly do important reforms in the energy sector, the lack of which disproportionately affects our macro parameters. These reforms will eventually fortify India from the ill effects of a sharper global slowdown. Indeed, some economists are predicting a mild global recession with the OECD economies slipping and the very real prospect of a property bubble -led recession in China.

India cannot escape if all major economies start slipping. It can, however, minimise the damage by getting its own domestic act right.

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