What Parikh Can't do for the government" Financial Express: Feb 6 2010

It may sound uncharitable to say that the Kirit Parikh Committee Report on Pricing of Petroleum Products is quite banal and lacks novelty. But we have had the Rangarajan and Chaturvedi Committee Reports in the past that spoke on similar lines. Hence, we already know that petroleum prices should be freed and there should be competition. The problem is on the implementation side, which is always outside the purview of government-appointed committees. Therefore, while this report does not really add to the literature on the subject, or at best, is an update, it can be considered to be another reminder to the government to act fast.
At the moment the government supports fuel prices at levels lower than the market price, leading to losses of around Rs 40,000 crore for the oil companies this fiscal year. The suggestions, to begin with, are to increase the price of petrol by Rs 3 per litre, of diesel by Rs 3-4 per litre, of LPG by Rs 100 and of kerosene by Rs 6 per litre. Further, better distribution of kerosene and LPG is recommended.
The focus here again is on implementation. Two different kinds of analogies may be drawn that provide a view on government action when moving from a controlled to an open system. The first is the telecom sector, where BSNL/MTNL had a monopoly and could charge high prices. Competition and opening of the market helped to lower prices. This was welcome but the two parties involved were a government company and the common man. The common man benefited finally and the government companies were forced to become efficient.
The farm sector is the second area where there is considerable regulation in terms of prices. Here the minimum support prices fixed by the government are often biased upwards to help the farmer. However, higher prices emanating from free market operations are viewed with suspicion. One can recollect that futures trading in wheat, sugar, etc, have been banned at times based on this argument.
This is so because the government gets caught in a quandary whether to favour the farmer or the consumer. Higher farm prices, while helping the farmer, also mean higher inflation for the consumer and that is not exactly palatable. Therefore, inflation caused by higher MSPs is acceptable, while the same for non-MSP products is not. The argument is that when the market arrives at a higher price, it is the middlemanwho gains and not the farmer, while when it is due to the MSP, it is the farmer who is gaining and not the middleman.
The farm analogy is pertinent to oil prices because the two counter-parties concerned are the common man and the oil company—that is the government at present. Keeping this in mind, the freeing of fuel prices raises some questions.
Let us assume that these recommendations are implemented and the prices are market- determined. Prices will move in line with world prices. Higher volatility currently has been eschewed by having prices fixed by the government. A deviation will lead to greater volatility. Another scenario is when global prices fall to, say, $40 a barrel and retail prices are rolled back commensurately, then both the government (excise collections) and oil companies will have a problem on their P&L. This is why prices remain sticky downwards. Are we prepared for this situation?
Higher fuel prices would automatically mean that transport costs will increase and feed into commodity prices. Therefore, even a good harvest could mean higher prices if fuel prices move up. Are we willing to accept these price changes?
Free pricing in the market that has, say, four to six companies will create an oligopolistic situation where prices can be driven higher to enhance profits. This happens in all markets where initial competition can lead to lower prices to keep others out, but that gets reversed subsequently. In this case it is more likely that prices will gravitate upwards. Is this okay with us?
Further, an oligopolistic situation can lead to shortages as companies will take bets on future price movements and it may make sense to supply less today and more in the future when prices increase. Will petrol and diesel then be classified as essential commodities and stock limits placed by the government as they have done for foodgrains?
Assuming that such situations come up, will the sugar model (or muddle) be applicable here where the government suddenly starts imposing quota releases and price bands for oil products?
While some of the doubts raised here may sound far-fetched, we have seen that the government isn’t politically prepared to have open markets and free pricing for essential commodities. Freeing markets is easy, but we need to show character by sticking to the consequences. Otherwise, the present approach where the referee (government) increases or decreases theprice is adequate. But, then this is not analogous to free pricing and competition.