Rangarajan Committee Report: Sets the ground, but implementation is a challenge

The pricing of petroleum products has always been a sensitive issue. In 2005, the government set up the C. Rangarajan Committee to review the key issues relating to the prices of petroleum products such as petrol and diesel. This story from our archives provided a critical insight into the committee’s recommendations and their expected impact. 

Even though the administered pricing mechanism in the petroleum sector was abolished as long ago as April 2002, the prices of petroleum products such as petrol and diesel are still being regulated by the government. Also, the subsidies on domestic LPG and PDS kerosene, which were supposed to be phased out within three to five years, continue to dent budgetary finances.

Ever since crude prices started spiralling in late 2003, this policy has translated into negative margins for oil marketing companies on petrol and diesel, a high subsidy of Rs 266 billion on LPG and kerosene and a burden on companies including ONGC, OIL and GAIL that have been sharing losses with the oil marketing companies.

The recommendations could lead to lower-than-required increases in petrol and diesel prices, reduced subsidies on kerosene and LPG account and a decrease in the burden on upstream players.

In order to bring a closure to this mess, the government formed a committee led by C. Rangarajan in 2005. The committee released its report in February 2006. The recommendations could lead to lower-than-required increases in petrol and diesel retail prices, reduced subsidies on kerosene and LPG account and a decrease in the burden on upstream players. The committee has made four broad recommendations for petrol and diesel. One, it has recommended shifting away from the current import parity pricing to a new trade parity pricing formula for determining refinery gate as well as retail prices. The committee argues that since the country exports 20 per cent of its production, the trade parity principle for pricing petrol and diesel – that is, a weighted average of the import parity and export parity prices in the ratio of 80:20 (with a provision to review the weights every year) – would be more appropriate. Also, the trade parity price should be port specific as against weighted average import parity prices currently followed for fixation of consumer prices of petrol and diesel. The trade parity price should be taken as the indicative ceiling by the marketing companies while fixing the actual retail price and there the committee has urged against any involvement of the government in price setting.

Two, the committee has suggested reducing the customs duty on petrol and diesel to 7.5 per cent from the current 10 per cent. This, it argues, would reduce the effective rate of protection for refining these two products from the present 40 per cent to a more reasonable rate of 20 per cent.

Three, the committee has asked for a movement towards a pure specific excise duty levy on petrol and diesel from the present mix of specific and ad valorem since the committee finds the practice of imposing ad valorem duties during the phase of escalating crude prices debatable. It has also asked for calibrating the levies at Rs 5 per litre of diesel and Rs 14.78 per litre of petrol. (Currently, the excise duty on petrol is 8 per cent plus Rs 13 per litre while it is 8 per cent plus 3.25 per litre on diesel.)

And fourth, the committee has voted against the principle of freight equalisation (that is equalised freight for all the locations across the country for computation of the prices of petrol and diesel) which according to it, will help in transmitting the right price signals specific to each location and would result in lower prices in coastal areas and higher prices at inland locations.

The first three recommendations, if followed, would lead to a lower increase in the prices of petrol and diesel than that which has been demanded since the last price revision in September 2005. Also, the committee has recommended a full adjustment in retail prices so that there is no loss on sale of petrol and diesel.

For PDS kerosene, the committee has recommended restricting the supply only to families below the poverty line (BPL) since the policy of giving kerosene at subsidised prices under the PDS to all customers regardless of their economic status is resulting in waste, leakage, adulteration and inefficiency. This, according to its estimates, would reduce the quantity of PDS kerosene going through the subsidised route by about 45 per cent from the present level and would consequently reduce the subsidy burden by Rs 63.15 billion.

The committee has recommended discontinuing the subsidy on domestic LPG as it believes that BPL households constitute only about 10 per cent of the total domestic LPG consumers and therefore the subsidy is not achieving its desired purpose. The issue price of domestic LPG is Rs 236 per cylinder (corresponding to retail price of Rs 294 per cylinder) against the cost price of Rs 407 per cylinder implying a subsidy of Rs 171 per cylinder. This translates, at the aggregate level, to a subsidy of over Rs 110 billion. The committee has suggested a one-time increase of Rs 75 per LPG cylinder, which will reduce the annual burden of subsidy by Rs 45 billion.

Overall, according to the committee, the above measures would reduce the annual gross subsidy on kerosene and LPG to Rs 158.75 billion from Rs 266.40 billion at 2005-06 prices. The reduced subsidy, the committee says, should be borne through the budgetary support of Rs 29 billion (the amount provided for in the budget for 2005-06) and by increasing the rate of cess on crude from the current Rs 1,800 per tonne to Rs 4,800 per tonne. This would bring in Rs 130 billion from ONGC and OIL. ONGC and OIL are currently bearing a cess of Rs 1,800 per metric tonne or Rs 50 billion which is pooled in the consolidated fund without explicitly being allocated for meeting oil subsidy. They also incur an upstream of Rs 130 billion. Due to the proposed arrangement, their contribution would stand reduced from Rs 180 billion to Rs 130.

While the report has certainly provided a framework for reducing the impact of skyrocketing oil prices, it remains to be seen how the government will tackle this politically sensitive issue with elections round the corner.

Deepika Mangla