Dilemma over fuel prices across Palk Strait

A few days ago, India’s state-run fuel ​retailers raised petrol and diesel prices by INR 3 per litre or more than 3% for the first time since the Iran-Israel war started to recover the losses incurred due to higher global crude oil prices, caused by military tensions in the Gulf region since early March. Incidentally, the world’s most populous country is one of the last major economies to raise retail fuel prices following the disruption to shipping through the Strait of Hormuz by the US-Israeli military aggression on Iran. Since the outbreak of the war, world crude oil prices have increased from $ 65/barrel to $ 105/barrel, reflecting a substantial 60% hike which has caused considerable financial pain on consumers worldwide. 

Prime Minister Narendra Modi had urged the Indian public to adopt austerity measures including fuel conservation, work-from-home, and limits on travel as well as consumption of imported commodities, as surging global energy prices put pressure on ‌the country’s ⁠foreign exchange reserves. Some states have already issued notices to Government departments to restrict travel, avoid physical events and shift meetings online, while also asking them to work from home two days a week, with offices half-staffed. As India is the world’s 3rd largest oil importer and consumer, such wide-ranging actions to curb fuel consumption would reduce the global demand for fuel, resulting in cooling off the price escalation, provided there are no severe disruptions to the crude oil supply chain owing to possible resumption of hostilities in the Gulf. 

India’s southern neighbour across the Palk Strait too is facing a quandary over rising oil prices and disturbances to the transportation of the commodity across the Strait of Hormuz. Recently, President Anura Kumara Dissanayake disclosed that the country’s oil import bill had surged more than six-fold between February and May owing to rising global energy prices. According to the CPC sources, although the cost of importing and distributing one litre of diesel is around Rs. 750, it is being sold at Rs. 392, incurring a loss of approximately Rs. 358 per litre. Last March, the FT View strongly argued in favour of maintaining a cost-recovery, pricing mechanism for fuel to safeguard the macroeconomic stability of the country. However, fearing the backlash of the masses who are illiterate in economics, the NPP administration, which is heavily influenced by the JVP’s populist viewpoints, has been hesitant to adjust local fuel prices in accordance with international price movements.

The non-adjustment of local fuel prices to match the rise in the international market has also irked the Central Bank (CB). At a public forum recently, Deputy Governor of the CB Dr. Chandranath Amarasekara had warned against reversing the post-2022, cost-reflective pricing mechanisms regarding utilities. The economist had emphasised populist subsidies and non-adjustment of fuel prices reflecting actual costs would again create the macroeconomic imbalances that led to the 2022 economic crisis while stressing that the commonly held perception among the islanders – fuel prices need to remain fixed regardless of the global developments – is in contravention of the fundamentals of economic theory.

It is only through market-based pricing; fuel consumption in the country can be effectively reduced, and not by public appeals. Furthermore, subsidising fuel consumption disproportionately favours the rich – an irrational course of action which our economy simply cannot afford. Unless the demand for fuel does not decline, the pressure on the local currency would not disappear, leading to an unnecessary rise in the cost of living.

Cost-recovery pricing of utilities is a key element of the IMF bailout package – the lifeline on which the economy is dependent. However, a considerable increase in fuel prices could adversely impact low-income groups. To relieve the pain arising from price increases on the financially vulnerable segments, the Government could explore the possibility of granting direct cash transfers to deserving households by deploying a portion of funds that have not been utilised for capital expenditure.