Wednesday, May 23, 2012

Petrol Price Hike: Fantastic for the Economy

The massive petrol price hike of Rs 7.50 per litre, although causing a lot of consternation among citizens and non-Congress political parties, is a great piece of news for the economy after a long, long time.

Although in the immediate term the impact could be slightly negative, it’s the longer term implications that would prove beneficial. The government’s oil subsidy burden would come down, providing much needed relief on the fiscal deficit front.

The hike would also result in an improvement in oil companies’ profitability, deleveraging of their balance sheets and increase their free cash flows. This in turn would have a positive impact on capital investment plans of oil companies.

The hike would also ensure that those who consume a commodity are paying a fair price. After all, somebody has to bear the cost of rising international oil prices. Keep in mind that the drop in international oil prices is fairly recent, while the petrol price hike has been pending for a long time.

Furthermore, the price hike might actually help in halting the fall of the rupee, partly due to a short-term reduction in oil demand and partly by its impact on foreign exchange speculators. As I mentioned in an earlier story, never underestimate the power of the state.

And here’s the icing on the cake. If the price hike goes through, it gives out a loud and clear message that Congress is back in control. With that comes a high likelihood of the reform process restarting.

Of course, it would have been great if diesel and LPG prices could have been hiked, but that is, understandably, a very difficult bullet to bite given the impact on rural and lower middle class populations. The petrol price hike is probably cross-subsidizing the diesel and LPG prices. But something is better than nothing. And it’s likely that government, if it’s able to push through this price hike, would soon tackle diesel and LPG, too.

As for the immediate impact on the economy, it could be slightly negative, with a slight jump in inflation and a minor demand compression. However, going by prior experience, the impact would likely only be transitory. The hue and cry would soon die down and, in no time, people will have forgotten all about the price hike. Keep in mind that petrol prices were nearly half the current prices not so long back in 2008.

What could go wrong? Well, in many previous brave attempts, Congress fell flat on its face and had to roll back its decision within a few days. The decision to open up FDI in multi-brand retail, and its subsequent reversal in a few days, left a bitter taste all around that is still fresh in the mind.

Hopefully, this time Congress has got its act together.