Petroleum Subsidies and Macroeconomic Variables in India

Abstract

The Government of India has been subsidizing petroleum products, particularly diesel, kerosene under Public Distribution System and domestic Liquefied Petroleum Gas (LPG), where these products are sold below their market prices. It is argued that rising petroleum subsidies have contributed to fiscal pressures in India. The present paper attempts to compare the trend of petroleum subsidies with other forms of subsidies given by the Government of India, and then examine the impact of petroleum subsidies on key macroeconomic variables like Wholesale Price Index, GDP, gross investment, fiscal deficit and interest rate based on official  data from 1992-93 to 2012-13. From a comparison with other components of gross subsidy, the study observes that it is not petroleum subsidy but food and fertilizer subsidies have grown at a sharper rate.  From the use of Vector Autoregression (VAR) for the difference of logarithm of the macroeconomic variable like GDP, investment, interest rate, Wholesale Price Index and Fiscal Deficit, the study observes that the growth rate of petroleum subsidy has no significant impact on the growth rates of these variables. On the contrary, petroleum subsidy has rather been Granger caused by some of the variables like interest rate and fiscal deficit. On the basis of these observations, the obvious argument should be not to target petroleum subsidy singularly as a culprit for rising fiscal deficit and inflation. However, when we make a closer look on the amount of under-recoveries of the Oil Marketing Companies (OMCs), our argument favors periodic revision of prices of petroleum products partially accommodating the fluctuations in the crude petroleum prices without reducing subsidies for the consumers as given in cases of PDS kerosene and domestic LPG.

JEL Classification Codes: C32, E60, H20, I38

Keywords:  Petroleum Subsidy, under-recoveries, macroeconomic variables, VAR, India