Dual pricing for diesel?

It is well known that the hefty diesel subsidy and the government's pricing policy, apart from adding a huge burden on the government finances, has also generated many distortions in the market for petroleum products. To add to the already distorted market, here comes news that the Government of India is toying with the idea of a dual pricing system for diesel. That this is a recipe doomed for failure ab-initio is too obvious to be stated. Besides, it will be a sure step backwards in the economic reforms path.

The government apparently wants to charge a higher price on certain categories of automobiles and industrial users, so as to reduce a subsidy burden that is fast sprialling out of control. The government has been spurred on by reports of a spurt in imports on non-commercial diesel vehicles and sales of big diesel vehicles in the domestic market. Faced with power cuts and uncertainties in power supply, many small industrial units and commercial establishments maintain diesel power generating units or generators, all of whom consume a substantial quantity of the subsidised fuel.

Despite its higher cost, diesel has traditionally been priced lower than petrol to keep costs lower for farmers, who use it for running tractors and other farm equipment. The subsidy on a litre of diesel now is Rs 13.69, as against Rs 6.31 for petrol. The price differential between the two types of diesel sold would therefore have to be more than Rs 10.

Needless to say, the administration of any such dual pricing mechanism will be a nightmare. The experience from kerosene and other PDS commodities at various times are immediate examples. It becomes an even bigger challenge than administering the aforementioned, since differentiating between these different categories of consumers is more difficult. Further, both types of diesel will have to be sold through the same outlets.

The economic logic against such a strategy is well known. With the demand for diesel relatively inelastic and the price differential being significant, any dual pricing would only incentivize the higher paying consumers to cheat. Why would I pay an extra Rs 10 for diesel when I can get it at a cheaper rate in the black? Vibrant underground parallel markets will spring up in every city, opening up massive rent seeking opportunities.

The only solution to reducing the increasing subsidy burden is to progressively raise the diesel prices and slowly dispense off with the distorting cross subsidies. Even if the government wants to adopt a price differntiation strategy, it should follow a more market based approach. It should tap into the differntial willingness to pay of differnt categories of consumers, rather than force consumers to buy at different rates. I have commented on this in an earlier post here.