By Rishabh Diwakar
During the 1980s, the situation of Brazils economy was quite similar to what India is facing today. The Brazil economy can be characterised as one of low growth, high inflation and fiscal imbalances (Current Account Deficit what we call today in India). The economic growth was about 3 per cent and inflation averaged 272 per cent. Fiscal policy was expansionary with overall budget deficit ranging from 5 per cent of GDP to 7 % in 1989. Weak reforms forced the authorities to control Imports and liberalize the economy, including energy sector. The energy market was similar to India which was also dominated by the state owned oil company, Petrobras. It had a monopoly in both upstream and refining fuels. Though fuel distribution was open to all private players, yet the prices of fuel, to the end customer, were determined by the government. To manage crude oil price volatility, an oil stabilization fund was established in 1980. The prices of oil sold to Petrobras refineries were adjusted by the government to keep final goods prices at a determined level. The fund was an accumulated contingent liability to the government when international crude oil prices were high and offset them when crude prices were low.
The case was similar to the diesel and LPG situation in India. Rise in international crude oil prices accumulated a huge loss on the stabilization fund and Petrobras ran up an enormous deficit.
Finally the government decided to remove the subsidy system. A gradual approach was adopted to remove the subsidies. The government promised that privatization and liberalization would reduce the cost of fuel by increasing the efficiency of the refinery.
Approach
Small steps were taken in liberalizing fuel prices. The process of liberalizing the market began in early 1990 with petroleum products like asphalt and lubricants. This was followed by liberalization of gasoline prices for the final consumer in 1996, LPG for the final consumer in 1998 and finally diesel in 2001. The subsidy of products which had weak political stakeholders was removed first and then those with better political stakeholders were phased out. Petrobras was left for the last in the liberalization process.
Affects
A short-run increase in inflation was seen, which was expected. This inflation was short term and eventually was offset in the long run; prices were allowed to fluctuate with developments in international markets.
Petrobras maintained its leadership in upstream and refining. Despite various steps of privatization Petrobras maintained its monopoly in the market.
Currency depreciation and high interest rates posed significant challenges for controlling the fiscal costs of subsidies. Frequent price increase was done despite the high inflation to avoid situations requiring subsidy.
Mitigating Measures
Fuel subsidies: Subsidies for the supply of fuels to thermal power plants in Amazonia, a politically sensitive region, were maintained for a period of 10 years until 2012.
Import tax: In 2001, the government introduced a new tax on the import and marketing of petroleum products. The levy raised revenues that were then used to fund: i) subsidies for ethanol producers and the transportation costs of hydrocarbons; ii) LPG used by low-income families; iii) projects oriented to environmental protection; and iv) the construction of roads.
Gas voucher: After the withdrawal of LPG subsidies in 2001, the government introduced a new LPG subsidy in 2002 to assist low-income families purchase of LPG through a gas-voucher. Eligibility was based on a means test.
Conditional cash transfers: A conditional cash transfers program, the ?Bolsa Escola,? was implemented in 2001.
Lessons learnt
Macroeconomic instability can contribute to the emergence of subsidies for products with controlled prices. Diesel subsidies emerged in 1999 in the wake of large currency depreciation and the failure to rapidly adjust fuel prices. The liberalization of prices soon afterwards allowed the subsidy reform to remain durable, as prices automatically adjusted with fluctuations in the exchange rate.
Targeted social programs can reduce opposition to subsidy reform and enhance its durability. Brazil adopted a gas-voucher to compensate low-income households for the increase in LPG prices after the liberalization in 2001, and subsequently it has adopted a conditional cash transfer program, which supports the durability of the subsidy removal.
He is an electronics engineer and is currently pursuing full time M.B.A in Energy and Infrastructure (Finance) from School of Petroleum Management, Gandhinagar. In past he has been associated with Tata Consultancy services Ltd for 3 years as a system engineer. He has also done research work for Indian Oil Corporation during his Internship and helped them to understand the role of media in branding.