India has the one-lakh car by Tata Motors (that’s 100,000 rupees or around US$2,500) while in China it’s the Chery QQ, which retails for US$3,600. These vehicles represent the low-end of their respective markets and, if Tata and Chery are to be believed, over the next two years they will become the cars of choice for two populations of 1 billion-plus.
The result will be a giant sucking sound at petrol pumps as aspirant members of the middle class feed the fuel demands that come with upgrading from two wheels – bicycles, scooters and motorcycles – to four.
The problem tied to rising consumption of gasoline and diesel is that both China and India subsidize pump prices to such an extent that it threatens macroeconomic stability. Failure to pass on the burden of increasing global crude oil prices inflicts considerable damage on federal budgets and the balance sheets for state-owned refiners.
Crude prices flirted with US$100 per barrel for most of the second half of 2007 – a jump of more than 50% one a year ago – and this put China’s refiners under so much cost pressure that many of the smaller players ground to a halt.
Beijing responded by raising prices 10% in November, even though it meant backtracking on an earlier promise that it would make no changes. By contrast, India hasn’t altered prices in more than a year.
“It’s hard to see how that’s sustainable especially in places like New Delhi which now can’t handle the 1,000 new cars that hit the roads daily,” was the verdict of Amit Sengupta, a broker in the capital who tracks Indian auto and refining companies.
Talks held in Bali in December on a successor to the Kyoto protocol on climate change, which expires in 2012, saw India and China’s environmental indiscretions once again thrown into the spotlight. Amidst the discussions on carbon emissions caps, it will not have escaped delegates that countries selling transport fuels below market rates account for more than half of the world’s growth in consumption.
Venezuela leads the way here, selling gas as US$0.13 per gallon, followed by several members of the Organization of Petroleum Exporting Countries. These nations can rely on rising revenues from crude sales to offset the subsidies, but India has no such luxury with the government and state-run oil companies facing an annual shortfall of nearly US$20 billion, roughly 10% of the federal budget.
What isn’t expressed in the figures released by the finance ministry is how this systen of subsidies contributes to inflation, creating a potential fiscal time bomb.
Weekly wholesale price inflation in India was hovering around five-year lows of 3% in November, although various monthly measures used to track consumer prices for rural, urban and industrial workers show it is above 5%.
Meanwhile, China saw its consumer price index jump 6.9% in November from a year earlier. The increase was driven by a 18.2% hike in food prices but there was also a 1.4% rise in the cost of non-food items – up from 1.1% the previous month – and much of this can be put down to the fuel price increase.
The pressures on consumers in both countries, especially the hundreds of millions who live on less than a dollar a day, mean that even a mild fuel price hike can have a severe impact on the massive supply chains that ferry food, clothes and other basic items. This could, in turn, spark what politicians in both countries have worked studiously to avoid – a backlash.
A price hike in India of just one or two rupees (US$0.05) a liter would lead to a truckers’ strike at the very least.
Central banks are therefore on the alert to any potential shocks caused by global crude prices. India kept interest rates near a five-year high in its latest policy review in October, citing crude prices and the risk of overheating – quarterly economic growth rates are above 9% – because of infrastructure and capacity bottlenecks. Similarly, the People’s Bank of China has said it will likely employ tighter monetary controls in 2008 to cool an economy that expanded 11.5% in the third quarter of 2007.
However, at some point both countries must address the issue of below-market-rate gas prices. Combined with rising fuel demands tied to expanding individual car use, the fuel subsidy scheme will only become more of an economic burden