| By KEN OHASHI, World Bank Country Director for Nepal, based in Kathmandu Published in Kantipur, Nepali National Daily, on August 12, 2004 This is the fourteenth in a series of opinion pieces on Challenges Facing Nepal's Development. |   |
Do I Dare Again… ...write about fuel prices? In the spring of 2003, compelled by the increases in international oil prices, His Majesty’s Government of Nepal (HMGN) raised fuel prices. Student groups and others objected violently to this, arguing that it hurts the poor Nepalis. I wrote an opinion piece that explained why Nepal could not have afforded massive subsidy for fuel prices, and, besides, that the bulk of subsidies tended to benefit groups that least needed them. I questioned whether those protesting the government’s policy had really thought through the logic of their opposition. Very upset with me, some groups even demanded that I be sent back to my home country! A year later, I am still here, and even back to writing about the same issues. Sadly for Nepal, the fuel price problem is also back. The Problem in Brief The basic problem is that when international oil prices go up, Nepal Oil Corporation (NOC) has not been allowed to adjust prices to reflect the higher cost of imported fuels. With the sharp increases in international oil prices since December last year, NOC is now losing some Rs. 264 million each month. This is a subsidy to fuel users funded by HMGN (one way or another, since NOC is 100% HMGN owned). Sometimes subsidies do make good policy sense, but not in this case. Much of these fuel price subsidies go to relatively high-income households, industrialists, and other businesses, and, moreover, to Indian consumers near the border (through the smuggling of cheaper fuels from Nepal), and then to the smugglers themselves. I just do not see any justification for HMGN to be subsidizing them. Furthermore, the magnitude of the losses HMGN is incurring is simply not affordable. This is a repeat of exactly the same problem HMGN thought it had solved last year. Why then did it happen again? It turns out that the answer has little to do with economics, or even politics. It is basically about human nature. No one likes to make an unpopular decision, least of all politicians. So, unless the problem becomes so pressing that HMGN has no alternatives, few government leaders would want to think about fuel price increases. After the courageous adjustments in the spring of 2003, HMGN also established a price-setting committee that was mandated to adjust fuel prices, without political considerations, as and when the international oil prices moved. In reality, however, this committee too opted to defer the difficult decisions when the international prices began to creep up again. Perhaps the committee felt that the cabinet would simply not hear of any price increases. Or perhaps it hoped that ups and downs in market prices would tend to cancel each other out, and that the problem would go away by itself. Well, it did not and the gap has kept widening steadily, and it just cannot be ignored any longer. So, is there a solution? Yes. The solution clearly has to overcome this fundamental human weakness to avoid difficult decisions. I am not about to appeal to the high-mindedness of the policymakers, nor would I urge them to adjust the fuel prices every time international prices move. No one likes pain. But when there is an "easy way out," and if such an alternative gives Nepal a good solution, why not use it? In this particular situation, there is just such a solution. It is to establish an automatic mechanism for price adjustments. Once HMGN adopts the principle of automatic price adjustment, designing a specific system should not be difficult. Although there are several different ways to do this, the principle is straightforward. Basically the prices would have to be linked closely to the costs that are determined by market forces. I have no doubt HMGN can easily design a sensible mechanism based on various approaches that other countries have used.
Reducing the Burden of Fuel Subsidies From the numbers that I have seen, NOC losses have averaged Rs. 264 million a month during the first seven months of 2004. And the situation is clearly headed from bad to worse. Last July alone, NOC had losses of Rs. 428 million. The first thing that HMGN could do immediately is to eliminate the subsidy for liquid propane gas (LPG) and take aviation fuel (ATF) to international prices, while taking steps to adjusting all fuel prices to the market levels. LPG is decidedly a commodity for relatively well-off households. There is no public policy reason to justify such a subsidy. With a subsidy of Rs. 186 per LPG cylinder, NOC has of late been losing some Rs. 91 million every month just from the underpricing of LPG. By removing this subsidy, NOC could use the savings to moderate the price increases for other fuels that tend to affect the public more generally. In the longer term, bigger gains will come from improving the efficiency of the fuel market. NOC is no doubt very inefficient. By gradually introducing competition into the fuel market, everyone could benefit from the lower costs of fuels. In this regard, the most important first step I would suggest is to establish an independent and professional regulatory body. Nepal already has a good model in the Nepal Telecommunications Authority, which regulates the telecommunications market. Once such a body is in place, HMGN could begin to deregulate the fuel market. Given the small size of the market, yet relatively high cost of entry by a new distributor, allowing private sector entry into the market alone may not guarantee real competition, at least not overnight. There is always a risk of collusion and monopolistic behavior and therefore a strong regulator needs to be in place to monitor this. When the market becomes fully open and competitive, Nepal will have not only lower fuel prices but also the most automatic of pricing systems and no more politics with fuel prices. Depoliticizing Fuel Prices Nepal has too many important political issues to contend with. For many of them, there are no technical solutions. They require truly political solutions. But fuel prices need not be one of those. There is a simple technical solution to this problem. Even just to accommodate greater focus of political energy on critical national issues, it would seem sensible to introduce an automatic price adjustment mechanism to reset fuel prices as soon as possible. |
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