AS the United Progressive Alliance (UPA) government entered the final lap of its five-year tenure this month, it has been jolted suddenly by a rude shock, caused by soaring global oil prices.

The government, which appeared to be on a roll during the first four years of its rule – thanks to a vibrant economy – splurged on a host of expensive (and largely economically wasteful) programmes that were financed by buoyant tax collections. But in the final year of its tenure, it has been caught up in a slick, caused by escalating crude oil prices, that threatens to sink the UPA ship.

The central government finds itself in a sorry situation, where it is being made to pay heavily for the sins (mostly caused by reckless spending) of the past four years. Last week, the Congress – which dominates the UPA government – suffered a humiliating defeat in the Karnataka state assembly elections, as its rival, the Bharatiya Janata Party (BJP), romped through, marking its presence in south India for the first time.

Elections to several key states – including Delhi, Rajasthan, Madhya Pradesh and Chhattisgarh – are due to be held later this year, and general elections have to be called before May 2009. The government seems to have played out all of its trump cards over the past four years – by unveiling ambitious programmes for the rural poor, offering a hefty pay hike for its own employees, and going in for a massive write-off of farm loans – and is now being forced to hand out a bitter dose of medicine to a wary electorate. Ironically, at a time when inflation is at its four-year peak.

Figures released last week indicate that inflation – as measured by the wholesale price index – touched 8.1 per cent, a 45-month high, for the week ended May 17. The last time inflation was this high was in August 2004, three months after the UPA government took over, when it was hovering around 8.33 per cent.

“This is a worrisome trend,” said Finance Minister P. Chidambaram. The Reserve Bank of India, the country’s central bank, had fixed a target of five to 5.5 per cent for inflation, and has taken several measures hoping to combat the price rise.

But last week saw the government dither over raising the price of petroleum products. Its hand was being forced by circumstances well beyond its control; state-owned oil companies issued a virtual ultimatum to the government to take drastic measures in the wake of the ceaseless rise in the international price of crude oil. With oil prices breaching the $135 a barrel mark, the UPA government had to give up its non-chalant approach and take radical remedial steps.

Hiking the price of heavily subsidised petroleum products – including petrol, diesel, kerosene and liquefied petroleum gas (LPG) – is a decision that most governments are loath to take even at the best of times. But being forced to do so towards the end of a five-year term, with elections just round the corner, is positively suicidal.

Unfortunately for the government, headed by the real McCoy reformer, Prime Minister Manmohan Singh – whose team includes equally outstanding reformers such as finance minister P. Chidambaram and deputy chairman of the Planning Commission Montek Singh Ahluwalia – the oil crisis threatens to blow up in its face ignominiously, delivering a nasty blow to its otherwise modest track-record.

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OIL sector reforms in India, initiated by the previous National Democratic Alliance regime, had taken off in a promising way about six years ago, resulting in the apparent dismantling of the administrative pricing mechanism. But the government lost a golden opportunity to de-couple itself from the onerous task of setting the retail price of the volatile commodity at a time when oil prices were tumbling and the marketing companies – mostly state-owned – could have opted for fortnightly fixing of prices.

At a time when international oil prices have been soaring – they have more than doubled over the past 12 months – the government finds itself unable to escalate the retail price of petroleum products. The last time the government allowed oil marketing companies to marginally increase the price of their products was in mid-February, when crude oil was being sold at $100 a barrel.

While private sector refiners such as Reliance have shut down their retail outlets across the country, unable to bear the huge losses caused by the difference in the international price of crude and the domestic retail price for refined products, state-owned majors – Indian Oil Corporation (IOC), Bharat Petroleum Corporation (BPCL) and Hindustan Petroleum Corporation (HPCL) – have been silently sustaining the losses.

But last week, Sarthak Behuria, the IOC chief came out with a stern warning: the Fortune 500 company would not be able to buy crude oil in the international markets after September, as it would have run out of money by then. Behuria warned of rationing of petroleum products.

In fact, in many cities across the country, petrol and diesel rationing have already started. The state-owned companies have also started imposing restrictions on the sale of LPG cylinders for domestic consumers.

According to Behuria, IOC is losing Rs3 billion a day on the sale of petrol, diesel, kerosene and LPG. The three state-owned oil marketing companies are expected to sustain losses of over Rs2.35 trillion, three times last year’s figures, because of under-recoveries. Every dollar increase in the price of crude oil adds Rs30 billion to the under-recoveries by the oil firms.

Though the oil companies buy crude from international markets at current prices – or slightly lower levels, depending on the contracts that they signed – they have to refine and sell the petroleum products at controlled prices. This results in huge losses on the sale of the products. Petrol is subsidised at Rs16 a litre, diesel at Rs23.5 a litre, kerosene at Rs29 a litre and LPG at Rs400 a cylinder.

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INDIA imports 70 per cent of its crude oil requirements, and demand has been growing phenomenally, fuelling the nine per cent annual economic growth of the past few years. According to the International Energy Agency (IEA), India, along with China, Russia and the Middle East, currently consume more crude oil than even the US.

While US consumption fell by 1.3 per cent this year to 20.3 million barrels a day, demand from these emerging economies went up by over four per cent to 20.7 million barrels a day.

With the government refusing to allow oil companies to raise the price of their products, consumers – mostly the affluent – do not feel the pinch of rising global oil prices. Consequently, there is abundant wastage in the economy and consumers (who include corporate users) do not have an incentive to save energy.

Two ministries – petroleum and finance – have been engaged in a long-drawn battle over the pricing of petroleum products. The petroleum ministry wants the finance ministry to reduce taxes and duties that add up to about 55 per cent of the retail price of petrol. Last year, the finance ministry earned over Rs710 billion by way of these taxes and duties.

Now with oil prices more than double last year’s levels, its earnings are also expected to more than double. But the finance ministry says that these revenues are needed to fund the ambitious programmes of the UPA government, including the National Rural Employment Guarantee Scheme, the Rs600 billion write-off of farm loans, and the recent hike in the wages of government employees.

In the past, the government had allowed oil companies to go in for a marginal increase in retail prices, and it had also issued long-term bonds to the oil companies to make up for their losses. However, with record oil prices, the government is no position to issue any more bonds to marketing firms.

Last week, IOC reported its first quarterly loss in over two years, and HPCL said fourth-quarter profits had tumbled to the lowest levels in over three years. IOC posted a loss of Rs4.14 billion for the quarter ended March 31, compared with a profit of Rs15 billion in the previous year’s corresponding quarter.

While the Left parties, which provide outside support to the UPA government, are opposed to any price hikes, there is confusion within the government on the right strategy to be adopted. The fact that elections are months away is not helping matters for the government, which already appears to be in lame-duck mode.