Saumyen's Pages
Select Aspects of Fuel Price Hike in India
(March 2021)
Apprehension in recent times about the fuel price reaching a 3-digit figure finally comes live! In the two cities of Sri Ganganagar in Rajasthan (Rs 101.84 per litre) and Anuppur in Madhya Pradesh (Rs 101.59), petrol price breached the Rs 100-mark in February. The rest of the country is not far behind. Such steep and apparently ad hoc price hike have many economic implications – though reasons for hike may differ and extent of impact may vary. Surprisingly, the political opposition to this move - unlike in similar situations in the past, appears visibly weak or non-existent!
Over the period 2003-21, price of petrol and diesel have increased by 178% and 268% respectively and sharply over the last few months to attain this feat. Diesel is priced lower than petrol except in 2020 when diesel price once exceeded petrol. Over the past 12 months, price has changed multiple times from Rs 72.99 in March 2020 to Rs 91.17 now (March 2021 in Delhi). The movement is far steeper than the real GDP per capita growth – more in recent years - normatively implying that fuel price is pinching more than the comfort due to income growth (Figure 1).
Figure 1: Indices of Real per capita GDP, Diesel Price for constant WPI
Low demand elasticity of petrol and diesel (also due to inadequacy of alternative fuels push), their interlinkages across sectors and implications thereof on the overall economy have been studied in a wide range of economic literature - that argues that such price rise results in inflation – an indicator that all governments want to keep low to showcase their success. In fact, this is a case when the retail price of these fuels has been deliberately raised to take advantage of the low inflation situation.
How is this price determined?
Historically, the government announced dismantling of the administered price mechanism (in existence since 1975) in 2002, when the pricing of petroleum products was expected to respond to global prices. But the government decided to stabilise domestic fuel prices to protect domestic market price against volatility in crude prices. Diesel and kerosene were given subsidies – the mechanism that put financial pressure on the government and oil marketing companies (90% owned by IOCL, HPCL, BPCL). Petrol prices were made market determined in 2010 and diesel in 2014 – allowing oil marketing companies (IOCL, HPCL etc) to determine the price of these products and revise them every fortnight. The prices for petrol and diesel are revised on a daily basis since June 2017 with the premise that daily revision would reduce the volatility in retail prices and protect consumers against sharp fluctuations.
India currently imports 89% of her overall crude requirement and this makes her vulnerable to volatility in the international crude market. So, it is likely to expect that the fuel price in this liberated sector will be adjusted according to crude price.
However, the fuel price has seldom followed the crude oil price movement (Figure 2). During the pandemic period last year when the price reached very low, thanks to the low global demand and high inventory – retail fuel prices did not respond to crude price. In fact, crude price fell by 42% but retail price of petrol grew about 40% and diesel price doubled. How?
Figure 2: Petrol, Diesel, Crude Oil Price movement (2010-21)
The government duties and cess contribute 59% and 54% of petrol and diesel prices (as on 1 March 2021) respectively and roughly one-third (and a little more in diesel) is crude oil (Table 1). This means, no matter whatever changes with crude, only about 33% of Indian retail prices are impacted - two-thirds of the local prices remains unaffected!
Table 1: Price build-up for Petrol and Diesel (Rs/ Litre)
While the sector is liberated, the government has increased taxes/ duties to take advantage of fall in crude prices in recent times. During the recent pandemic (2020-21), when demand for fuels came down drastically, excise duty collection, increased by 48% (April-November 2020) vis-à-vis the same period in 2019 when the most-used-fuel diesel demand was lower by 10 million tonnes and petrol by 3 million tonnes. On the other hand, the period witnessed a sharp 26-27% decline in direct tax collections.
While the pandemic period may possibly justify the moves to enhance resource mobilization – to support the additional expenditure and boost the economy primarily through government spending/ investment, excise was increased in previous occasions too. In fact, the current government managed to raise the total excise collection from Rs 99,000 crore per year to Rs 2.4 lakh crore per year within the first 2 years of coming to power in 2014! Apart from the excise, the VAT by state government also contributes 23% and 15% of the retail price of petrol and diesel retail prices respectively. Thus, increase of taxes on fuel has been used as an easy instrument of earning more for the exchequer by both the central and state governments.
It is argued though that the central government has been using levy more as cess, which doesn't have to be shared with the states. It means the centre gets to keep more and more of the pie - leaving states with little option but to impose or raise their own taxes on fuel. Accordingly, the States charge extra state excise tax and also VAT - to compensate the potential loss of revenue (Ranade, ET Online, 18 Feb 2021).
Whatever be the reasons, fuel revenue being a large part of exchequer, neither the centre nor the states show a concrete plan towards GST for this sector. While there are arguments in favour and against, oil products and natural gas remain outside its purview of Goods and Services Tax (GST) since its introduction in 2017. If the recent comments from the Finance Minister and the RBI Governor are an indication, the government apparently has an intent now to include fuels under GST.
Figure 3: Break-up of Tax Revenue for the Centre (FY2019-20)
Excise is only 11% of the tax revenue (Figure 3) and any hike in excise may not significantly increase the overall tax revenue for the government but this is, as mentioned above, easy to execute. This also possibly indicates the government’s inability and/or intent to raise the other revenue earning components where a small percentage change could generate higher revenue. The sharp decline in GST collections (that contributed about 30% of revenue) in FY 2019-20 led to Rs 1.80 lakh crore shortfall in GST revenues on states. This includes Rs 1.10 lakh crore revenue loss on account of GST implementation and Rs 70,000 crore on account of the pandemic. Otherwise, such hike in excise/ VAT could have been avoided – atleast partially.
Interestingly, such hikes can be administered by the government - ad hoc and conveniently timed. We have witnessed the same in the past. Excise increased when crude price slumped in 2020 – justifiably to support the higher unplanned pandemic expenditure and to avoid expensive borrowing for its capital expenditure. On the other hand, price was stable before the last Karnataka election and is unlikely to see further change till the forthcoming state elections are over! Moreover, in the current situation when inflation is under control (Consumer Price Index at 4.06% in January 2021), such a hike is easier to execute vis-à-vis measures like direct tax rate increase, expanding the tax base to include other sectors like agriculture or imposing higher GST on sectors that saw growth during the Covid-19 pandemic. Any direct tax increase is a tougher call as this may have potential political repercussions that the government would like to avoid.
We only hope that the increase of taxes on fuel is a short-term and temporary phenomenon. The implications of indirect taxes on diesel, LPG, petrol have a larger adverse impact on the economy that the public investment can possibly compensate for in the medium and long run. The economic need is - for the government to take a tougher fiscal stance of managing revenue pressure through direct taxes and GST. Let’s watch when the government bites this bullet – politically, for economics sake!
(The views are personal)
Rethink