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Published on: Nov. 15, 2021, 11:32 a.m.
Crude rally
  • The rising prices of fuel are threatening to complicate India's comeback story

By Rakesh Joshi. Executive Editor, Business India

On 3 November, the Finance ministry announced a Rs5 per litre cut in excise duty on petrol and a Rs10 per litre cut in excise duty on diesel. This was the first cut in central excise duties in over three years and came at a time when fuel prices were soaring record-high. Over the last one-and-a half years, the price of petrol had shot up by Rs36 while that of diesel had increased by Rs27. The high fuel prices were more than pinching the common man and fuelling inflation, clearly leading to a dip in the popularity of the Bharatiya Janata Party. 

While food inflation is now largely under control, after the government addressed the supply-side factors in pulses and edible oils, core inflation continues to remain elevated. Fuel inflation also inched up to a new high of 13.6 per cent in September. The rising prices of fuel were also threatening to complicate India's comeback story at a time when everyone – the policymaker, the economist, the common man – was hoping a rapidly reopening economy would put the country's year-and-a-half-long pandemic travails firmly in the past.

The issue was dominating discussions in policy circles, in television studios, at dinner tables and on the street. With the common man having to pay through the nose at petrol pumps, it threatened to sour the festive season. It is therefore no coincidence that the decision was announced just a day ahead of Diwali.

After the Centre slashed excise duty on petrol and diesel, all BJP-ruled states also cut value-added tax (VAT) on fuels. Odisha and election-bound Punjab also decided to reduce VAT on fuels, with the latter becoming the only Congress-ruled state to bring down fuel prices. 

Crude to remain high

But the relief will be momentary. Global oil prices are expected to remain structurally high because of rebounding global consumption amid tight supply as well as years of underinvestment in new supply following the 2015 crash. India imports 86 per cent of its total oil use. The Modi government will either have to subsidise petrol and diesel prices, reversing the decision to decontrol the two fuels, further slash excise duty, give up on the cess it slapped on the fuels or devise some new formula to provide relief to the common man.

When the Modi dispensation first took office in 2014, it benefitted from the rock-bottom crude prices. When nations around the world were passing on the benefit of plunging oil prices to consumers, the Modi government kept petrol and diesel prices at levels prevalent when crude touched an all-time high of $107 a barrel (during UPA-2). Excise duty on petrol was Rs9.48 per litre and Rs3.56 per litre on diesel when the Modi government took office. Today, a different scenario is staring the government in its face.

To understand how petrol and diesel prices are fixed, one needs to first know the difference between central and state taxes on fuel. Central taxes on petrol and diesel are split into multiple components. While some of these taxes are ad valorem – tax imposed as a share of price of the commodity – in nature, some of them are fixed.

While state taxes are also a mix of ad valorem and fixed, the latter is a much smaller share than the former when compared to the taxes levied by the Centre. In many states, the ad valorem taxes have an upper limit, which means that even when prices increase beyond a point, taxes do not increase. It is the ad-valorem component of state taxes that has come down with a cut in central duties.

State levy

State taxes are levied on the price which is inclusive of Central duties and dealers’ commission. This means that a cut in central duties automatically lowers the tax burden on account of state taxes as well. Ashok Gehlot, chief minister of Rajasthan, made this point on 4 November: “With the reduction of Excise Duty by the Centre, the VAT of the states is automatically reduced in the same proportion, yet we demand that the Centre should reduce the Excise Duty more to reduce the inflation."

This can be seen clearly from the price build up data for petrol and diesel which is available for Delhi. A litre of petrol in Delhi on 16 October included Rs32.9 as central excise duty and the state tax (VAT) on it was Rs24.34. After the cut in excise duty to Rs27.9 on 4 November, the VAT component has fallen to Rs23.99. Similarly, a litre of diesel included Rs31.8 as excise duty on 16 October which resulted in VAT of Rs13.8.This amount has reduced to Rs12.7 after central excise duty was cut by Rs10. This is why the price of petrol and diesel has fallen by more than Rs5 and Rs10 per litre in the four metro cities.

While the BJP-ruled states have fallen in line with the Centre’s diktat, the opposition states are revisiting and for good fiscal (if not political) reasons too. States have seen a decline in their share in petroleum revenues over time. 

Reluctance

In its latest award, the Finance Commission, which decides on distribution of revenues between the Centre and states every five years, put the share of states at 41 per cent. However, special duties and cesses collected by the Centre do not come under the divisible pool which is governed by the commission’s awards. With the Centre shifting a bigger share of petrol-diesel taxes under the special duty/cess heads, states have seen a fall in their share in taxes collected from sale of petroleum products in the country.

This share was the lowest since 2014-15 in 2020-21, when the states faced the biggest fiscal squeeze on account of pandemic related spending. The share has improved in the first quarter of 2020-21, perhaps on account of higher prices leading to higher tax collection on ad valorem state taxes. But the improvement is not much. That is why states are loath to cut VAT on petrol and diesel.

There is a theory that apart from importance of the recent festive season, the results of the recent round of Lok Sabha/assembly by-elections and the fear of how the issue would pan out in the upcoming assembly elections in five states led to the Centre’s cut in excise tax. Whether the rising fuel prices were a contributory factor in the outcome of the by-elections is not easy to assess, given that the BJP, while suffering setbacks in several states, also swept the Assam by-elections and did well in Madhya Pradesh. Top BJP ministers like Nitin Gadkari and Hardeep Puri have also denied that this was the case.

By-polls setback

But the fact remains that the general public, facing the brunt of the hikes, was none too happy. The BJP suffered a setback in parliamentary and assembly by-polls in Himachal Pradesh, West Bengal, Karnataka and Rajasthan, even as it registered a big win in Assam. The bypolls were announced in 29 assembly constituencies across 13 states and the Union Territory of Dadra and Nagar Haveli. Out of the three Lok Sabha seats, the BJP and Congress grabbed one seat each while the Dadra Nagar Haveli Lok Sabha seat was won by the Shiv Sena. 

While BJP leaders informally say that the reason the party candidates lost in some states was mainly because of ticket distribution at the local level and infighting in some of the state party units, it was clear that anti-incumbency was setting in. At least two BJP chief ministers, Jai Ram Thakur of Himachal Pradesh and Basvaraj Bommai of Karnataka, failed to deliver the goods in their respective regions. “The fuel price hikes could have been the tipping point,” a senior leader of the Janata Dal (United), an ally of the BJP, concedes. Prime Minister Narendra Modi did not campaign but party candidates did seek votes in his name.

In Karnataka, this was the new chief minister Basavaraj Bommai's first electoral test. And Bommai has no reason to feel happy with the 1-1 result in the two by-elections held to the assembly constituencies of Hanagal and Sindgi. Hanagal would hurt because the constituency is in Bommai's home district of Haveri, with the CM elected thrice as a lawmaker from the Shiggaon seat. The BJP realised that the battle was tough from the beginning, given the popularity of the Congress candidate on the ground. Srinivas Mane had toiled hard during the second wave of Covid, and the electorate has acknowledged his help by responding on the EVM. 

The results should also worry the BJP in Himachal Pradesh as it is also the home state of party president J.P. Nadda. The Congress won all three assembly seats – Fatehpur, Jubbal-Kotkhai and Arki – and also clinched the Mandi Lok Sabha seat. The Congress fielded Pratibha Singh – wife of late chief minister Virbhadra Singh’s – in Mandi against BJP candidate Brigadier Khushal Thakur, a Kargil war hero. The results come a year before the assembly polls and definitely raise questions on the ability of the chief minister, Jai Ram Thakur. Mandi is also the chief minister’s home district. 

Pressure on cadres

Of late, BJP workers in Punjab, Haryana and UP, which are the epicentres of farmers’ protest, have been facing public pressure due to the high inflation rate and public anger over high fuel prices. Farmer leaders agitating against the three farm reform laws point out that while BJP workers in rural areas may not openly participate in the protests against fuel prices, they do support it in private. BJP workers were beginning to fear that if the Modi government does not control the fuel prices, the BJP will face serious consequences in the upcoming assembly elections in five states.

More than the by-elections, it is the upcoming assembly elections in five states – Uttar Pradesh, Punjab, Himachal Pradesh, Uttarakhand and Manipur – that seem to be worrying the BJP. What if the rising trend of crude prices continues? All indicators suggest that global crude prices are not going to cool down soon. As such, some hard fiscal as well as political calculations have gone into the decision.  

The Modi government will also have to chalk out a strategy to deal with the fallout of rising prices in the coming months. Last year, the Centre had introduced the steepest hike in taxes on petrol and diesel, hiking the road and infrastructure cess by Rs8 each for petrol and diesel and special additional excise duty (SAED) by Rs2 per litre and Rs5 per litre, respectively. The entire hike went to the Centre's coffers and was not devolved to the states. If fuel prices get out of hand again, will the government withdraw the cess and SAED?

After seven consecutive hikes, petrol prices went beyond Rs110/litre in Delhi on 2 November. Diesel had also reached within striking distance of the psychological mark of Rs100 a litre. In Mumbai, petrol prices had overshot that mark quite a while ago. 

Projections galore

To be sure, crude prices were higher by $9-10 a barrel compared to August. But that is still poor justification for consumers in a country where taxes account for almost half the price of fuel. Taxes made up more than 53 per cent of petrol prices and over 47 per cent of that of diesel (Delhi market). The government’s stance, based on indications from FinMin, that taxes won’t be lowered irrespective of where crude prices reach was sending out wrong political signals.

Given the oil-producing countries’ current playbook on production schedules and quantum, crude prices are unlikely to come down anytime soon. Worse, as experts say, they can only go up. In fact, even the BJP’s own in-house experts on the energy sector like Narendra Taneja have been maintaining that the prices of petrol and diesel will only increase again in the coming months.

“Whenever there is an imbalance in demand and supply, prices are bound to increase. The second reason is the lack of investment in the oil sector as governments are promoting renewable/green energy sectors like solar power. Crude oil will be more expensive in the coming months. In 2023, the price of crude oil can rise by Rs100,” says Taneja.

Taneja’s predictions are only in line with that even Wall Street banks have been saying of late: Goldman Sachs, for instance, sees Brent hitting $90 per barrel at the end of this year, up from $80 expected earlier. This means an even bigger hole in the Indian consumer's pocket in the weeks ahead unless the centre steps in and gives further relief on excise duty.

Shale not a winner

In such a scenario, the US shale companies could have benefitted by ramping up their production.  But investors have punished the shale companies that tried to increase their spending on drilling for the last two years – knocking shares of companies that did not cut their budgets and aim for flat oil production. Indeed, US shale operators have pulled away from far-flung locales where the break-even cost is higher than in the Permian Basin, the largest US shale play, based in Texas and New Mexico.

The irony is that US President Joe Biden, who has set himself an ambitious agenda to stem global warming by shifting away from fossil fuels, is now urging OPEC to increase production and lower prices. So far, OPEC+, led by Saudi Arabia and Russia, has rebuffed calls from the US and other consumers for a more rapid unwinding of output cuts made last year during the worst of the pandemic.

LPG, ATF costlier

It is not just petrol and diesel which are proving to be a bugbear for the BJP. On  1 November, the price of commercial LPG cylinders was hiked by Rs266. After the increase, 19-kg commercial cylinders now cost Rs2,000.50 in Delhi, compared to Rs1,734 earlier. The price of domestic LPG cylinders, however, was spared from the recent hike. The last time cooking gas prices were hiked was on 6 October, when they rose by Rs15 per cylinder to a new record high.

Domestic cooking gas, also called liquefied petroleum gas (LPG), now costs Rs899.5 per cylinder in Delhi. Its prices have gone up by Rs305 a cylinder, or 50 per cent, in just one year

There could be more bad news in store for the consumer. Various reports say the government is making plans to raise LPG cylinder prices to more than Rs1,000. Which means, you might again end up having to revise your monthly budget upwards.

Then there is Aviation Turbine Fuel (ATF). On 1 November, oil companies hiked jet fuel prices by 13.9 per cent. After the latest hike, the rate of ATF is now Rs82,638 per kilolitre (Delhi). This is an astounding increase of 95.8 per cent over November 2020 prices. Fuel accounts for up to 40 per cent of the total cost of flight operations. This is one of the highest rates in the world. The sharp hike is set to hit the aviation sector hard at a time when things were just beginning to be back to normal after months of unprecedented hurt. It could be very bad news for flyers too, because prices going up further seem to be a most normal thing at this point.

Some industry people, however, say it might be tough for airlines to pass on the hike to flyers in the face of intense competition. In which case, it will be very bad news for airlines.

GST the solution?

Bringing petrol and diesel under Goods and Services Tax (GST) seems to be the only way the Indian consumer can get some sort of relief from the fuel scourge. But with both the Central and state governments openly reluctant to let go of this easy-gotten bounty, when India is likely to get such relief is anyone's guess.

Taneja said, “It is to understand that we import oil. It is an imported commodity. Today, we have to import 86 per cent of our total oil use. The prices of oils are not in the hands of any government. Both petrol and diesel are de-controlled commodities. In July 2010, Manmohan Singh's government implemented the deregulation on petrol. In 2014, the Modi government decontrolled diesel.”

Explaining the Centre's move to decrease excise duty on petrol and diesel, Taneja said, “When oil prices are low, the government increases the excise duty, when oil is too expensive, the government reduces the excise duty. The consumption and sale of oil had come down to 40 per cent during the time of Covid. Later, it had come down to 35 per cent. When the sales have reduced, the income of the government will automatically decrease. But now that sale is back like the pre-Covid era."

“Secondly, the GST collection is indicating positive sign for the economic recovery. The government is relatively in comfortable position than earlier. Plus, our economy is based on diesel. If the price of diesel goes up that increases the price of everything. The inflation is high. Considering these things, the government has taken this step.” 

Taneja believes that petrol and diesel should be included in GST so that more relief can be obtained and there will be more transparency. But the last time the issue figured on the agenda of GST Council meeting, it was unanimously torpedoed by the states. One may have to live with costlier crude for some time to come.

Why oil is on the boil

• Prices have risen as more vaccinated populations are brought out of corona virus lockdowns, supporting a revival in economic activity.

• There has been limited capacity addition since the 2015 crash

• OPEC-plus countries want to rebuild revenue hit by the pandemic

•  At the same time, from Asia to Europe, the global commodity prices, including those used as fuel for power generation such as coal and gas, have also surged.

• Crude oil prices rallied on substitute demand from gas and coal consumers over rising prices, apart from coal shortages. 

• This makes oil an attractive commodity for generating power and keep the economic activity steady, and thus the higher demand is pushing crude markets higher.•

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