One fallout of the lockdown was that the revenues of the government were affected, as lower economic activity impacted income and spending. The response of the government was to focus on fuel products for additional revenue, as these were out of the purview of the GST. This meant increasing the taxes at both the Central and state levels, leading to abnormal prices of the final products. While the justification is that these products are used by the rich, the argument is specious, as it affects everyone’s daily commute and also adds to the cost of all goods which tend to be transported by vehicles that use diesel. Hence, the impact is quite comprehensive.
Absurd retail prices
The absurdity of the retail prices can be gauged from the fact that the global price of crude oil has been relatively stable, at $60/barrel. But governments have relentlessly increased the excise rate (Centre) and VAT (states) to garner higher revenue as, practically speaking, demand is inelastic to price -- as with social distancing, it is prudent for most people to use their own vehicles where feasible. The table above gives the break-up of prices of petrol and diesel as provided by the IOCL for February 16 in Delhi.
Prices vary across states and cities, depending on the VAT rates imposed. Hence, Mumbai has a petrol price approaching Rs 100/litre due to the VAT factor. Excise is constant across the country, being imposed as specific duty by the Centre.
In FY18 and FY19, crude oil averaged $57/ barrel and $70/ barrel respectively. Yet, the price of petrol was averaging Rs 69 and Rs 75/ litre respectively. Interestingly, the cost to the dealer was marginally lower, at Rs 31.39/ litre. The difference in this cost today can be attributed to the movement in crude oil price, as well as the exchange rate. But the remainder of the increase in price is purely in the government domain. In FY18, excise was around Rs 20/ litre, while VAT was Rs 15 in Delhi. One can hence get an idea of how heavily taxed these two products are.
Why does the government impose such high duties? In FY20, the Centre got as much as Rs 2.2 lakh crore and states Rs 2 lakh crore from excise and VAT. If other charges like customs/IGST/royalty etc. are added, the governments got around Rs 5.1 lakh crore from petro-products, with the Centre getting Rs 2.87 lakh crore. This is around 12-14 per cent of total tax revenue for the Centre. The advantage here is that these products have been kept outside the purview of GST, which provides flexibility.
Fuel products have a distinct inflationary impact and are today being driven by the government, and not the price of crude oil. In the WPI, fuel products have a weight of almost 8 per cent, with petrol and diesel having a weight of 4.7 per cent. Intuitively, it can be seen that with 10 per cent increase in price, the inflationary impact will be 0.8 per cent. in the last few months, the price of petrol has increased by over 20 per cent, which means that 1.6 per cent is the increase in WPI due to this factor. The impact will tell on the index in future too, as the benefit of last year’s base wanes.
In case of the CPI, the weights are smaller but have a pernicious impact, as they have a strong, indirect impact on the prices of other goods and services. The direct weight of petrol and diesel, along with lubricants, is 2.4 per cent, while taxi commute has a weight of 0.57 per cent. Therefore, the weight is approximately 3 per cent in the index. The impact on other goods is sharper, as has already been witnessed with the cost of horticulture products, grains, travel, recreation, tourism, being affected, as also finished goods, as producers hike their prices to buffer in the transportation costs.
Until the pandemic set in, it was generally believed that the government would ensure that the price of petrol remained less than Rs 90/ litre. However, with crude price climbing to $60/ barrel, it was expected that the government would relax the duty rate, which was not done. It is expected that the price of crude will move up by at least 10 per cent this year, as the world economy revives -- some upward movement has already been witnessed in this market. This can see the dealer price rising by Rs 3-3.50/ litre, which if not matched with a reduction in duty can send the price to well beyond Rs 100/ litre. This is a probable scenario which will add to inflation, for sure.
A call has to be taken by the government on these tax rates, as the inflation impact will have a bearing on future monetary policy decisions. Presently, the MPC is not looking at inflation, as the focus is growth. But at some point of time, it will have to revert to the mandated inflation targeting, which will be influenced by fuel prices. This should be kept in mind.
The writer is Chief Economist, CARE Ratings and the author of: ‘Hits & Misses: The Indian Banking Story’ (SAGE). Views are personal.