Fuel levy-cuts welcome relief

By: |
November 08, 2021 5:28 AM

The current environment may still remain inflationary, but they will have a salutary effect on the prices of certain goods

The revenue loss of an estimated Rs 45,000 crore in the rest of FY22 seems to have been weighed against the potential gains at the hustings; some key states, including Uttar Pradesh, are going to the polls early next year.The revenue loss of an estimated Rs 45,000 crore in the rest of FY22 seems to have been weighed against the potential gains at the hustings; some key states, including Uttar Pradesh, are going to the polls early next year.

The Union government’s decision to lower central excise duties on petrol and diesel by Rs 5 per litre and Rs 10 per litre, respectively, may have been motivated by political considerations but will cool inflation somewhat, leaving households and RBI breathing easier. The revenue loss of an estimated Rs 45,000 crore in the rest of FY22 seems to have been weighed against the potential gains at the hustings; some key states, including Uttar Pradesh, are going to the polls early next year.

Indeed, the government has spoken of how the reduction in excise on diesel would be a boost for farmers in the upcoming rabi season. The cuts are overdue given the government earned a whopping Rs 3.35 lakh crore from excise duties in FY21. The pickings in the current year, ahead of the cuts, were estimated at over Rs 4 lakh crore. Since the state-level ad valorem taxes are levied on a price inclusive of the central levies, this allows for even higher reductions in the retail prices. In addition, several states have cut the value-added tax by anywhere between Rs 2 and Rs 7 per litre so that pump prices there would come down further.

Economists estimate the tax cuts should bring down headline CPI inflation by 0.14 pp due to direct effects and up to 0.3 pp if indirect effects are included. Petrol has a 2.2% weigh in the CPI basket while diesel has a much smaller weight of 0.15%.

However, the current environment is expected to remain an inflationary one thanks to the severe shortage of key inputs, like chips and energy, and high international prices of crude oil. Nonetheless, the cuts on central duties that leave them at Rs 27.9/litre and Rs 21.8/litre on petrol and diesel, respectively, will help. The bigger cut on diesel makes sense because consumption levels are three times that of petrol and particularly because it would likely bring down road transportation costs. Lowering the cost of logistics does have a salutary effect on the prices of a range of goods, but is not expected to lift consumption meaningfully. Private consumption expenditure was weak well before the pandemic, growing at just 2% y-o-y in Q4FY20 and at 6.4% and 6.5% in Q3 and Q2, respectively. However, since then, the recovery in the economy has been fairly swift and consumption has clearly gotten a boost.

This is reflected in the strong tax collections—direct and indirect—that have given the Centre confidence to cut central excise duties. The Centre’s gross tax collections were up 64% year-on-year in H1FY, well above the 9.5% required run rate to hit the annual target of Rs 22.17 lakh crore. More importantly, net tax receipts jumped 101% y-o-y; at Rs 9.2 lakh crore, that is nearly 60% of the sum pencilled into the budget estimates.

At the same time, expenditure has been contained at 35% of the target in H1FY22.The revenue loss, of about 0.2% of the GDP, could see the fiscal deficit at around 6.5-6.6% against the targeted 6.8%. However, the government is unlikely to increase its borrowing and will likely stick to the planned Rs 5.03 lakh crore for H2FY22. This would help RBI as much as the tax cuts and the impact on inflation. Given the broad inflationary pressures and the imminent tapering by the US Fed, the central bank will have little choice but to continue normalising policy; it has started by draining excess liquidity but could soon hike the reverse repo rate.

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