As crude oil price is essentially a supply-side problem, prudent supply management can contain inflation better than through demand management. If inflation arising out of supply shock is controlled through demand management, the entire economy may have to pay a heavy price.
International prices of crude oil have been ruling firm in March 2018, close to $70 per barrel. Several factors are responsible for this buoyancy, which include, inter alia, demand-supply mismatch, global economic recovery, control over daily production by oil producing countries, trade war among major economies, and other geopolitical reasons. This is a major cause of concern for the oil importing emerging economies in general and India in particular.
India is the third largest consumer of crude oil, next to the US and China. The country’s domestic consumption of crude oil, which was 158.4 million metric tonnes (mmt) in 2013-14, seems to have crossed 200mmt in 2017-18. Domestic production continued to remain stagnant, at around 36mmt, during the same period. As a result, import dependency has gone up from a little over 77% in 2013-14 to about 82% in 2017-18.
Historically, the government subsidised consumers by regulating the prices of petroleum products. The fiscal burden arising out of petroleum products’ subsidy crossed Rs 1 trillion in 2008-09, forcing the Union government to deregulate their prices in a phased manner. After the global financial crisis, the fall in international prices of crude oil provided an opportunity to do so without disruption in the domestic economy. While petrol prices were deregulated in 2010, diesel prices became market related since 2014. As of now, while kerosene and LPG prices are still regulated, prices of other petroleum products have been freed before 2010.
As part of prudent fiscal management, the Union government did not pass on the entire benefit of the fall in crude oil prices to the consumers by imposing excise duty on petroleum products. The state governments also collected sizeable amount of revenues from VAT/other state taxes imposed on such products. The oil sector, which has been a major source of receiving subsidy, has now emerged as a major source of revenue for both central and state governments in the deregulated regime (see table).
Currently, the element of taxes (excise duty, road cess and state taxes together) on petrol and diesel at New Delhi has been approximately 48% and 39%, respectively. At Mumbai, the tax element on petrol/diesel is the highest. Dealers have separate margins of about 5% on petrol and 4% on diesel. A sizeable amount of revenues received from the oil sector has significantly contributed to fiscal consolidation at both central and state levels.
In the deregulated regime, there has been a two-way movement of petrol/diesel prices depending on global crude oil prices. The Union/state governments have also reduced excise duties/state taxes on certain occasions when the burden on the consumers has been high. In the context of the recent increase in international prices of crude oil, the consumers expect the government to reduce taxes so that the burden on them shall be reduced, besides anchoring overall inflation.
As of now, the fiscal situation is tight at both central and state government levels, following their commitment to achieve fiscal consolidation. Hence, it is natural for them to avoid cut in the taxes on petroleum products to prevent the fiscal arithmetic going haywire. On the other hand, the persistence of crude oil prices above $70 per barrel for a long period is likely to be inflationary. As indicated by the Reserve Bank of India, the global crude oil price is a major upside risk to inflation in the country. If inflation shoots up, the Monetary Policy Committee shall not hesitate to hike the repo rate at the earliest. The question, therefore, arises as to whether the inflationary impact of the rise in global crude oil prices should be handled through supply management or demand management?
As crude oil price is essentially a supply-side problem, prudent supply management can contain inflation better than through demand management. Under the flexible inflation targeting regime, there is an implicit understanding that the government, besides adhering to fiscal consolidation, has to undertake suitable supply management as and when required. If inflation arising out of supply shock is controlled through demand management, the entire economy may have to pay a heavy price. After demonetisation and GST shocks, India’s economic recovery is at a nascent stage. Unless nurtured carefully, India’s recovery may be short-lived, particularly if the cost of credit goes up significantly.
The oil ministry desires the GST Council to bring petroleum products under its ambit at the earliest. Tweaking of taxes on petroleum products, if any, can be done by the GST Council. The burden of revenue loss in case of a cut in taxes on petroleum products may be borne by both Union and state governments.
It is advisable to bring petroleum products under the ambit of GST at the earliest, at least from the point of view of having a uniform price of each petroleum product throughout the country. But there are quite a few issues that need to be sorted out before central and state GST rates are finalised on each petroleum product.
Being essential commodities, it may not be appropriate to impose the highest GST rate on petroleum products. The local taxes imposed on petroleum products by each state government are widely divergent. Moreover, it may take time to build consensus to bring petroleum products under GST. Adjusting the exiting tax element within 12% or 18%, particularly on petrol and diesel, may be difficult. Hence, both central and state governments may have to go in for reduction in excise duty/state taxes on petroleum products sooner or later, if global crude oil prices persist above $70 per barrel for a long time.
Barendra Kumar Bhoi, Former Principal Adviser and Head of the Monetary Policy Department, RBI.