As prices of crude in the global markets and petrol at the domestic pumps are poised to hit 100, Prime Minister Narendra Modi's cooperative federalism will have its first major test. Under the given scenario, the medium-term solution for fuel inflation lies only with states, which reaped a windfall thanks to cheap crude and heavy state taxation over the last four years.
While the demand for a cut in excise duty is growing, the mandarins of north block are avoiding any knee-jerk firefighting measure. The government is working on a medium-term strategy to douse the fuel fire as excise duty cut seems unsustainable owing to the trajectory of crude prices.
Crude futures are trading near their highest levels in three and a half years, bolstered by strong demand, supply cuts from big producers and mounting geopolitical tension in West Asia and Venezuela. Even Organisation for Economic Co-operation and Development (OECD) inventories may fall sharply during the current year compounding the constraints of global crude availability.
A possibility of crude touching $100 per barrel is a clear signal that period of "lower for longer" oil prices is over. As prices are likely to keep rising, repeated cuts in excise duty may not bode well for a stressed fiscal situation. It is important to note that every Rs 2/litre reduction on petrol and diesel could lead to a revenue loss of around Rs 280 billion that translates into a slippage of 0.1 per cent of GDP in fiscal deficit.
Even if the Centre yields with a token excise cut at once, states will have to bear the brunt of deeper tax cuts to offset the huge hike in prices.
Cruel taxation has to go
In the last four years of discounted crude, the Centre and states have brutally competed against each other on fuel taxation.
Let's have a look at how states are taxing (as on May 1, 2018) us when it comes to fuels.
a) There are as many as nine states - Andhra Pradesh, Assam, Madhya Pradesh, Maharashtra-plus Mumbai, Rajasthan, Punjab, Kerala, Tamil Nadu and Telangana that are charging VAT on petrol at a whooping 30 to 39 per cent. In other words, big states are leading the way when it comes to taxing motor fuel.
b) With 20 to 29 per cent VAT on petrol, Bihar, Chhattisgarh, Delhi, Gujarat, Haryana, Himachal, Jammu and Kashmir, Jharkhand, Karnataka, Odisha, Manipur, Meghalaya, Nagaland, Sikkim, Uttarakhand, Arunachal Pradesh, Uttar Pradesh and West Bengal are not far behind.
c) Goa, Nagaland, Chandigarh and Tripura are the only states/Union territories taxing petrol between 16-18 per cent.
d) In case of diesel, Andhra Pradesh, Assam, Chhattisgarh, Gujarat, Jharkhand, Kerala Madhya Pradesh, Maharashtra-plus Mumbai, Rajasthan Punjab, Odisha, Tamil Nadu and Telangana charge 22 to 29 per cent VAT on motor fuel.
e) The rest of the states levy 11.42 to 18.30 per cent VAT on diesel.
States have not only benefitted from increased central transfers out of the oil gains, but also unleashed heavy taxation on fuels under the VAT regime. This has brought the average state taxation to 30 per cent and 20 per cent on petrol and diesel over and above average excise duty of Rs 20 and Rs 17 per litre, respectively.
While crude price is likely to stay out of the "sweet spot" for longer than expected and could herald inflation, PM Modi can well ask 21 BJP ruled states to bring average taxation on petrol and diesel back at 20 per cent and 15 per cent by cutting VAT by 5-10 per cent in the medium-term. If this happens the other states will have to follow suit.
The time has come for PM Modi's team to stand by him to avoid an inflation explosion and the resultant political meltdown.