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What Modi government can do to curb surging petrol and diesel prices

The consumer has not benefitted from low oil prices in the last four years and hence should be shielded when oil prices are rising.

 |  5-minute read |   21-05-2018
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We are back to the bad old days of surging petrol and diesel prices as international oil prices continue their upward spiral after a four-year respite. The four-year respite had seen oil prices sliding to $25 per barrel from a record high of $110 per barrel in 2013. The consumers would have rejoiced if the government had not decided to hike taxes steeply and pocketed the gains of sliding oil prices. Now that the prices are touching $80 per barrel and the taxes have not been reduced, the prices of petrol and diesel have started their steep march upward.

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Let us look at the structure of oil products pricing at the moment. Petrol and diesel have been left out of the Goods and Services Tax ambit. The central government charges a specific rate of duty which is approximately Rs 19 per litre on petrol and around Rs 10 per litre on diesel. Specific rate of duty means it is independent of the ex-refinery price of petrol and diesel. Whether oil is at $25 per barrel or $80 per barrel, the duty remains the same.

Most state governments charge anywhere between 20 per cent and 30 per cent Value Added Tax (VAT), which is ad valorem, meaning it is charged on the ex-works price of refineries. Thus as prices go up, VAT collection of states also goes up. Some states have also local taxes which push up the prices further. Thus petrol in Mumbai costs Rs 84 per litre whereas in Gujarat the price is around Rs 76 per litre. But on an average the government collects about Rs 33 to Rs 38 per litre on petrol and about Rs 24 to Rs 30 per litre on diesel.

The other factor pushing up oil prices is the weakening rupee. About 80 per cent oil is imported and the rupee is weakening pushing up the cost of imports. The rupee was at 58 to a dollar in 2014 but it is at 68 to a dollar today. It has weakened by about 17 per cent in four years, which works out to about four per cent per year. Thus the cost of import has gone up by about four per cent only on account of weakening rupee.

The oil headache is back. The government has so far bravely denied lowering taxes as a solution. The government rightly feels that fiscal deficit going out of control could worsen the macroeconomic picture. On the other hand, general elections are just a year away and high prices of fuel could impact voter behaviour because it is almost certainly going to push up inflation.

The government has so far kept macroeconomic stability under control but it has been aided by low oil prices. That luxury is now gone. Fuel prices have been kept steady during important state elections. We have the recent Gujarat and Karnataka elections as examples. Thus the government continues to administer oil prices through the back door though it claims otherwise.

What are the options before the government? In the short term, if oil prices continue to rise, the best and morally just solution is to reduce taxes. The excise duty was Rs 9 per litre in 2013 when oil prices were $110 per barrel. Today it is Rs 19 per litre. A reduction of Rs 5 in excise duty will result in Rs 6 to Rs 7 per litre reduction because state VAT is ad valorem. The consumer has not benefitted from low oil prices in the last four years and hence should be shielded when oil prices are rising. This will also make political sense for the government. Loss of revenue should be compensated either through disinvestment or by reducing expenses.

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In the long run, as I have written earlier the government has to reduce its dependence on oil revenues. Oil products have to be brought within the GST ambit and India's fuel prices should match international fuel prices.

The prices then do not have to be administered by the government and the political backlash would disappear because people would treat oil as just another commodity which depends on international prices.

A big advantage of reduction in oil duties is that it will help the country tremendously on the export front. It will make our exports competitive and help us reduce our current account deficit. This will help us in our currency valuation and we may no longer see the rupee depreciating. This will help us in lowering the cost of our imports. The other great benefit would be that it would force the government to become more efficient. It can get rid of its loss making units, do strategic disinvestment of its assets, reduce its non productive expenses and become lean and mean.

I know very few of the long-term solutions will be incorporated in an election year. The easier options will be followed. But the time for reckoning may not be far away. The pressure of high oil prices and ballooning current account deficit will force the government to go for structural changes. Otherwise history will continue repeating itself and we may be back to oil deficit pools.

The oil bonanza in the form of high taxes may not also last long because of technological changes. We may see electric vehicles taking off in India in the next 10 years. This may result in drastic cut in oil consumptions and hence lower revenues for government.

The time to act is now. Put long-term solutions in place and over the next three to four years, we may see a much better economy with oil prices in sync with rest of the world. Let us not wait for crises to force us. Let us be proactive and not reactive. Indians deserve it.

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Writer

Nishat Shah Nishat Shah @nishatshah2

Writer is an alumnus of IIM-A. He is an Ahmedabad-based commentator on business and economic affairs.

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