The costs of rising fuel prices in India

As the Covid-19 pandemic devastated the finances of the Centre and States, they increased taxes on fuel to generate additional revenues, to meet out the rising expenditure in the pandemic times. For instance, excise duty and VAT, contributes to nearly 63 per cent of petrol and 60 per cent of diesel costs in Delhi.

Hyderabad: On 9th December, 2020, retail fuel prices in India touched their highest level since October 2018. While petrol is sold at Rs. 83.71 per litre, diesel is priced at Rs. 73.87 per litre in the national capital.

The prices remained unchanged for six consecutive days after that, and there are further expectations that they could rise further, subject to the changes in the global crude oil prices. This hike in the retail fuel prices came in the backdrop of India’s Oil marketing companies’ decision to hike the prices of petrol and diesel by over Rs 2 and by nearly Rs 3.50 respectively. There are two fundamental reasons behind this rise in the domestic fuel prices.

The first reason is the rising global crude oil prices. Brent crude constitutes a large share of India’s crude basket and the price of Brent crude touched nearly $49 per Barrel, from its $ 19 per barrel in April 2020.

In this context, it is to be noted that, the Government of India deregulated the domestic petrol prices in 2010, in order to keep them in tandem with the global crude oil prices. Technically, the domestic fuel prices goes up when the global crude oil prices raise and vice versa. The latest OPEC plus deal had resulted the rise in the global crude oil prices and thus triggered a rise in domestic fuel prices.

The second reason for this rise is the improvement in the demand outlook for petrol and diesel, in the wake of relaxed Covid-19 restrictions and the prospects of the vaccine for Corona virus to be available soon.

The Conundrum of Taxes

While the trigger for the rise in domestic prices holds a valid logic, it is to be noted that another 29 paise per litre increase in petrol prices would take their prices to the highest level ever recorded in the national capital. Last time they touched Rs 84 per liter on October 4, 2018, when the global crude oil prices was at around $80 per barrel.

Now at the level of $49 per barrel the prices should have been lower than that, given the price deregulation mechanism in India. This did not happen due to the large scale taxes, duties, cess levied by Union Government and different state governments. For instance, excise duty and VAT, contributes to nearly 63 per cent of petrol and 60 per cent of diesel costs in Delhi.

As the Covid-19 pandemic devastated the finances of the Centre and States, they further increased taxes on fuel to generate additional revenues, to meet out the rising expenditure in the pandemic times. According to the Petroleum Planning and Analysis Cell (PPAC), petrol prices were revised 56 times and the diesel prices were revised 67 times in Delhi, since April 2020.

Except for the period between September-October 2020, these prices witnessed an upward trend. In fact, when the crude oil prices went down, the respective governments imposed taxes on domestic fuel prices and offset the gains from favourable global oil prices.

However, the consumers did not feel this pinch as the global crude prices were low. Now as they too started raising due to geo-political developments, the heat of higher taxes is being felt now.

The Cost of High Fuel Prices

While imposing taxes on fuel is a low hanging fruit for the governments to generate additional revenue, a persistent increase would lead to a counterproductive outcomes. First and foremost, high price of fuel would result in inflation in the economy. Presently, India’s retail inflation is 7.6 percent, a level that is close to its seven-year high.

According to an estimate by Barclays', an increase of $10 per barrel in the crude oil price would lead to an increase of the fuel prices by Rs 5.8/litre at the pump, and also adds nearly 34 basis point (bp) to headline inflation over three to six months. This estimate is done by assuming no change to petroleum taxes. This would be even higher, if the taxes are considered.

On the other hand, an expected rise in global crude oil prices due to renewed demand is going to pose a tougher challenge in the time to come. Indeed this drives home the effect of fuel prices on inflation and underscores the need to ensure that they remain under control.

The second danger of a high fuel prices is a possible collapse of demand due to price pressure, which could result in macro-economic instability. This is due to the fact that the additional expenditure on fuel would reduce the incomes in hand of the consumers, thereby resulting in a fall in demand. This would have serious economic consequences in the long term.

Thirdly, it is to be remembered that diesel is widely used fuel for freight transport through road and the higher diesel prices would serve a blow to transport sector and the people dependent upon it.

Last but not the least, due to the pandemic we are going through, the public transport across the country is yet to resume and large population relies on personal vehicles. Higher fuel prices would only deteriorate their financial condition, which is already fragile due to the Covid-19 induced economic slowdown.

All these possible consequences hold an important policy lessons for the governments to exercise restrain while imposing further taxes on these products that could directly impact the lives and livelihoods of common man. Reducing the taxes or not raising them for a while may not be a silver bullet for all the problems that arise from the high fuel prices.

However, it would definitely offer enough elbow room for the policy makers to manoeuvre better economic plans for the country’s macroeconomic stability. On the other hand, the policy makers need to explore the long term possibilities to reduce fossil fuel consumption and develop renewable and clean energy, in order to serve the long term needs of the country.

(Article by Dr. Mahendra Babu Kuruva, Assistant professor, H.N.B. Garhwal Central University, Uttarakhand)