Retail prices of petrol and diesel have been rising over the past several weeks. In some parts of the country, the retail selling price of petrol has crossed Rs 100 a litre. Globally, oil prices have been rising because of resurgence in demand, and an increase in the retail prices of petrol and diesel is an outcome of that.
Taxes constitute a high proportion of the retail price of petrol. When tax revenues were hit hard by the Covid-19 pandemic, the Modi government raised the excise duty on petrol and diesel in March 2020 and again in May 2020 to garner revenues. Households did not feel the pain of the rise in excise duties because global crude oil prices had crashed.
Despite a slump in international crude oil prices due to the pandemic, the prices of petrol and diesel did not decline. The gains were adjusted against the excise duty hike to provide a cushion to the government’s tight fiscal situation.
Impact of high duty
There are two consequences of the high duty. First, it hurts consumer pockets and can be inflationary. The rise in crude oil prices in recent weeks, amid the elevated excise duties, is causing retail prices of petrol and diesel to rise. High fuel prices will feed into higher inflation.
This could happen through two channels: Directly, as crude products feature as constituents in the Consumer Price Index basket (in the ‘fuel and light’ and ‘transport and communication’ category), and indirectly, as higher transportation costs due to increase in the price of fuel. The latter would impact the price of other products ranging from vegetables, egg, meat, milk, to cement, fertilisers, chemicals etc. The prices of services could also likely rise due to an increase in fuel prices.
Second, it creates excessive fiscal dependence on petroleum products. Petrol and diesel have been easy targets for raising revenues for the government. The government needs to diversify its sources of revenue and reduce its dependence on oil for bridging its fiscal deficit.
The RBI’s MPC has raised concerns over the inflationary impact of rising crude oil prices and high indirect taxes on petrol and diesel. The MPC has called for a calibrated reduction in high indirect taxes on petrol and diesel to contain the build-up of inflationary pressures in the economy.
Oil price controls in India
A look at the revenue composition of the last few years shows that oil has become a significant source of revenue for the government. The share of tax revenues from oil in the government’s gross tax revenue has shown a steady increase. Between 2014 and 2016, when global crude oil prices were declining, the government raised the excise duty on petrol and diesel on multiple occasions. The government’s dependence on the oil sector for revenues is likely to remain high in the next year as well.
In the long run, India has been shifting away from petrol price controls. India imports nearly 85 per cent of its oil needs and since the domestic prices are benchmarked to international rates, retail prices are increasing.
The prices of petrol and diesel used to be fixed by the government under the Administered Price Mechanism (APM), which was in existence since 1975. In order to boost competition, the government announced the dismantling of the administered price mechanism from 1 April 2002.
Post-APM, the pricing of petroleum products was expected to respond to global prices, but the government started setting prices of petrol, diesel, kerosene and LPG to ensure price stability amid extreme volatility in the international markets. Under this regime, subsidies were being given to diesel and kerosene.
The system of price controls put stress on the finances of oil marketing companies as well as of the government. In 2010, on the recommendations of the expert group on a viable and sustainable system of pricing of petroleum products, petrol prices were made market determined. The price of diesel was decontrolled in 2014. Since then, the prices of petrol and diesel are supposed to reflect the prices in the international markets. Domestic prices of petrol and diesel are revised by oil marketing companies based on the changes in the international prices.
Alternate energy sources
Environmentalists concerned about global warming may not object to high taxes on petrol and diesel as they constitute a carbon tax and discourage greater use. Studies indicate that India’s oil needs will be more than any other country by 2040. But carbon taxes are inadequate to move towards renewable sources of energy. There is also a need to incentivise the use of alternate energy sources like natural gas and solar power.
The government has announced initiatives to strengthen the country’s oil and gas infrastructure. It is working towards increasing the share of natural gas in the country’s energy basket from 6.3 per cent to 15 per cent.
Another area that can help reduce the dependence on fuel is incentivising the use of electric vehicles (EVs). This will also provide a boost to India’s efforts at reducing air pollution. The voluntary vehicle scrappage policy announced in the Budget aims to phase out private and commercial vehicles that are more than 15 and 20 years old. The removal of these old cars would give space for fuel-efficient and environment-friendly vehicles and will also help reduce the huge import bill.
Going further, import duty rationalisation is necessary to make EVs more cost-competitive.
Excessive fiscal dependence on oil can discourage the move towards renewable sources of energy. Further, until public transport that depends on renewable power is created, increasing fuel prices by higher excise is only going to pinch pockets without offering a long-term solution.
Easing access to alternate sources of energy is required to save billions of resources on imported fuel, to prevent a surge in trade deficit and to guard against oil-price shocks.
Ila Patnaik is an economist and a professor at National Institute of Public Finance and Policy.
Radhika Pandey is a consultant at NIPFP.
Views are personal.