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Why Budget 2022 must lay down path for more fuel tax cuts

Heavily under fire for sky-high fuel prices, the Centre in November caved in to the demand to reduce excise duties on petrol and diesel to ease inflationary pressures. (REPRESENTATIVE IMAGE) (HT_PRINT)Premium
Heavily under fire for sky-high fuel prices, the Centre in November caved in to the demand to reduce excise duties on petrol and diesel to ease inflationary pressures. (REPRESENTATIVE IMAGE) (HT_PRINT)

With the worst of the pandemic distress over, 2022-23 might be the ideal year to restore the pre-covid excise duties on fuel. It’s necessary to keep inflation in check and boost consumption, currently the weakest pillar in the recovering economy

Heavily under fire for sky-high fuel prices, the Centre in November caved in to the demand to reduce excise duties on petrol and diesel to ease inflationary pressures. But it was only a partial rollback to pre-pandemic excise rates. As the government plans the Union Budget this month, its revenue calculations must not miss the host of factors that make 2022-23 the ideal year to start restoring the old rates, several economists said.

In 2020, the Centre found an easy ally in excise duties to prop up its coffers amidst the pandemic distress. The revenue kitty swelled, but fuel got dearer, crossing the 100/litre mark in many cities. The steep cuts in early November were only about 30-60% of the cumulative hikes undertaken in the months after the pandemic began. Duties still make up a quarter of the total pump cost, which is almost double the share eight years ago.

Excise duty
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Excise duty

The other revenue shortfalls that fuel helped compensate for in 2020-21 are no longer a stress point in 2022 as the economy is growing, thus giving space for further cuts in excise rates, said Madan Sabnavis, chief economist at Bank of Baroda. “There is room for the government, both central and states, to reduce taxes as crude oil prices rise," Sabnavis said.

All eyes are on the Union Budget’s plans to revive the economy. Restoring pre-pandemic rates sometime in 2022 is necessary to give a fillip to consumption, currently the weakest pillar of the economy. The Budget day is unlikely to see fresh excise cuts but it may still be the best platform to lay out the intent for the upcoming fiscal year.

Crude pressures

Back in 2014, a retreat of crude oil prices to below $100/barrel gave space to the Narendra Modi government to start hiking fuel taxes. But the hikes in 2020-21 were the steepest, and helped government revenues stay afloat, with excise collections from petroleum products more than doubling to 3.72 trillion. But as revenues stabilised and inflation began to pinch, clamour grew for tax cuts, including from the Reserve Bank of India itself. Even after the partial reversals, the excise mop-up was already 72% of the full-year aim by November, and the Centre is still on track to meet Budget estimates.

Next year, however, collections can get impacted for the full year, possibly discouraging the Centre from further cuts unless crude prices break out of the current $80/barrel range and head towards $100, said Abhisek Upadhyay, senior economist at ICICI Securities Primary Dealership. That possibility cannot be ruled out: Goldman Sachs predicts crude oil prices at $100 a barrel over the course of two years.

Excise duties on petrol and diesel.
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Excise duties on petrol and diesel.

Misplaced defence

With fuel prices being a consumer-centric topic, the government has often come under criticism for the high tax rates. Finance Minister Nirmala Sitharaman had in August defended her stance, citing liabilities from oil bonds issued by the preceding Congress-led government to cover for fuel subsidies. However, Budget documents show the liability of oil bonds was only a fraction of total excise duty collections in 2020-21.

Indeed, this liability is set to go up sharply from 10,000 crore in 2020-21 to 31,150 crore in 2023-24 and 52,860 crore in 2024-25. But even this principal amount due annually will be little compared to the excise duty likely to be collected every year, and the interest to be serviced annually will be an even tinier share.

Moreover, the government does not have any redemption pressures from oil bonds in the upcoming financial year at least, leaving room for further excise reduction before crude oil prices begin to head south.

Consumption boost

Lower fuel prices have the potential to boost private consumption, which is struggling to reach pre-pandemic levels and is down to its lowest share in the economy in at least 11 years. In addition to moderating inflation, excise duty cuts also exert a favourable impact on consumer sentiment, inflation expectations and consumption in general, said Yuvika Singhal, an economist at QuantEco Research.

“The government can reduce duties further during the course of the year depending on how growth and other sources of tax revenue collections pan out," she said. According to Nomura, the recent fuel tax cuts would lower headline inflation by 14 basis points (bps) due to direct effects and up to 30 bps overall.

The Budget comes amidst the third pandemic wave but its tax projections have to take into account the developments expected at least over the next one year. If fuel prices continue to rise and stoke inflation, the government faces another year of demands to reduce excise rates further.

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