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How India’s luck ran out on oil

In March 2022, the average price of the Indian basket of crude oil was at $112.9 per barrel. This was the first time since August 2014 that oil price crossed $100 per barrel. (Photo: PTI)Premium
In March 2022, the average price of the Indian basket of crude oil was at $112.9 per barrel. This was the first time since August 2014 that oil price crossed $100 per barrel. (Photo: PTI)

  • Russia’s invasion of Ukraine has fuelled high prices. What can the government do to cool it?
  • The overall tax revenues of the central government have gone up in FY 22— almost 5 trillion above the budget estimate. Therefore, there is scope for a further cut in excise duties

MUMBAI : During the period April 2021 to February 2022, India imported 85.4% of the oil that it consumed. In fiscals 2019-20 and 2020-21, the import dependency had stood at a similar 85% and 84.4%, respectively.

Given this dependence, high-oil prices end up making things difficult for the Indian economy. Nonetheless, since the Narendra Modi government was elected in May 2014, India has been lucky on the oil-price front. Take a look at Chart 1, which plots the average monthly price of the Indian basket of crude oil, starting from April 2011 onwards.

Fuel economics 
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Fuel economics 

From April 2011 to August 2014, the price of crude oil was greater than $100 per barrel (except in June 2012 when it averaged at $94.5 per barrel). Prices started falling after August 2014 and have largely stayed lower than $70 per barrel since then, except for a period of six months in 2018, when they briefly touched $80 per barrel.

In March 2022, the average price of the Indian basket of crude oil was at $112.9 per barrel. This was the first time since August 2014 that oil price crossed $100 per barrel, with a gap of 90 months in between. Oil prices rose by more than 50% in the second half of 2021-22. Of course, much of this increase happened because the oil market started taking into account the increasing possibility of Russia attacking Ukraine.

Russia is the world’s second largest exporter of oil. Data from Organization Economic Complexity tells us that in 2020, Russia exported oil worth $74.4 billion. It was behind Saudi Arabia which exported oil worth $95.7 billion. With the supply of Russian oil being impacted, global oil prices, not surprisingly, have gone up. Interestingly, India doesn’t import much crude oil from Russia. In 2019-20 and 2020-21, the Russian imports had stood at 1.6% and 1.5%, respectively, of the total oil imported by India.

While oil prices have been higher than $70 per barrel since September last year, the price of petrol and diesel in the open market didn’t move from 2 November 2021 to 21 March 2022. This was primarily on account of state assembly elections in Uttar Pradesh and four other states.

On 21 March, the price of petrol in Delhi and Mumbai had stood at 95.41 per litre and 109.98 per litre, respectively. Since then prices have gone up to 105.41 and 120.51 per litre, respectively. Prices have seen a similar increase in other parts of the country as well.

In this scenario, the question is how is India placed? What can it do to tackle the high price of petrol and diesel and are there any conditions under which the price of oil can go down? If not, at least stagnate at current levels?

We try answering these questions in this piece.

Price of petrol and diesel

As mentioned earlier, the price of both petrol and diesel have gone up since 21 March. Take a look at Chart 2. It breaks up the petrol price of 101.81 per litre on 1 April at Indian Oil Corporation pumps in Delhi.

Let’s try and understand how a price of 101.81 per litre is arrived at. The company sold petrol to dealers who run fuel pumps at 53.54 per litre. On this, the central government charged an excise duty of 27.9. The dealers were also paid a commission of 3.83. These three elements add up to 85.27 per litre. On this, the Delhi government charged a value added tax of 19.4%, which works out to 16.54. We add this to 85.27 arrived at earlier and get a retail petrol price of 101.81 per litre.

What does this calculation tell us? On 1 April, the central government tax and the Delhi government tax worked out to around 44% of the retail price of petrol. This proportion will vary from state to state primarily because different state governments charge a different rate of value added tax or sales tax on petrol.

Take the case of Mumbai. On 1 April, the price of petrol in the city was 116.72 per litre, nearly 15 per litre higher than that in Delhi. The reason for this is straightforward. The Maharashtra government charges a value added tax of 26% along with an additional tax of 10.12 for every litre of petrol sold in the city. Hence, in the case of Mumbai, the total taxes easily amount to more than 50 per litre. The state government tax varies and is the lowest in Lakshadweep and Andaman and Nicobar islands where it stands at 0% and 1%, respectively. Further, what is true for petrol is also true for diesel. In Delhi, on 1 April, the price of diesel was at 93.07 per litre. Taxes formed around 38% of the price. In other states, with higher value added tax or sales tax rate, the proportion of taxes is higher.

Can governments cut taxes?

Prices of petrol and diesel have risen by 10 per litre since 21 March. One way to lower these prices is for the governments to cut taxes. The question is are they in a position to do so? Let’s try and understand that.

Take a look at Chart 3. It plots the total excise duty on petroleum products earned by the central government as a percentage of the gross domestic product (GDP), along with the sales tax/value added tax on petroleum products earned by state governments as a percentage of GDP. This is done primarily to take into account the size of the economy given that as the size of the economy increases the government should end up collecting higher taxes in absolute terms as well. A bulk on the tax of petroleum products comes from the sale of petrol and diesel.

Chart 3 makes for a very interesting reading. In 2014-15, the total excise duty earned by the central government by taxing petroleum products had stood at 0.79% of the GDP. Sales tax/value added tax for state governments was at 1.1% of the GDP. Since then, the tax collected by the central government has gone up and it was 1.88% of the GDP in 2020-21. In the first six months of 2021-22, the last fiscal, it stood at 1.58% of the GDP.

As mentioned earlier, oil prices fell below $100 per barrel post August 2014. The excise duty on petrol and diesel as of 1 October 2014 had stood at 9.48 per litre and 3.56 per litre, respectively. After this, as the oil price fell, the central government increased the excise duty. On 2 November 2021, it stood at 32.9 per litre and 31.8 per litre, respectively. On 3 November, the excise duty was cut by 5 per litre for petrol to 27.9 and 10 per litre for diesel to 21.8, and which is where it currently stands.

This shows us how the central government has managed to milk petrol and diesel since late 2014 onwards. Given that the central government did not pass on the total benefit of the fall in price of oil—in the form of lower prices of petrol and diesel to the end consumers—it is only fair that it protects them a little at a time when oil price is on the higher side.

Also, this is at a time when the overall tax revenues of the central government have gone up. An 8 April press release of the central government puts the total gross tax revenue for 2021-22 at 27.07 trillion, almost 5 trillion above the budget estimate and 34% more than the tax collections in 2020-21. Given that, there is still some scope for a further cut in excise duties at the central government level.

When it comes to sales tax/value added tax, the earnings of the state governments have been more or less constant at 1-1.1% of the GDP over the years. Hence, on an aggregate basis, state governments are really not in a position to cut sales tax/value added tax on petrol and diesel. Another factor that needs to be kept in mind is that in the last few years, the two major revenue earners for the state governments—taxes on alcohol and real estate—have taken a beating due to the pandemic. Further, with most indirect taxes being subsumed under the goods and services tax, the ability of state governments to earn revenue from different forms of taxes has gone down.

Nonetheless, the situation might vary from state to state. Take the case of the Delhi government, which in December cut the value added tax on petrol to 19.4%, from the earlier 30%.

What can drive prices lower?

If the war in Ukraine ends, oil prices will automatically cool down. Your guess is as good as mine on when that will happen.

Nonetheless, Ray Dalio, who manages Bridgewater Associates, the world’s largest hedge fund, said in a recent LinkedIn post: “I believe that the Russian-Ukrainian war is just the first battle in a long war for control of the world order."

While the war remains an unpredictable factor, there are other short-term factors which one can understand slightly better. The price of the Indian basket of crude oil was at $126.6 per barrel on 8 March. As of 12 April, it stood at $99.9 per barrel. Much of the fall in April has happened because of a covid lockdown in China.

Up until now, China has followed a no-tolerance policy when it comes to the spread of covid and that has led to the government locking down entire cities, most recently Shanghai. The way the oil market is reading this is that if the pandemic continues to spread in China and leads to other major lockdowns, the overall global demand for oil will fall. China is the world’s biggest importer of crude oil. In 2020, it imported oil worth $150 billion.

Given this, if China’s no-tolerance policy fails in the time to come, demand for oil will come down, and prices will fall or at least remain stable. This, in a weird sort of way, will benefit India. Of course, the Chinese economy will also slow down and this will lead to a global slowdown.

Another factor that can push oil prices down a little is the interest rate policy of the rich world central banks. Oil, other than being a widely consumed commodity, is also a widely speculated commodity. If rich world central banks keep raising interest rates in the months to come, this will lead to lesser speculation around the bet of oil prices going up. This should help cool oil prices as well.

Finally, India is looking to buy oil directly from Russia, something that it hasn’t been doing up until now. An estimate made by The Economist in early April suggests that up until now, India has bought around 15 million barrels of oil from Russia which works out to around three days of consumption.

The trouble here: how does India carry out trade with Russia without breaking the economic sanctions on Russia? As T Rabi Sankar, a deputy governor of the Reserve Bank of India, recently said: “We will not do anything which goes against the sanction."

All in all, this remains an extremely fluid situation with trade-offs on both sides.

Vivek Kaul is the author of Bad Money.

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