Home / Markets / Mark To Market /  The fallout of excise cut on petrol and diesel

The central government reduced the excise duty on petrol and diesel by 8 per litre and 6 per litre, respectively, to control surging retail inflation. This has led to prices of these fuels falling across the country. All other things remaining the same, economists expect this to help bring down retail inflation by 20-40 basis points (bps). One basis point is one-hundredth of a percentage point.

The cut will also lead to lower government earnings. Over the years, the excise duty on petrol and diesel has helped the government earn substantial revenue. In October 2014, the excise duty on petrol and diesel was 9.48 per litre and 3.56 per litre, respectively. By February 2021, this had gone up to 32.9 per litre and 31.8 per litre, respectively, pushing up overall government revenues.

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Douse the fire

In 2014-15, total excise duty earned on petroleum products was 99,068 crore. By 2021-22, this had jumped to 3.73 trillion. The excise duty earned from petrol and diesel makes up for the bulk of the excise duty on petroleum products. For April to December 2021, the first nine months of the last fiscal year, these revenues were 2.63 trillion.

It was important for the government to reduce excise duty on petrol and diesel as inflation is a politically sensitive issue and Assembly elections are scheduled in Gujarat and Karnataka in some time. Nonetheless, this will come at the cost of lower revenues than projected and, hence, a higher fiscal deficit, which is the difference between what a government earns and what it spends.

The latest excise duty reduction is expected to cost the government 1 trillion when the government’s ability to earn money through disinvestment is rather limited. The initial public offering of the Life Insurance Corporation of India has not instilled much confidence. Also, the sale of Indian stocks by foreign institutional investors makes further disinvestment difficult.

What doesn’t help is that the Reserve Bank of India’s (RBI) dividend to the government for this fiscal year is 30,307 crore, substantially lower than what has been budgeted for. Also, high inflation might hurt corporate profits, leading to lower dividends from public sector enterprises.

According to economists Sonal Varma and Aurodeep Nandi of Nomura, the fiscal deficit is now expected to jump to 6.8% of the gross domestic product against the budgeted 6.4%. The war in Ukraine will push up fertilizer subsidy massively.

A higher fiscal deficit implies that the government will have to borrow more unless it cuts its expenditure. In this scenario, RBI, as the debt manager of the government, will have to ensure that the interest rates that the government pays on its debt do not go up too much. This is when it is trying to control inflation by raising interest rates.

Other than controlling inflation, RBI is also trying to ensure the rupee doesn’t weaken too much against the dollar. To do this, it has been gradually sucking excess money out of the financial system. As of the beginning of April, excess money in the financial system was more than 8 trillion. It is now around 3.2 trillion. With fewer rupees going around, the value of the rupee against the dollar hasn’t fallen as fast as it otherwise would have. However, with fewer rupees, interest rates are likely to go up.

This makes the situation tricky. Will RBI try to control inflation, which is its mandate? Or does it keep the finance ministry happy by ensuring interest rates on government borrowings do not rise too fast? Given the recent experience, RBI is likely to do the latter. Hence, it will have to gradually let the rupee weaken against the dollar.

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