Markets
The many fallouts of excise duty cut on petrol and diesel
Summary
- The excise duty cut is expected to cost the Centre ₹1 trillion at a time when its ability to earn money through disinvestment is rather limited. The IPO of Life Insurance Corp. hasn’t instilled much confidence. Also, FIIs selling out of Indian stocks makes any further disinvestment difficult
In order to control burgeoning retail inflation, the central government has cut excise duty on petrol and diesel by ₹8 per litre and ₹6 per litre, respectively. This reduction has led to prices of these fuels falling all across the country. All other things remaining the same, economists expect this to help bring down retail inflation by 20-40 basis points. 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 a lot of money. In October 2014, the excise duty on petrol and diesel had stood at ₹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.
In 2014-15, the total excise duty earned on petroleum products had stood at ₹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 had stood at Rs2.63 trillion.
It was important for the government to cut the excise duty on petrol and diesel, given that inflation is a politically sensitive issue and state 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. Fiscal deficit is the difference between what a government earns and what it spends.
The latest excise duty cut is expected to cost the government ₹1 trillion at a time when the government’s ability to earn money through disinvestment is rather limited. The initial public offering of the Life Insurance Corp. of India hasn’t instilled much confidence. Also, foreign institutional investors selling out of Indian stocks makes any further disinvestment difficult.
What doesn’t help is that the Reserve Bank of India’s (RBI) dividend to the government for this fiscal this year is at ₹30,307 crore, substantially lower than what has been budgeted for. Also, high inflation might end up having a negative impact on 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%. Other than a fall in fuel taxes, the war in Ukraine will push up the fertilizer subsidy massively.
A higher fiscal deficit implies that the government will have to borrow more, unless it cuts its expenditure. In this scenario, the RBI as the debt manager of the government will have to ensure that the interest rates that the government pays on its debt don’t go up too much. This when it is trying to control inflation by raising interest rates.
Other than trying to control inflation, the RBI is also trying to ensure that the value of the rupee doesn’t fall too much against the US dollar. In order to do this, it has been gradually sucking out excess money from the financial system. As of the beginning of April, the excess money in the financial system had stood at greater than ₹8 trillion. It is now down to 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. But with fewer rupees going around, the interest rates are likely to go up.
This makes the situation tricky. Does the RBI try to control inflation which is its mandate? Or does it keep the finance ministry happy by ensuring interest rates on government borrowings don’t rise too fast? Given the recent experience, the RBI is likely to do the latter. Hence, it will have to gradually let the rupee fall against the dollar.
