Home / Markets / Mark To Market /  There is no free lunch on auto fuel prices

The prices of petrol and diesel were hiked again on Sunday by 50 paise a litre and 55 paise a litre, respectively. This is the fifth increase in the prices of these fuels in six days, leading to a cumulative per litre increase of 3.70 and 3.75 respectively at the level of oil marketing companies (OMCs). The increase in price at the fuel pumps would vary from state to state depending on the local sales tax or value added tax.

However, the prices of petrol and diesel have barely gone up in comparison to the rise in crude oil prices. The price of the Indian basket for crude oil, which was $117.7 per barrel on 24 March, has risen by nearly 41% since early November.

Windfall gains
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Windfall gains

State-run OMCs need to raise the prices of petrol and diesel by about 22 per litre and 25 per litre, respectively, to have a normative marketing margin of 2.7 per litre, if the price of a barrel of crude oil is $120, according to Hemang Khanna, analyst, Kotak Institutional Equities.

However, it would be difficult to implement such a price increase. Not only will it be politically difficult, it would also immediately fuel retail inflation, which is already above the Reserve Bank of India’s upper level of tolerance of 6%. It would thus make things difficult for a large section of the population that is struggling to counter the negative economic impact of the coronavirus outbreak.

Nonetheless, if the OMCs do not raise their prices by the above recommended levels, their marketing margins will be hit. Kotak estimates gross marketing margins on petrol and diesel to be in the negative territory so far in March.

Excise duty and sales tax or value added tax of state governments, account for the bulk of the price of petrol and diesel across the country. As such, one option is for the central government to reduce the excise duty on petrol and diesel to ensure that OMCs at least do not lose money. As of October 2014, the excise duty on petrol and diesel was 9.48 per litre and 3.56 per litre respectively. This gradually increased and as of November, it was 32.90 per litre and 31.80 per litre on the two fuels respectively. On 3 November, the excise duty was cut to 27.90 per litre and 21.80 per litre, respectively, providing some relief to the end consumer.

The dependence of the central government on the revenue it earns from different taxes, cess, and surcharges paid by the petroleum sector has only gone up over the years.

The contribution of the petroleum sector to the central government includes excise duty collected on petroleum products, corporate income tax, and dividends paid by oil companies to the central government, dividend distribution tax, customs duty, cess, and royalty on crude oil. This contribution was 1.38% of gross domestic product (GDP) in FY15. In FY21, it was 2.3% of GDP. This year it has been 2.01% of GDP.

This was primarily driven by the excise duty hike on petroleum products, which has jumped from 0.79% of GDP in FY15 to 1.88% in FY21. It was at 1.58% in the half year ending September (H1FY22).

The dependence of the central government on revenues from the petroleum sector has risen significantly. Nonetheless, if it wants to ensure that the burgeoning oil price does not translate into high inflation, it has to cut the excise duty on petrol and diesel. Also, given that the government captured the bulk of the fall in oil prices from late 2014 by raising the excise duty on petrol and diesel, it is only fair that it reduces the duty now.

This would mean lower tax collection. To make up for that, it will have to either borrow more or try and earn more money through non-tax avenues such as disinvestment and land sales. There is no free lunch in economics. At the end of the day there are perpetual trade-offs.

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