On High Oil Price and Government Policy

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Surajit Das

Petrol and diesel prices have reached almost Rs. 80 and Rs. 70 per litre respectively in the country today, which is definitely a cause of concern. Since oil enters into the production and transportation of almost all commodities and services, directly or indirectly, the overall price rise is expected with rise in domestic price of oil. Total consumption of petroleum products in India is around 200 MMT (million metric ton) and crude oil production in India is around 36 MMT per annum – the rest we import. Gross import is around 250 MMT plus LNG import was around 6 MMT in 2016-17 and export was around 65 MMT. The domestic price increased mainly because of sharp rise in the international price of oil from US40$ (in the second quarter of 2016) to almost US 80$ per barrel (in May 2018) as well as because of rise in the tax rate on oil from 37.5% (as on 1st September, 2012) to more than 50% (on 19th June, 2018) for petrol and from 20% to almost 40% for diesel, on an average, in India.

On 19th June, in Delhi, the prices of petrol and diesel per litre were Rs.76.27 and Rs.67.78 respectively. The prices in which the dealers bought petrol and diesel were only Rs.36.96 and Rs.39.96 per litre respectively. The dealers’ commission on petrol was Rs.3.62 per litre and that on diesel was Rs.2.52 per litre. The rest of the differences were taxes collected both by the central and the state governments. Rs.19.48 of central excise duty and Rs.16.21 of VAT (value added tax of the state governments) have been added to the dealers buying price and commission to arrive at the final selling price of petrol of Rs.76.27 per litre in Delhi on 19th June. And the central excise duty and VAT charged on diesel was Rs.15.33 and Rs.9.97 per litre respectively. Therefore, in the price build-up, there was 47% tax on petrol and 37% tax on diesel in Delhi (VAT rate vary state to state). It is important to note here that more than half of the tax went to the central exchequer rather than the State government. On top of that there is 2.5% basic custom duty, which is also collected by the central government. As high as one fourth (24%) of the total revenue receipt of the central government came from taxes collected from the petroleum sector in 2016-17 financial year. This sector has contributed 8% of total revenue receipts of all the state governments taken together. This data is taken from the “Ready Reckoner – May, 2018”, page no.19 & 20, released by the Petroleum Planning Analysis Cell (PPAC) of the Ministry of Petroleum & Natural Gas, Govt. of India.

To understand the picture more clearly, let us consider the monthly average domestic petrol price of four metro cities, Delhi Mumbai Chennai and Kolkata (the thick black line in the graph below) since January 2010 till May 2018. Petrol price was around Rs. 50 per litre in the beginning of 2010, which increased almost to Rs. 80 by the middle of 2012 when the international price of crude oil of Dubai Fateh went up by more than 50% from less than US80$ per barrel to more than US120$ (the broken thin line on the top in graph below). Now, the international price of oil is comparable with what it was in the beginning of 2010 (i.e. near US80$ per bbl). However, the domestic petrol price has become Rs.80 today instead of Rs.50 as it was in January 2010. In fact, today’s domestic price is comparable with the situation when the international price crossed US120$ per bbl in the beginning of 2012. This has happened because of increased tax rate on petrol and not because of the rise in international price of oil. The thin continuous line depicts the international price of oil per litre in terms of Indian rupees in the chart below. The difference between the domestic and the international price of oil per litre has been shown by the thick broken line in graph. This difference has gone up significantly during the NDA period as compared to the UPA-2 regime. When the international price was near Rs.20 per litre, the domestic price was as high as Rs.70. The difference constitutes of not only tax by centre and state governments but also dealers’ commission, upstream and downstream companies’ profit and cost of refining etc. However, around 75% of this difference is comprising of the taxes, which has gone up, as mentioned above, from 37.5% to more than 50% of the final price in case of Petrol.

Higher tax rates on petrol and diesel contributed substantially to both central and state government exchequers in the recent years. It is a leakage free tax that can be raised effortlessly without incurring any cost for tax collection. The tax rates could be hiked without raising the domestic price of oil because of the substantial reduction in the international price from over US100$ a bbl in mid-2014 to little less than US50$ in the beginning of 2015 and further to less than US30$ by the beginning of 2016. In fact, domestic petrol price came down due to fall in international price to Rs.60 in the beginning of 2016 from around Rs.80 (in July 2014) despite higher tax rates. So, the higher tax rates on oil did not affect the consumers and, at the same time, government also could mobilize extra revenue from the oil sector by increasing the tax rate to use the opportunity of lower international price. It is a clever strategy indeed. However, since February of 2016 and particularly since the middle of last year (2017), the international price started firming-up again (see either thin broken or continuous line in the graph). But, the tax rates, that were hiked during lower international price, were not reduced at all. As a result of which, the domestic price of petrol has gone up from Rs.60 in the beginning of 2016 to Rs.80 in May, 2018 (see the thick continuous line). The numbers are different but, the story is the same for diesel price as well.

Graph: Trend in Domestic Price of Petrol and International Price of Oil

Source: Indian Oil Corporation Limited (IOCL), RBI and Dubai Fateh Prices.

Since, the international oil price fluctuates so much from US80$ to US120$ to US30$ again to US80$ per barrel within a span of 8 years, to stabilise domestic price of oil and that of the other commodities and services, the government should increase the tax rate when the international price is low and take advantage of the situation, however, when the international price rises, the government must adjust the tax rates downward for maintaining price stability. In fact, government might as well think of creating a corpus fund for the domestic oil price stabilisation. When the international price is low, government may raise more tax from this sector and build this corpus fund for the bad times when the exogenous international price is high – to cross-subsidise the domestic oil prices. This does not have any direct contradiction with ‘deregulation’ of the oil sector because this tax expenditure (or lower tax rate) would be applicable equally on both public and private sector oil marketing companies so that the private companies also get a ‘level playing field’. Although, oil sector has been kept outside the ambit of GST, however, 40% indirect tax on diesel and 50% indirect tax on petrol on the face of rising international price, are simply too much.

In anticipation of inflationary pressure in the economy, the Monetary Policy Committee (MPC) of RBI has already increased the repo rate by 25 basis points on 6th June. Whether rise in interest rate would be able to curb the inflationary pressure in future or not is a matter of another debate, however, this monetary policy move may further aggravate the situation of slowdown and rising unemployment in the country. Instead of raising the interest rate, the government simply could have reduced the tax rates on oil and incur little higher fiscal deficit as a proportion of GDP, without necessarily reducing the government expenditure on social sector and/or otherwise. This is primarily responsibility of the central government not only because of the fact that the maximum revenue from oil sector accrues to central exchequer but, also because the responsibility of price stabilization comes under the jurisdiction of the centre. As of now, there is no effort visible on the part of the government to reduce domestic oil price on the face of rising international price rather, a contractionary monetary policy stance is evident in the fear of future inflation. The cost of production and transportation would now increase not only because of higher domestic oil price but, also because of costlier credit – this might actually push up the future prices and reduce growth and employment. The six eminent members of the MPC have reportedly unanimously voted in favour of a monetary policy measure to curb a ‘demand-pull inflation’ under a situation of ‘cost-push inflation’ due to rise in exogenous international oil price and due to higher tax rate on oil (which is also an exogenous policy variable). Therefore, the economic doctors are prescribing wrong medicine and doing wrong treatment, which actually might aggravate the economic problems of higher inflation and lower growth and employment generation in the economy.

The Author is Assistant Professor, CESP, JNU, New Delhi