Biting the bullet on petro prices

Thiruvannathapuram S Ramakrishnan | Updated on October 22, 2021

Stymieing recovery   -  Murali Kumar K

It’s time to slash Central and State taxes on fuel, as higher prices may spur inflation and derail the incipient economic recovery

There are compelling reasons for the Centre to bring down petrol and diesel prices now.

The most compelling one being that a price above ₹100 will be politically painful for the ruling party.

The second reason is given the Modi government’s good track record on inflation management, a key factor in its 2019 victory, it cannot afford to forego this goodwill.

If the petrol and diesel prices’ hike in October 2021 are accounted for, there are chances that the consumer price index (CPI) may breach 6 per cent soon.

Despite high fuel prices, it is possible to control the inflation by checking the prices on food and beverages, which has around 50 per cent weightage in the CPI.

Moreover, diesel prices breaching the ₹100 mark will have a serious cascading effect on food inflation. Cooking oil, which witnessed a 50 per cent hike in the last six months, is one of the key items under food and beverages pushing CPI inflation up.

Cooking oil prices may ease only in 2022-23, when the MSP hike of oilseeds leads to its increased production.

Stagflation worries

The third reason is that if CPI inflation goes beyond 6 per cent, it may result in stagflation, which hurt the prospects of recovery.

The Centre managed to hold CPI inflation at about 5 per cent between 2014 and 2020, enabling RBI to cut the repo rate from 6.50 per cent in April 2016 to 4 per cent in May 2020. However, if the CPI inflation breaches 6 per cent, the RBI will be forced to hike policy rates, which will severely impact the post-pandemic economic recovery.

India has reached the 100-crore mark in vaccinations, which dims the chances of a third wave of Covid.

India may witness 8.5 per cent growth in FY 2021-22 as estimated by IMF or can even reach double digit growth if the growth momentum picks up. Given this, the tax revenues for both central and state governments would be back to pre-Covid levels, giving leeway for both the Centre and States to slash taxes on petrol and diesel.

On the flip side, a cut in taxes will increase the demand and consumption of fuel, leading to greater crude oil imports, which could widen the trade deficit.

India has never had a trade surplus historically and it could happen only when the imports, especially crude oil, reduce substantially or exports increase exponentially.

Despite the trade deficit, India accumulated huge foreign exchange reserves to the tune of $640 billion and hence there is no dearth of forex to import crude oil. The other issue is that if the international crude oil price increases further in the next six months, which cannot be ruled out, then should the government further reduce the taxes or not. It would be prudent for the government to adopt a wait-and-watch approach.

Since the pros of reduction in taxes on petroleum products outweigh the cons, the Centre must not hesitate to cut taxes on petrol and diesel.

The moot question then is how much revenue the government may forego if it cuts taxes on petrol and diesel. One solution is to bring petrol and diesel under the maximum GST tax rate of 28 per cent (14 per cent for central government and 14 per cent for State governments where the consumption is made). This move would reduce the petrol and diesel prices to less than ₹50.

On expected lines, Tamil Nadu, Punjab, West Bengal, Telangana, Rajasthan, and Kerala vehemently objected to bringing petrol and diesel under GST ambit in the GST council meeting held in September 2021. There will be a huge tax revenue shortfall for the Centre and State governments once petrol and diesel prices are brought under the GST regime, which may be infeasible at this point of time.

It is also not a wise idea to bring petrol and diesel under GST because with such a move, the life cycle cost may be favourable to ICE vehicles than electric vehicles and would enormously delay the proliferation of vehicles across passenger and freight transport.

Then what is the alternative? The Centre and State governments may have to forgo some tax revenue and bring the price of petrol and diesel to below ₹100. The Centre should take the lead in slashing preferably cess up to ₹10 and should ask the BJP-ruled States to slash the VAT up to ₹10, so that the price of petrol and diesel reduces to less than ₹100. It is left to the discretion of the non-BJP state governments to reduce VAT or not.

However, if the difference is about ₹10 between States which cut VAT and the States that do not, vehicle owners would prefer to fill petrol from bunks where the fuel is cheaper. Hence the increased sales of petrol and diesel would compensate the revenue loss for States that have cut VAT.

Author is a public policy expert

Published on October 22, 2021

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