Fuel prices — from petrol and diesel to CNG and LPG — are still very high in India. It is just as well that the Centre has now cut its share of excise duties on petrol and diesel by ₹8 and ₹6, respectively. Three or four States have followed suit, with the rest expected to do so.

The rapid rise in fuel prices is mainly on account of the ongoing Russian invasion of Ukraine, which has disrupted supply chains and curbed supply drastically. Further, economic sanctions on Russia combined with European nations’ voluntary resolve to import gas from elsewhere are also contributing to rising oil prices globally.

While international crude prices were on fire, India kept a lid on domestic prices since last November due to State elections. Thereafter, the retail price of petrol was hiked almost 14 times over roughly two weeks in April 2022. How do India’s prices compare globally? A Bank of Baroda note prepared by Sonal Badhan finds that India’s petrol price ($1.35/litre) stands at 42nd position out of 106 countries in absolute terms while the median price was around $1.22/litre. The note, however, suggests that while India’s petrol price is at par with that in Australia, Turkey, South Korea, and Philippines, its per capita income is much lower than these countries.

According to some media analysts, when viewed in terms of the purchasing power of the domestic currency, India’s price per litre of petrol is the perhaps third highest in the world ($5.2/litre), whereas for diesel, India is the eighth most costly country ($4.6/litre); price per litre of LPG is perhaps among the highest in the world ($3.5/litre). Given India’s oil import dependence (about 85.4 per cent of its oil consumption in 2021-22), the cost of the Russian invasion is going to be felt hard on Indian pockets.

Russian invasion not the only reason

The Ukraine crisis is not the only factor behind India’s sky-high fuel prices. The taxes levied by governments (Centre and States put together would amount to over ₹40 a litre, taking the November 2021 reduction into account by the latter, or about 40-45 per cent of the retail price) is the real culprit.

The Union government levies excise duties and various custom duties, and the States levy sales tax/VAT. This proportion could be lower than in some European countries, but is higher than in the US, where taxes account for about 20 per cent of the retail price.

However, the impact of taxes need to be seen in context. Fuel consumption erodes a major chunk of the disposable income of a large section of the population. WPI inflation is up by 15 per cent in April 2022, not least due to the rise in oil prices. WPI inflation captures intermediate goods inflation. It would percolate to retail prices. CPI inflation surged to 7.8 per cent in April 2022, much above the upper band of RBI’s target.

As for the impact of reducing taxes, a survey conducted by Chicago Booth’s Initiative on Global Markets veers around to the view that a temporary suspension of taxes would provide relief to consumers. The IGM economists opined that this is an efficient way to protect the average household from rising energy costs, instead of collecting higher taxes and transferring them through various welfare measures.

However, a few economists felt that a cheaper fuel supply would increase consumption, which would be counter-productive in reducing CO2 emissions.

Will it be feasible for India?

The question is who should reduce taxes and why. Cooperative federalism demands that the Centre must come forward to slash that component of central excise duty which is outside the divisible pool — as it indeed has done a few days back. Though the States have limited fiscal bandwidth, they can consider reducing the “additional tax” and other cess and surcharges partly.

The fiscal implication of this reduction of taxes may not be much. The Centre’s total gross tax revenue collection for 2021-22 touched ₹27.07-lakh crore, almost ₹5-lakh crore above the Budget estimate of ₹22.17-lakh crore. Further, GST revenue is growing at a faster pace and is slated to grow more due to economic recovery and other administrative measures. Thus, the Centre can afford cuts in central excise duties.

Raising taxes on fuel products was necessary in the wake of the pandemic since the revenue dried up and expenditure requirements shot up. As the economy crumbled, oil consumption and prices also fell sharply. So did fuel tax revenue of the Centre and States. To offset this loss of revenue, the governments started raising fuel taxes. Now that the economy has surpassed the pre-pandemic level of consumption, the government should reduce the taxes partially or suspend them temporarily.

Prolonged inflation — led by fuel price rises and high taxes — would threaten RBI’s inflation-targeting framework. The RBI might hit the brakes too hard and send the economy into a recession, which the economy can hardly afford.

In another poll conducted by the IGM survey, over three-quarters of the panel agree that the Russian invasion of Ukraine will both reduce global growth and raise global inflation over the next year. The government may have recognised that India cannot afford to have such sky-high prices owing to high taxes. It does more damage to the economy and overall welfare of its people than the benefit from the tax revenue it collects.

A situation of higher fuel prices coupled with lower per capita income provides a compelling case for the Union and State governments to reduce fuel prices to bring some relief to the common man.

Dash is an Assistant Professor at Gulati Institute of Finance and Taxation, Thiruvananthapuram, and Lakshmi is an Assistant Professor of Finance at IFMR GSB, Krea University