Pradhan’s Chakravyuha

Cutting taxes on petrol and diesel will hit the fisc, but long-term solutions would be to extend GST to them and introduce cost-plus pricing for oil firms

Petroleum Minister Dharmendra Pradhan is under intense political pressure. He is being asked to reduce retail prices of petrol and diesel, which have now risen to levels that prevailed a little more than three years ago, when the monthly average price of the Indian basket of crude oil was almost double of what it is today.

Pradhan has resisted all such pressure, arguing that he can’t interfere in the fixing of retail prices, which are now linked to the market. Equally comforting is Pradhan’s determination to use the opportunity to ask for the inclusion of petrol and diesel in the goods and services tax (GST). But how feasible are these suggestions?

Monthly averages of the Indian basket of crude oil prices began moving southwards from 2014. They declined from $107 a barrel in May 2014 to as low as $28 a barrel by January 2016, before rising to $55 a barrel by September 2017.

Consequently, diesel’s retail price in Delhi in January 2016 went down by 22 per cent to ~44.18 a litre, compared to ~56.71 in May 2014. Similarly, Delhi’s retail petrol price went down by 17 per cent from ~71.41 a litre to ~59.35 in the same period. Clearly, the decline was much smaller than the 74 per cent reduction in crude oil prices in this period.

This was largely because the Union government pocketed a major chunk of the gains from softening crude oil prices by raising excise duty on petrol and diesel on 11 occasions between May 2014 and January 2016, with the excise burden on them rising by 127 per cent and 387 per cent, respectively.

Remember that the states also increased the sales tax and valueadded tax on these two products and their overall collections in 2016-17 rose by 16 per cent, compared to a lower rise of four per cent in the previous year. Delhi’s revenue growth on petrol and diesel went up by 14 per cent.

However, when the crude oil price went up to $52 a barrel in April 2017, an 86 per cent increase over that of January 2016, retail prices of petrol and diesel also increased, but by lower margins of 11 per cent and 24 per cent, respectively, in the same period. And when the crude oil price went up by another six per cent in September 2017 over the April 2017 price, retail prices for petrol and diesel increased by almost similar margins of seven per cent each, respectively, in the same period. Taxes were not changed in this period and indeed they have remained unchanged since January 2016.

The real cause of the current discomfort, therefore, is the tax on petroleum products raised between July 2014 and January 2016, as a result of which excise and VAT collections rose to ~4 lakh crore in 2016-17, of which the Centre collected ~2.4 lakh crore and the states accounted for ~1.6 lakh crore. But since the states also had a share of 42 per cent in the Centre’s revenues, their total tax collection on petro products was ~2.6 lakh crore, compared to the Centre’s excise kitty of ~1.4 lakh crore. Thus, if taxes have to be cut, the states will be the bigger loser!

The decision to increase taxes was justified on the grounds that the governments needed to reduce their respective fiscal deficits and oil companies had to be spared the burden of their rising under-recoveries on all these products. Indeed, fiscal deficits were reined in and the oil companies’ under-recoveries too came down, as the Centre’s oil subsidy bill declined from ~76,285 crore in 2014-15 to ~22,738 crore in 2016-17.

But Pradhan and Finance Minister Arun Jaitley did not reckon on the problem that raising taxes on petrol and diesel, while crude oil prices fell, was like entering the Chakravyuha, a war formation in the Mahabharata. The skill of exiting that formation is more important than entering it.

Even while raising tax rates, Pradhan and Jaitley should have figured out their strategy in the event of oil prices going up and triggering popular unrest. As it turns out, crude oil prices have gone up, but reducing taxes for both the Centre and the states is a difficult task because of revenue and deficit implications.

Including petrol and diesel in the GST is a way out, but this is a longterm solution. When crude oil prices were soft, the government also could have asked oil companies to abandon trade parity- based pricing of petroleum products and embrace a system of cost-plus pricing. It is still not too late. Both the GST and enforcing cost- plus pricing for oil companies could be a way out of the Chakravyuha to avoid economic as well as political consequences of the price rise.