THE OiL CRISIS
The government is in a bind: can it afford substantial fuel price cuts to assuage public anger? Can it afford to lose revenue and risk its social sector programmes in the run-up to elections? Does it have options?
The government is in a bind: should it cut fuel prices to assuage public anger and risk cuts in its social programme budgets ahead of the 2019 elections? THE OIL TURMOIL
THE CONCERN WAS PALPABLE on Union minister for oil & gas Dharmendra Pradhan’s face as he summoned an emergency meeting on Thursday, May 31, with ministry officials and top honchos of India’s public sector oil companies in New Delhi. There was rising public anger, though in certain pockets of the country and on social media, and severe criticism from the opposition on the government’s perceived inability to rein in fuel prices that have touched historic highs in the past few weeks and threatened to spur a price rise across the board. An embarrassment the Narendra Modi government can do without in its final year in office. But the meeting, which went on past midnight, offered no solution. Petrol and diesel prices were as high as
Rs 86 a litre and Rs 74, respectively, in Mum bai on June 3, and Rs 78 and Rs 73.58 in Delhi, compared to Rs 66.12 and Rs 56.81 in Mumbai and Rs 63 and Rs 51.67 in Delhi in May 2016.
Although various options were discussed at the meeting—slashing excise rates on fuel, prodding states to cut taxes, telling oil companies to share part of the price rise burden and even a taking a hard look at the policy of dynamic pricing, introduced by Pradhan in June 2017 where fuel prices are adjusted daily in tandem with price changes in the global market—no decision was taken. Experts say there is little the minister can offer at this juncture, when the government has to juggle a delicate fiscal situation with finding funds to feed its numerous social programmes ahead of the general elections in May 2019. But at the same time, it cannot afford to allow
fuel prices to continue their northward journey and be seen as doing nothing about it. Therefore, Pradhan chose to temporise as best as he could under the circumstances. “Many options are being explored for both short and long term solutions,” he said, quickly stressing the states’ role in lowering value-added tax (VAT) on fuel prices, a major source of their income. “In a federal structure, I can only appeal to the states,”he says (see interview).
On May 30, a reduction of a meagre 1 paisa on fuel by the country’s largest state-owned refiner, Indian Oil Corporation, invited severe criticism of the Centre. “Dear PM, you’ve cut the price of petrol and diesel today by 1 paisa. ONE paisa!? If this is your idea of a prank, it’s childish and in poor taste,” tweeted Congress president Rahul Gandhi. While the government quickly clarified that the 1 paisa reduction was a technical glitch, fuel prices have fallen only marginally in the past few days, sometimes by 9 paise a day, and other times, by as low as 7 paise.
Suchitra Menon, a teacher in Thane, has been driving to school since 2008, and has seen petrol prices go up by over Rs 15, from Rs 70 in 2016. “In 2016, I could tank up with Rs 2,000, which would last me two weeks. Now it lasts me just 10 days,” she laments.
Consumers are also angry that fuel prices have remained high despite crude prices softening globally. Between September 2014 and January 2016, crude prices fell by $66, to $30, but petrol prices in India fell only by Rs 10. Then they started to climb again, reaching record highs.
Interestingly, fuel prices remained unchanged for 19 days in the run-up to the Karnataka assembly elections in mid-May, but began to rise soon after. The government, however, denies interfering in fuel pricing to please the electorate. Meanwhile, IOC said it independently decides retail selling prices of petrol and diesel based on international price trends following the deregulation of petrol and diesel prices in June 2010 and October 2014, respectively.
High fuel prices also have a cascading effect on transportation costs which drives up inflation. According to research firm Dun & Bradstreet, all-time high fuel prices in India are likely to affect other segments and keep the rate of inflation higher, even if the monsoon is normal this year. It expects consumer price inflation, derived from the weighted average of prices of a basket of goods and services, to be in the higher range of 4.6-4.7 per cent, at a time when the Reserve Bank of India (RBI) is trying to keep inflation below 4 per cent. On June 6, the six-member monetary policy committee of the RBI headed by Governor Urjit Patel hiked the repo rate—the rates at which the central bank lends to other commercial banks—by 25 basis points (bps) to 6.25 per cent. This is the first hike by the RBI since the Modi government came to power, and signals its concern over rising inflation. The RBI revised upwards the retail inflation range to 4.8-4.9 per cent in the first half of 2018-19, and 4.7 per cent in the second half.
The rupee being the worst performing currency in Asia this year, down more than 5 per cent against the dollar, does not help either. “It is important to address the issue immediately with an excise duty cut by the Centre, and a subsequent slashing of VAT by states,” Kirit S. Parikh, chairman of Delhi-based research institute IRADe (Integrated Research and Action for Development), told india today. “Sixty per cent of Indian families own two-wheelers and not all of them are rich.”
GENESIS OF THE PRICE RISE
How did oil prices hit such a high and upset the government’s applecart? For a fuel-guzzling nation such as India (it is behind only the US and China in oil consumption), where local oil production was a mere 36 million tonnes (mt) in 2016-17 against a requirement of 195 mt, imports are the only option. India gets 63 per cent of its oil from West Asia, Iraq pipping Saudi Arabia as India’s largest oil supplier in December last year (see graph: Crude Picture).
Iran, Venezuela and Nigeria are the other major suppliers. India imported 220 mt of crude in 2017-18 worth Rs 6.53 lakh crore, according to the Petroleum Planning & Analysis Cell (PPAC), a government energy think-tank. Such huge imports (India’s overall imports were Rs 27 lakh crore in 2017-18) make the country vulnerable to geopolitical risks.
Although oil prices have been moving up since last year, the latest trigger for the sudden spurt to $80 a barrel in May was US president Donald Trump’s withdrawal from the Iran nuclear deal earlier that month. When Iran, the third-largest producer in the Organisation of the Petroleum Exporting Countries (Opec) producing 2.5 million barrels of oil a day, pledged to limit its nuclear ambitions to civil energy production under the 2015 deal, sanctions were lifted on oil exports, which boosted oil supplies and lowered prices. With the US pulling out now, the sanctions are expected to be reinstated by August, curtailing production and raising oil prices. Moreover, Opec has been trying to push up oil prices after they collapsed in 2014 from over $115 a barrel to below $30 as Russia, Venezuela and other Opec nations stepped up production, and the US provided more shale gas. Although prices subsequently cooled down after Saudi Arabia and Russia said they planned to hike production by a million barrels a day, some experts see oil crossing the $100 barrel mark if Venezuela, with its staggering economy, is forced to shut down oil production. That will be more bad news for India. According to government estimates, every dollar per barrel change in crude oil prices impacts the import bill by Rs 823 crore (the same when exchange rate fluctuates by Re 1 per US dollar).
FUEL PRICING DYNAMICS
State-run oil companies import oil and other petroleum products by inviting bids from global suppliers. Crude oil is then processed across 23 oil refineries in India of which 18 are state-owned (belonging to IOC, Bharat Petroleum Corporation and Hindustan Petroleum Corporation), three private refineries (of Reliance Industries and Essar Oil) and two in joint ventures between state-run
oil firms and overseas companies. Together, they have a refining capacity of 234 mt annually. The refined fuel is then distributed to company dealers and dispensed through over 56,000 retail outlets. This is where fuel pricing dynamics kick in.
To illustrate, let us look at the various components of the price of a litre of petrol in Delhi on June 3. The oil companies sold the fuel in its processed state to dealers at Rs 38.39 a litre. The Centre then added an excise duty of Rs 19.48 and, subsequently, a dealer commission of Rs 3.63. The state (Delhi) added a VAT of Rs 16.61 (including on the dealer commission) taking the final retail price to Rs 78.11. In short, the various central and state government taxes constitute as much as 50 per cent of the price of petrol. For diesel, dealers were charged just Rs 41.08 by the refineries, an excise duty of Rs 15.33 and VAT of Rs 10.17 were then added, and along with the dealer commission of Rs 2.53, the final cost was Rs 69.11.
Is it justified to have taxes comprising half the cost of fuel? Excise duty and VAT on fuel are major revenue-earners for the Centre and states. According to reports, the central government earned close to Rs 10 lakh crore in the past 3.5 years on petroleum products, while the states made Rs 6.6 lakh crore. The government says the money helped it meet expenses on various social welfare programmes. “Of the entire money the central government collects, 42 per cent is given to the states as per the 14th Finance Commission,” says Pradhan. “Of the balance, 60 to 70 per cent goes back through centrally sponsored schemes. Development of the states is a priority issue.”
But experts say there is room for excise duty cuts when prices go up, at least to soften the blow to consumers. “The government needs to contemplate some action on the excise duty front,” says D.K. Joshi, chief economist with Crisil. “When fuel prices were low, the
government raised excise duties. Now, when the prices are high, they should reduce the excise duty, whatever the consequences.” However, some critics blow a hole in the government’s argument about social sector spending, saying it hasn’t been adequate. In 2014-18, between seven ministries, 13 ministers and 69 schemes, the Modi government spent only six per cent of the GDP on the social sector—almost unchanged since 2012-13, as estimated by the Economic Survey of India, 2017-18. “Since the fisc’s been kept on a tight leash, no big-bang social spend took place in the last few years,” says an economist. Rather, between 2014 and 2016, drastic cuts were made in some important social sector areas, especially education and health.
The Centre, has, indeed, reaped the benefits of softening fuel prices for a good part of its term. In May 2014, when Narendra Modi was sworn in as the prime minister, crude oil prices were hovering above the $100 a barrel mark. Petrol then cost Rs 71 in Delhi and Rs 80 in Mumbai. As luck would have it, crude prices in the international market began to fall sharply since September 2014, when they stood at $97 a barrel to below $30 on January 14, 2016. This was the first time in 12 years that crude prices dropped so steeply. Although petrol prices briefly dropped to Rs 59 in Delhi and Rs 66 in Mumbai that month, they began rising again since March. When crude prices fell, the windfall gains for the government came from both the lower cost of imports as well as from the higher excise duties on fuel. For instance, India’s savings on its import bill in 2015-16 due to lower crude prices was as high as Rs 2.14 lakh crore. Excise duties, on the other hand, were being raised. Ever since the Modi government came to power, excise duty on petrol has gone up from Rs 9.48 a litre to over Rs 19, while that on diesel has gone up from Rs 3.56 a litre to Rs 15.33. The last cut in excise duty was effected in October 2017, by Rs 2 a litre, because of which it said it lost revenues to the tune of Rs 13,000 crore. Now we know why governments won’t let go of such revenues so easily.
Collections from excise duty on petroleum products surged to 1.6 per cent of the GDP in 2016-17 from 0.7 per cent in 2013-14. “While most of these gains were transferred to states (under the 14th Finance Commission) and central government employees (7th Central Pay Commission), the fiscal situation still improved for the Centre as interest payments and subsidies were steadily controlled,” says a Delhi-based economist. “Besides the fiscal, oil gains accrued to the external sector too, with the current account deficit to GDP improving to 0.7 per cent from 1.7 per cent and inflation softening between 2013-14 and 201617.” Current account deficit is a broader measure of an economy’s health that includes trade deficit, income from land, labour and capital, as well as financial transfers. A nation has a trade deficit if the total value of goods and services it imports is greater than the total value of exports.
OIL PRICE AND ECONOMIC IMPACT
What if crude prices keep rising in the international market? Experts say higher crude prices will have a bearing on three key areas. On the fiscal side, the government will face pressures from higher outlay in the form of subsidies to oil companies to sell LPG and kerosene below market rates and from lowering excise duties, if at all it decides to do so. Assuming crude at $65 a barrel, these could increase the gross fiscal deficit to GDP ratio by 10-12 basis points from budget estimates. One basis point is equal to one-hundredth of a percentage point. Second, a $10 per barrel increase in crude price from current levels could spike inflation by around 50 bps in fiscal 2019. Third, a runaway rise in oil prices could stir the inflation scourge back to life and impact other macro indicators too. “A back-of-the-envelope estimate shows that every $10 per barrel increase in crude oil price can shore up India’s fiscal deficit by 8 bps as a percentage
of GDP and similarly the current account deficit by 40 bps, other things remaining the same,” says Joshi.
In his last budget, Union finance minister Arun Jaitley made all budget calculations assuming crude oil prices will remain constant. PPAC’s recent calculations reveal that if crude prices remain in the $70-$80 a barrel range, India may have to shell out around Rs 2 lakh crore more to buy the same quantity of crude it bought in the last fiscal. To mitigate the impact, India is looking for countries accepting different currency payments for crude, apart from searching for new destinations to source the commodity. For example, since Iran and Iraq accept Euros, they are becoming the most relied trading partners to India in oil and dependency on the dollar-dominant Saudi Arabia is shrinking. “Given India’s role as a net oil importer, higher oil prices will lead to higher inflation and will negatively impact the fiscal and current account deficits,” says Derrick Kam, India economist at Morgan Stanley. The firm has forecast a central government fiscal deficit of 3.4 per cent for the current fiscal, a shade higher than the government’s 3.3 per cent target.
WHAT THE GOVERNMENT CAN DO
It is, therefore, clear that reining in oil prices is not just critical to assuage public anger but also to keep government finances in check and the economy in good shape. But what are the options before the government, and what are the chances they’ll be exercised? One way is to bring fuel under the Goods and Services Tax (GST). “Since the highest slab in GST is 28 per cent, the taxes will still be much lower than they are at present,” says Joshi. The current debate surrounding bringing petroleum products under GST should put additional pressure on states to come around to agree to this, but at the moment, this is just a proposal. Moreover, it can be a disruptive move, something the government may not want at this juncture. The other is to tell ONGC, India’s domestic producer of oil, which has reaped big profits from high crude prices, to sell crude at lower prices to refiners, and in turn, compensate the firm by seeking lower dividends from it this year. There are reports the government may impose a windfall profit tax on ONGC. However, Parikh says he is against taxing the firm, since “taxing ONGC is as good as the government taxing itself, since the latter is a major shareholder owning two-thirds in ONGC”.
The third is to procure crude at a discount from Opec countries, instead of buying at the ‘Asian premium’ India currently pays. This would require intense negotiations with these countries. With Pradhan crediting himself with visiting several key oil-producing countries to boost relations, it is but natural to expect the government to convince its suppliers to lower the prices.
Parikh, who advocates a slashing of excise duties, says governments reducing taxes is the only option. “The Centre should cut excise duty by
Rs 1 or 2, and the states should reduce VAT by 3 or 4 percentage points, so that revenues from VAT are the same as when crude prices were at $60,” he says. This way, the states do not lose revenue. He wants the states to make bigger cuts in VAT, because it is calculated ad valorem or in proportion to the estimated value of the commodity. So, when crude prices are higher, states get higher tax. “This way, fuel prices can be brought down by Rs 4 to Rs 5,” he says. He feels no need for bringing fuel under GST in the short run as the benefits will not be as significant compared to a plain reduction in central and state taxes.
But Ajit Ranade, chief economist at the Aditya Birla Group, disagrees. “Between the states and the Centre, it is the latter that must bear a bigger burden of reduction in excise because expenditure commitments are higher at the state level and their fiscal situation is more precarious,” he says.
With the government reluctant to slash excise duties since it fears it might impact its social schemes, the other option is to pressurise states to cut VAT. Kerala, a non-BJP ruled
state, has recently cut VAT by Re 1, foregoing Rs 500 crore in annual revenues. But much to the Centre’s consternation, states are taking their own time before resorting to any such cuts. As for the other options, the government has categorically said it will not go back on its policy of dynamic pricing. Backtracking on its earlier policies will send a negative signal to the investor community and the rating agencies, which the government does not want to do now. It can also wait until crude oil prices fall further, but the problem then is that, given the geopolitical tensions that can crop up in West Asia anytime, such gambles may backfire.
“India also needs to build strategic reserves of oil, acquire equity interest in international oil companies and diversify the energy portfolio as part of a long-term sustainable energy security strategy,” says Ranade.
Right now, the government is in a bind over oil prices. It can neither easily forego revenue that helped it maintain fiscal discipline nor afford to turn a blind eye to rising prices. With just a year to go before the general elections, it just cannot allow the opposition to capitalise on the sensitive issue. That explains the government’s concern and the clamour to find a ‘long-term’ solution. After all, high fuel price was one of the weapons that Modi used to target the previous UPA government in his election campaigns, but it is now back to haunt him, even as his party faced reversals in recent Lok Sabha and assembly bypolls.
Chances are it’ll wait some more, during which it will watch if oil prices fall or more states agree to cut taxes, or even try and reach a consensus with states on bringing fuel under GST. Till then, the aam aadmi will continue to bear the brunt of rising fuel prices.