High Fuel Prices: Does the End Justify the Means?

Over the last few days, the issue of high fuel prices, despite the reduction in international crude prices over the past three years, has been a contentious subject of discussion. Data regarding international crude prices, price per litre of diesel and petrol in some of our neighbouring countries, as also the absolute amount of taxes (both central and state), dealers’ margins per litre of fuel in each state and the percentage component of these elements are available. What has been missing in the discussions is how has the government used the additional resources that have been generated as a result of the high fuel prices?

Price comparison with other countries

All countries have access to the same petroleum prices of international markets but then decide to impose different taxes. The differences in prices across countries are due to the various taxes and subsidies for diesel (Diesel is chosen as an example here because it is the highest consumed petroleum product). As a result, the retail price of diesel is different. The average price of diesel around the world on 18 September 2017 was $0.96 per litre. However, there is a substantial difference in these prices among countries. As a general rule, the richer countries have higher prices while the poorer countries and the countries that produce and export oil have significantly lower prices.

The above table tells us that rates in India are around the average world price.

Trends in international petroleum prices in the recent past

The price trends of crude and three major consumption petroleum products based on indices hosted on the website of the Economic Advisor, Department of Industrial promotion (DIPP), are tabulated in Table No 2. The data indicates that the prices fell through in 2014-15 and the price fall gathered momentum in 2015-16. The prices were nearly stable through 2016-17 and began to rise in April 2017-18, remained nearly stable in May to July, but began to rise in August and the rise has continued in September.

Why public outcry in September 2017

Petrol prices were made ‘market-determined’ effective 26 June 2010. With diesel remaining subsidised, the gap in the price between petrol and diesel began to widen. It rose to Rs 27.14 per litre in 2012 which resulted in the dieselisation of private vehicle ownership and SUVs began to be seen in larger numbers as well. The diesel price was made market-determined only effective 19 October 2014. The last notified price of diesel at the pre-market determined date was Rs 58.97 on 31 August 2014 and from 19 October 2014, it became Rs 55.6. Thereafter it continued to fall reflecting global trends and was in the range of Rs 40 to Rs 50 till April 2016. This was a welcome step, which though was feared for political reasons, as the withdrawal of subsidy would increase diesel prices, and lead to a rise in the already high inflation rates.

The prices were revised every 15 days and after breaching Rs 50 mark in May 2016, they rose to Rs 59 in January 2017 to again fell gradually and the price on 01 June was Rs 55.94.1 The government launched a ‘pilot project’ in five cities from 01 May 2017 to do a daily review of petrol and diesel prices (a norm in most countries). Beginning 16 June 2017, the state oil companies throughout the country began daily revision of petrol and diesel prices.

The crude oil prices began to harden immediately after Hurricane ‘Irma’. After ‘Irma’ dissipated, a human hurricane ‘Kim Jong-un’ is keeping the crude prices high. In Table No 3 below are tabulated the price in rupees of crude oil per barrel (Indian basket). One barrel is 159 litres.

This resulted in upward revision of retail prices on nearly daily basis and the last straw on the camel’s back was the release of GDP data for the first quarter and the inflation data, which resulted in the chorus for reduction of fuel prices getting louder.

Components of retail fuel price

The price breakdown of the retail price into various components in percentage terms is given in table below.

There was no excise duty on diesel and petrol when these were being subsidised. The central government took advantage of the falling crude prices while passing on the benefit to the consumers because of ‘market-determined pricing’ and also used the opportunity to generate additional resources. The excise duty rates post diesel ‘market-determined’ prices, i.e. October 2014 are:

The states too were not far behind. For instance, the VAT on Petrol & Diesel in Delhi, which was 20 per cent and 12.5 per cent respectively of base price prior to November 2014, is now 27 per cent and 16.75 per cent + 25 paisa cess, respectively. While state taxes vary, the central government excise collection on account of petrol and diesel in rupees in crores is as shown in table below:

Where have the additional resources been spent?

Interest, Subsidies and Defence Expenditure are the three major components of the central government Expenditure.2 The details of expenditure under these heads is given below:

Despite the rising public debt, the government has been able to manage to moderate the interest burden through retiring high cost debt and take advantage of the economy moving towards a more benign interest rate cycle. The food subsidy which was Rs 85000 Crores in 2012-13 has risen to Rs 139419 crores and the BE for 2017-18 is Rs 145339 crores. Yet the total subsidy in 2016-17 due to the containment of fuel subsidy through ‘market-determined’ pricing approach (for impact see Table No 8 below) and an innovative fertilizer policy initiative is less than what it was in 2012-13. As may be seen in the table above, the rise in defence expenditure has been very modest in the last three years. The capital expenditure BE sanctioned from 2012-13 onwards till 2016-17 has been revised down substantially at RE stage adversely impacting the modernisation process.3 The withdrawal of customs exemption and excise duty on sales from DPSUs to defence forces in the last year has put additional strain on the already meagre defence budget and in the current year, the rising fuel prices will impact the training effort. So the government has been conservative in its expenditure. If that were the case, where has the additional revenue been utilised?

States share of the revenue

The 14th Finance Commission examined the issue keeping in mind three factors: (a) the spirit of constitutional provisions; (b) the concerns about fiscal space expressed by States and Union; and (c) the need for clarity on the respective functional and expenditure responsibilities of Union and States in the interest of sound federal fiscal relations. They were of the view that ‘tax devolution should be the primary route of transfer of resources to States since it is formula-based and thus conducive to sound fiscal federalism. However, to the extent that formula-based transfers do not meet the needs of specific States, they need to be supplemented by grants-in-aid on an assured basis and in a fair manner’. In their report they recommended that ‘tax devolution to 42 per cent of the divisible pool would serve the twin objectives of increasing the flow of unconditional transfers to the States and yet leave appropriate fiscal space for the Union to carry out specific purpose transfers to the States’. The report of the commission was submitted in December 2014. The result of this may be seen in the Table below:

As can be seen from Table 9, Excise Duty has increased by about Rs. one lakh crore in 2015-16 and 2016-17. The major factor in this increase has been both direct and indirect contributions of the fall in crude prices and the government mopping up additional funds through revising the excise duty and the indirect contribution of lower fuel prices pushing the sales of the automobile industry. The states’ share of central tax revenue grew by almost 50 per cent in 2015-16 and 20 per cent in 2016-17. This being non-discretionary distribution based on percentage share of each state as recommended by the Finance Commission, the increase in the share of the states has substantially contributed to federal polity and spirit of co-operation. This has generated the goodwill and trust that the Central government will be able to stand by its promise to ensure compensation for loss of revenue, if any, due to GST implementation and has thus enabled the much needed economic reform of ‘GST’ finally being implemented and the rates being agreed by consensus.

The revenue growth has also been utilised for capital expenditure which has grown from Rs 192,000 crores in 2014-15 to a BE of Rs 309,000 crores in 2017-18 (as per the Medium-term Expenditure Framework Statement laid before Parliament on August 10, 2017). The major components of this are Railways (Rs. 55,000 crore), Road Transport & Highways (Rs. 54,177 crore), Urban Development (Rs. 19,332 crore) and Department of Financial Services (Rs. 14,718 crore) for re-capitalisation of banks.

Conclusion

The additional resources generated have been generously passed on to the states and the impetus to infrastructure improvement is visible. The GST roll out has had its share of expected teething problems and it will be some time before it settles down. Its impact on revenue collection for the year 2017-18 will be known after it settles down. The central government needs to ensure that states get their budgeted share of revenue, as they would have already committed these expected funds. The goodwill generated in federal relations needs to be carried forward. Funds committed for road, rail and urban infrastructure are much needed both for infrastructure up-gradation as well as their multiplier effect on the economy. This leaves no room for the government to yield to the demand for roll back of fuel prices at this stage. It needs to be alive to this demand to ensure that should the crude prices harden any further, it should find a mechanism in consultation with states to maintain them at the present level.

Views expressed are of the author and do not necessarily reflect the views of the IDSA or of the Government of India.

• 1. Prices quoted are for Delhi. See https://www.iocl.com/Product_PreviousPrice/DieselPreviousPrice.aspx
• 2. RBI Handbook of Statistics on Indian Economy, Table 102: Major Heads of Expenditure of the Central Government
• 3. For details, please see http://www.idsa.in/system/files/jds/jds_11_1_2017_indian-defence-budget.pdf