Can reducing cess levies ease high fuel prices?

The story so far: Ratings agency ICRA recently postulated that the government had room to cut cess levies on retail prices of petrol and diesel, thereby easing prices. Lower fuel prices will likely help cool inflation levels, which are currently beyond the 6% upper limit specified by the Reserve Bank of India (RBI).

Why has the ICRA said that there is room to cut cess levies?

The ICRA anticipates an increase in the mobility of the population and economic recovery after the easing of curbs and accelerating pace of COVID-19 vaccinations. It forecasts that consumption of petrol and diesel would hence grow at about 14% and 10%, respectively, in the financial year 2021-22 (from the low base in a national lockdown-hit 2020-21).

The agency projects aggregate revenue from such taxes on these two fuels to expand by about 13% in FY22 from the previous year, assuming that the total cesses on unbranded petrol and diesel remain unchanged at ₹32.9/litre and ₹31.8/litre, respectively. That is, the forecast for government revenue from the cesses imposed on these two fuels is ₹3.6 lakh crore this fiscal, or about ₹40,000 crore more than in the last financial year.

The ICRA argues that if the government decides to forgo the additional revenue that could accrue with higher fuel consumption, it would be able to cut up to ₹4.50 per litre for petrol and diesel each.

How much tax do we pay on a litre of petrol?

As of June this year, taxes accounted for close to 58% of the price of petrol in Delhi. Between May 2014 and June 2021, the Centre’s share of taxes on the retail price of petrol rose 216%, even though the base price of the fuel declined 24%. As per an analysis by The Hindu, if one had bought a litre in New Delhi for ₹94.49 on June 01, 2021 (as per the latest data available from the government’s Petroleum Planning and Analysis cell), ₹32.90 would have accrued to the Centre as tax. Compare this with the Centre’s tax of ₹10.39 when the total price of the fuel was ₹ 71.41 per litre in May 2014.

In its June analysis, the ICRA highlighted that the current fuel prices reflect the higher cesses that have been imposed by the Centre since March 2020 and an increase in Value Added Tax (VAT) rates by more than three-fourths of the State governments.

Its estimates showed that on average, the prices of petrol and diesel rose to ₹98/litre and ₹90.7/litre, respectively, in June 2021, from ₹75.5/litre and ₹68.4/litre, respectively, in April 2019, despite the U.S. dollar price of the Indian crude oil basket being at similar levels (about $72 on average in June in Indian basket terms) at these two points in time.

Would a reduction in fuel cesses affect the government’s ability to pay interest and principal on oil bonds issued to public oil marketing companies (OMCs) as compensation for subsidies?

The agency has estimated that the Centre needs ₹20,000 crore in the current financial year to service the interest and principal related to special oil bonds issued to oil marketing companies (OMCs) in the period 2005-2010. If this debt servicing obligation is to be offset through additional revenues collected from fuel cesses, then the potential duty cut could be to the tune of ₹2 per litre for both fuels, it said. The government had serviced interest of close to ₹10,000 crore related to the oil bonds in each of the financial years FY20 and FY21, according to a recent BusinessLine report. The last principal payment was made in March 2015, of ₹3,500 crore. The total current outstanding is about ₹1.30 lakh crore, out of which ₹10,000-crore principal and an equal amount as interest is payable this year, the report said, citing official data. These bonds are interest-bearing, having a fixed coupon rate and paid on a half-yearly basis. The annual interest due of around ₹10,000 crore has been provided for in the Budget.

How can lower fuel prices make it easier for the RBI to balance economic growth and inflation?

Retail inflation based on the consumer price index (CPI) has been persistently higher than the RBI’s medium-term target of 4%, which, however, allows for a range of 2%-6%. For May 2021, the provisional inflation reading was 6.3%, owing to persistent price pressures in the transport and communication category, which includes the automotive fuels of petrol and diesel and has a weight of 8.59% in the CPI. The transport and communication category saw price gains accelerate to 12.38% in May, from 11.04% in April.

While the RBI has been trying to maintain a growth-supportive stance by retaining an accommodative monetary stance that includes keeping benchmark interest rates substantially low and unchanged in response to the pandemic, its monetary policy committee (MPC) has been repeatedly warning of upside risks to the inflation trajectory from “international commodity prices, especially of crude, together with logistics costs”. The MPC’s prescription to address this reads: “Excise duties, cess and taxes imposed by the Centre and States need to be adjusted in a coordinated manner to contain input cost pressures emanating from petrol and diesel prices.”

Lower pump prices of the transport fuels would ease some pressure on retail inflation and thus allow the RBI a little more elbow room to continue to keep the cost of borrowings lower. This, in turn, could facilitate more demand for credit to both consume and invest in new business activity, spurring growth.

(With inputs from Vignesh Radhakrishnan)