COVID, Taxes & Russia: What Lies Ahead for India’s Soaring Fuel Prices?

There are multiple reasons, both external and internal, for the record high fuel prices in India.

Image used for representational purposes only.

(Photo: The Quint)

Fuel prices were increased for the eighth time in the last nine days. Petrol costs around Rs 101.01/litre in Delhi, Rs 115.88/litre in Mumbai, Rs. 106.69/litre in Chennai, and Rs. 110.52/litre in Kolkata. Diesel is priced the highest in Mumbai at Rs. 100.10/litre for now, with other cities increasing prices, too.

It has been known for some time now that prices of petrol and diesel vary across Indian states due to differential taxing, based on the rates of value-added tax (VAT) imposed by states combined with the higher central excise duty calculated on the retail price of fuel, which is levied by the Central government.

However, this crazed hike in fuel prices was foreseen due to the nature of events unfolding amid the Russia-Ukraine crisis. The Indian government kept fuel prices steady for four months during the campaigning period for the recently held assembly elections in five states. In the last week, fuel prices have rapidly increased.

So, what’s driving a sustained increase in crude oil prices across the globe along with the fuel price in India?

There are multiple reasons, both external and internal.

How the Ukraine-Russia War Triggered Panic-Buying

The current price hike has been catalysed by the rapidly escalating global economic tensions from the military aggression seen between Russia-Ukraine, adversely impacting global oil supplies (including exports-imports from Russia), while also affecting shipping routes.

Adding to this is the direct and indirect impact of sanctions on Russia, which is inhibiting its ability to complete its oil export contracts. See the figure below to understand the volatility seen in crude oil prices over the last few months.

(Source: Trading Economics)

Crude futures traded higher than $106 per barrel this Tuesday after a 7% decline in the previous session as investors were monitoring the situation in Ukraine and assessing the impact of COVID-19 curbs in China on global demand ahead of the OPEC+ meeting next Thursday.

In the context of the Russia-Ukraine conflict, crude oil prices were expected to rise across the world even before the attack happened on Ukraine. This was because the world feared that the war would lead the West to ban Russian oil (which subsequently happened in phases).

Even before countries like the US and the UK sanctioned to ban Russian oil and gas imports, some countries had halted their purchases, while others went into a ‘panic-buying’ mode. Short-term crude oil prices soared to a 14-year high of $140 a barrel on 7 March. They have come down since then, but only slightly.

Russia, being the third-largest oil producer after the US and Saudi Arabia, supplies 14% of global production, or 7-8 million barrels per day of crude oil to markets worldwide. Many EU nations are still importing Russia’s oil and gas but prolonged sanctions will only deepen the global fuel supply crisis, keeping prices more volatile in the short-to-medium term, when supplies remain tight.

Beyond the effects of the Ukraine-Russia war, the global oil production supply chain has already suffered from a prolonged disruption due to COVID-19-induced shutdowns, causing a catastrophic economic impact across the world.

A case in point in South Asia is Sri Lanka’s recent economic crash, resulting from its inability to source fuel imports at an affordable cost due to a weak foreign currency reserve position and high inflation.

India's Import-Dependence Is Also to Blame

India is 85 per cent dependent on imports to meet its oil needs. Roughly, it consumes 7 million barrels of crude oil a day, with the bulk of imports coming from West Asia and the US.

From Russia alone, India imports 2% of oil from its total import share. This may not sound a lot in volume, but when seen now from the volatility observed in global fuel prices and an overall restriction on oil imports from Russia, in aggregate, India’s high import bill for oil adversely affects its macroeconomic situation.

There is a historical context here. India’s overall import dependence for oil has only increased over the last few decades. This has naturally led to a volatile effect on its domestic fuel-diesel prices when there is a serious ‘volatile price shock’ in the international market.

Subsequent governments have also tried to diversify the import basket of crude oil dependence by getting into arrangements with multiple oil-exporting nations, such as Iran and others.

Still, it would be a mistake to put all the blame for the fuel price hike on external factors alone (see Figure below for reference).

Data below show cycles when despite the low price of crude oil price (as seen in the case of the period between September 2019-March 2020), petrol and diesel retail prices remained high.

Figure: Trend of the global crude oil price vs. retail prices of petrol and diesel (in Delhi)

(Source: Petroleum Planning and Analysis Cell, Ministry of Petroleum and Natural Gas; PRS)

The Tug-of-War Between Centre and States

A large levy of domestic taxes on fuel, including the central excise duty (imposed by the Union Government) plus state taxes, have kept fuel prices higher even in times of relative calm in global oil markets. See additional Table and Figure for a break up below.

Table: Break Up of Petrol and Diesel Retail Prices in Delhi (as on October 16, 2021)

Figure: Sales Tax/VAT rates levied by States on Petrol and Diesel (as on 1 October 2021)

(Source: Petroleum Planning and Analysis Cell, Ministry of Petroleum and Natural Gas; PRS)

The above data provide a breakdown of petrol and diesel prices in Delhi and other states (from 2021). Delhi has levied a 30% VAT on petrol and 16.75-17% VAT on diesel in the past. Other states, such as Karnataka, Assam and Rajasthan, have even higher taxes.

The excise duty levied by the Central government is 31% of the total retail price of fuel, while the dealer price is around 42%. It is critical to point out that the excise duty levied on petrol and diesel consists of two broad components:

1. Tax component (ie, basic excise duty), and

2. Cess and surcharge component.

Of this, only the revenue generated from the tax component is devolved to states. Revenue generated by the Centre from any cess or surcharge is not devolved to states. Currently, the Agriculture Infrastructure and Development Cess and the Road and Infrastructure Cess are levied on the sale of petrol and diesel, in addition to the surcharge.

In the last Union Budget, the Agriculture Infrastructure and Development cess on petrol and diesel was announced at Rs 2.5 per litre and Rs 4 per litre, respectively.

However, simultaneously, the basic excise duty and surcharge were reduced by equal amounts, so that the overall rate remains the same. Essentially, this provision shifted a revenue of Rs 1.5 per litre of petrol and Rs 3 per litre of diesel from the states’ divisible pool of taxes to the cess and surcharge revenue, which lies entirely with the centre.

Similarly, over the last four years, the share of the tax component in the excise duty has decreased by 40% in petrol and 59% in diesel. Currently, the majority of the excise duty levied on petrol (96%) and diesel (94%) is in the form of cess and surcharge, due to which it is entirely under the Centre’s share. Given this, states have no option but to impose a higher sales/VAT rate of their own on retail fuel prices. The result remains this: the average consumer suffers from a double-tax burden. This has been a major concern that a few of us have raised earlier.

Figure: Excise duty & Sales Tax/VAT collection from Petroleum Products (Rs. lakh crores)

(Source: Petroleum Planning and Analysis Cell, Ministry of Petroleum and Natural Gas; PRS)

India Had Problems Even Before the War or COVID

As a recent PRS study also explains:

“Between June 2014 and October 2018, the retail selling prices did not adhere to change in global crude oil prices. The global prices fell sharply between June 2014 and January 2016, and then subsequently increased between February 2016 and October 2018. However, the retail selling prices remained stable during the entire period. This disparity in the change in global and Indian retail prices was because of the subsequent changes in taxes. For instance, central taxes were increased by Rs 11 and 13 between June 2014 and January 2016 on petrol and diesel respectively. Subsequently, taxes were decreased by four rupees between February 2016 and October 2018 for petrol and diesel. Similarly, during January-April 2020, following a sharp decline of 69% in the global crude oil prices, the central government increased the excise duty on petrol and diesel by Rs 10 per litre and Rs 13 per litre, respectively in May 2020."

This scenario was evident in the pre-pandemic context or before the Russia-Ukraine war, which merits a closer look and policy correction, given how the dense fog of COVID-related reasons and war may overshadow the gravity of certain macroeconomic issues that have existed in India from a much longer time.

It is difficult for India to find prompt, effective solutions for external events such as the Russia-Ukraine war. The most vital impact of a higher fuel price base globally can be seen in the subsequent inflationary rise seen across goods within India’s consumer price index (weighted from food to all essential services consumed by Indian consumers).

The most India can do for now is hope that the Centre and state governments will work together in restoring the broken ‘federal-state’ compact by reducing their tax-revenue dependence imposed on retail fuel prices, at least till global oil markets calm down. Else, there is a high probability of seeing a prolonged effect of the rise in fuel price, triggering an even higher inflationary spell for both consumers and producers.

And this would come at a time when ‘joblessness’ is high and wages, particularly of the low-income and middle-income groups, continue to stagnate.

All this will wreak havoc on household budgets, whose spending capabilities shall continue to fall, negatively impacting aggregate demand and the gross production capacity.

This would be enough to send an already low growth cycle of the Indian economy into a more prolonged ‘Keynesian tailspin’.

(The author is Associate Professor of Economics, OP Jindal Global University. He is currently Visiting Professor, Department of Economics, Carleton University. He tweets @Deepanshu_1810. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)