As of now, oil marketing companies are estimated to be incurring ‘losses’ to the tune of Rs 10 per litre of fuel.
It is difficult to assess the exact extent of the damage the sharp increase in crude oil prices, to over $105 a barrel, could cause to the economy following Russia’s attack on Ukraine, but a big spike in domestic fuel prices will certainly hurt the nascent recovery. Consumers have been protected from rising auto fuel prices for over a month now because the oil marketing companies have not passed on the additional cost of crude oil, possibly due to the ongoing assembly elections. At Rs 27.9/litre and Rs 21.8/litre on petrol and diesel, the levies are already fairly steep. As such, given retail inflation is already elevated at round 6%, the Centre must try and rein in pump prices of fuels.
As of now, oil marketing companies are estimated to be incurring ‘losses’ to the tune of Rs 10 per litre of fuel. The Centre must try and absorb at least this amount and give consumers some relief. In early November last year, the Centre had cut the central excise duties on petrol and diesel by Rs 5 per litre and Rs 10 per litre, respectively, with the revenue loss for the five months to March estimated at Rs 45,000 crore. While this was undoubtedly a loss to the exchequer, the Centre had earned a whopping Rs 3.35 lakh crore from duties in FY21.
In the current fiscal too, the Centre’s revenues from fuel levies, post the cuts, are estimated at close to Rs 3.5 lakh crore. At the same time, with the organised sector having recovered smartly from the pandemic, GST collections have been fairly robust. For seven months in a row, since July 2021, GST revenues have come in at over Rs 1 lakh crore.
Following the Centre’s move, some states, including Assam and Tripura, had trimmed the value added tax on auto fuels by anywhere between Rs 2 -7 per litre. This time around, all states must follow suit and shoulder some of the burden. Since the state-level ad valorem taxes are levied on a price inclusive of the central levies, it allows for a bigger reduction in retail prices.
The excise and VAT cuts on diesel need to be bigger because consumption levels are three times that of petrol. It is important to arrest the cost of logistics because consumption demand has been faltering, and a prolonged conflict in Ukraine could push up oil prices further, leading to demand destruction. Private consumption expenditure was weak well before the pandemic, growing at just 2.7% y-o-y in Q4FY21 and 8.6% in Q2FY22, despite a helpful base. Unless demand improves substantially, companies are unlikely to invest meaningfully in capital expenditure.
Critically, if rising auto fuel prices stoke inflationary pressures, RBI will find it very difficult to not withdraw from its accommodative stance; sooner rather than later, it will need to raise policy rates. While yields have already moved up across the curve, RBI has so far managed to reassure the bond markets it will remain accommodative for as long as it is needed.
However, if CPI inflation overshoots 6% significantly, the central bank may have little option but to start tightening at a much faster pace than it has been doing so far. That then would drive up interest rates through the financial markets, hurting small and mid-sized borrowers that are just beginning to get back on track. The demand from individuals for home loans too could slow, which would be a setback for the real estate sector that is coming out of a near-decade-long slump. With joblessness still high, it is important the recovery does not lose steam. It is better to make a small sacrifice now.
