The announcement comes after fuel prices have been consistently hitting record highs since mid-August. Petrol prices jumped 14 paise on October 4 to Rs 91.34 per litre in Mumbai.
Ahead of the festive season, the Centre, on October 4 has decided to cut the excise duty on petrol and diesel by Rs 2.50 per litre, with immediate effect.
The Centre will bear the burden of Rs 1.50 per litre, while oil marketing companies (OMCs) will absorb another Re 1 in cost, bringing the total benefit to consumers to Rs 2.50, said Finance Minister Arun Jaitley.
“Simultaneously, I am writing to all state governments today that the way the Central government has absorbed the cost of Rs 2.50 per litre through revenue and OMCs, the states should also absorb an equivalent amount...Which means they should absorb Rs 2.50 per litre on VAT (value added tax),” Jaitley told reporters here, adding that the decision was taken after approval from Prime Minster Narendra Modi.
A reduction in taxes from the Centre and the states could mean a relief by as much as Rs 5 per litre to consumers.
He further explained that when crude oil prices rise, the Centre’s revenue is fixed, while states’ tax, which is in this case VAT, is ad valorem that increases with higher crude oil prices.
“The excise cut on petrol diesel announced by FM today will become effective from midnight of today. We urge States also to announce their cut in VAT with effect from 12 midnight today, if possible, so that the consumers get full benefit of the reduction immediately,” Finance Secretary Hasmukh Adhia said on microblogging site Twitter.
According to India Ratings, estimates suggest that the tax cut will translate in a 3.79 percent decline in the retail prices of petrol and a 3.88 percent decline in the retail price of diesel, based on prices and taxes prevailing in Delhi.
“The impact of this retail inflation would be 9 bps. A matching cut in VAT by state governments would result in retail inflation declining by 16 bps,” Devendra Kumar Pant, Chief Economist at India Ratings said.
Despite robust Gross Domestic Product (GDP) growth and falling inflation, India is facing the threat of a widening twin deficit—current account and fiscal deficit— which led to a clamour for an excise duty cut on fuel as the falling value of rupee against the dollar has made petrol diesel more expensive for the common man.
On October 4, domestic currency slipped to a fresh record low of 73.81 per dollar on the back of rising global oil prices, and concerns over current account deficit and capital outflows. Rupee closed at Rs 73.70 per dollar.
Despite denying it several times in the last month, the government has reduced taxes after fuel prices kept hitting record highs since mid-August. As of October 4, petrol prices jumped 14 paise to Rs 91.34 per litre in Mumbai.
While the impact of price cut on OMCs is unknown, the Centre, however, will have to take hit of Rs 10,500 crore in the second half of the financial year, which is 0.05 percent of the fiscal deficit.
Despite the revenue loss, the government is confident of staying in path of fiscal prudence.
“We will maintain the (fiscal deficit of) 3.3 percent (of GDP) figure,” Jaitley said.
Shares of OMCs including HPCL, BPCL and IOC touched a 52-week low after the government announced that they would absorb a Re 1 cut on fuel prices. Hindustan Petroleum Corporation ended at Rs 194.80, down 22.44 percent from previous close, while that of Bharat Petroleum Corporation ended at Rs 306.50, down 18.88 percent at the National Stock Exchange. Indian Oil Corporation ended at Rs 129.50, down 18.24 percent.
Earlier during the day, S&P BSE Sensex plunged by over 600 points in morning trade on October 4 to break below 35,600, while the Nifty50 broke below its 200-days simple moving average placed around 10,777.
Jaitley attributed the price hike to international factors, primarily the rising cost of Brent Crude oil prices, which touched $86 per barrel, the highest in four years. In addition, the US increased interest rates to its highest ever of 3.2 percent.
“Both of these developments have led to a situation, where there has been a significant impact across global markets. We have seen that today- both on stock and currency markets. It leads to larger flow of dollar back into the US market,” Jaitley said.
He further said that there was also a significant impact in the markets on account of the contagion effect that took place due to uncertainties surrounding debt-laden IL&FS.
The subject of high fuel price has become a hot-button issue, with political parties attacking the government for the rise. Since the BJP government came to power, the finance ministry raised excise duty nine times between November 2014 and January 2016 to shore up finances as global oil prices fell to as low as $30 per barrel, but cut the tax only once in October, 2017 by Rs 2 per litre, when petrol price hit Rs 70.88 per litre in Delhi.
Central, state taxes and levies, form up to more than the cost it takes to manufacture auto fuel.
While the government’s decision to cut taxes on fuel is positive, experts said that the move’s impact could be limited if the crude price continues to go up and the rupee falls.“Therefore, the critical part is as to how long will it take for the rupee to stabilize and at what level. Further, post November when the Iran sanctions kick-in, where will the oil price go? If it remains elevated, then there will be more acute inflationary problems for the economy,” Care Ratings said in a note.