Sachchidanand Shukla
The sharp fall in global oil prices had kindled hopes that this will be a boon for the hard-pressed government revenues at a time when there are demands of ~5 percent of GDP worth of extra spending to counter the deleterious effects of the Covid-lockdown. Not surprisingly, the Centre instituted sharp hikes in duties on fuels, to capture the surplus owing to the collapse in oil prices over the last two months. It raised duties on petrol by Rs10/litre and on diesel by Rs 13/litre. These hikes have not been passed to end consumers but have been absorbed by Oil Marketing Companies (OMCs), bringing down their marketing margins from supernormal levels of Rs17-19/litre seen through April. This is the second hike in duties by the Centre; duties had been raised by Rs3/litre on petrol and diesel in Mid-March.
The states, too, have not been far behind in raising taxes on fuels, given the paucity of resources. As many as 13 states have raised VAT on petrol and diesel, by varying degrees during the lockdown and more are expected to follow suit. The degree of these hikes is, however, much smaller than the Centre. These hikes have largely resulted in higher retail prices.
What do the duty hikes on petrol and diesel mean for the fisc? Based on an assumption of ~15% drop in petrol & diesel volumes in FY21, the Centre would gain ~Rs1.8tn in additional receipts due to these hikes. Further, based on a simple assumption that all states hike their VAT rates, and this translates into approx. Rs3/litre, the States would see a gain of ~Rs0.35tn – taking the total gains to well ~Rs2.1tn, or ~1 percent of GDP.
A fair assessment of the distribution of these gains would need to take into account devolution of the Centre’s tax receipts. Of the Rs13/litre hiked on petrol and Rs16/litre hiked on diesel cumulatively since mid-March, Rs9/litre is on account of Cess, which is not a part of the divisible pool. The remaining is on account of Special Additional Excise Duty, which would need to devolved to the States. Accounting for this, the Centre would gain Rs ~1.4tn, while the States would garner ~Rs0.7tn.
The assumption is that fuel tax hikes will provide the government with a material fiscal buffer, with only a modest effect on inflation. However, note that these gains, while seemingly large, are not additions over the FY20 revenues and are only accruals on account of duty hikes. The increment in FY21 would be lower than the gains due to these duty hikes.
More importantly, the accrual of these gains during the year is likely to be backloaded. This is because fuel consumption is expected to fall very sharply in the near term and recover somewhat in the latter part of the year. The Centre’s revenues are contingent on volumes sold as it levies a fixed rupee amount of duty per litre on petrol and diesel. The states’ typically levy an ad valorem VAT making their receipts contingent on the value of fuel sales.
This implies that the near-term stress that the Centre and States are facing on account of weakness in receipts might only see limited respite on account of these duty hikes. Besides, the accrual of the benefit would also depend on the sustainability of low fuel prices in the second half of the fiscal (when volumes recover). If oil prices rise in the latter part of the year (which is likely to be the case) and the government is forced to reverse duty hikes, then these gains to the fisc would shrink. It is thus important to exercise caution while accounting for the oil bonanza.
Given that India is a large importer of oil, gains from the sharp fall in fuel consumption and oil prices will certainly accrue to India’s Current Account, which may even see an intermittent surplus, even if marginal, during the first quarter. This is intuitive; a sharp fall in spending on fuels (and other items) during the lockdown is likely to lead to a temporary build-up in household savings, resulting in a Current Account surplus. External imbalances are, ultimately, manifestations of the Savings-Investment gap.
Thus, in the first half of the fiscal, the gains due to lower oil prices are likely to bypass the fisc (owing to the sharp fall in volumes consumed) and accrue to households, in the form of higher savings, also reflecting in lower external imbalances. This situation, however, will reverse as the year progresses and fuel prices and consumption normalizes, or even spikes owing to a preference for personal vehicles. Nevertheless, gains to the fisc in H2 would only occur if oil prices don’t rise significantly in H2.
That is the short term but what about the medium-term implications? There are two key takeaways.
- First, the government relies excessively on oil receipts. Consider this – the petroleum sector contributed as much as Rs 5.8tn to the Central and State exchequers, together, in FY19 – equivalent to 3 percent of GDP. Nearly 90 percent of this amount is by the way of indirect taxes excise duties and VAT on petroleum products.
Thus the government must work towards reducing its over-reliance on oil receipts and must look for ways to diversify for the long-term fiscal health of the Centre and especially the States, which have limited tax levers. Notwithstanding the sharp fall in fuel consumption owing to the lockdown, longer term trends such as a switch towards electric vehicles and increasing fuel efficiency, would also hurt fuel consumption, in turn affecting receipts from the petroleum sector.
It could be argued that stagnating volumes be offset by increasing tax rates. However, this may not be a sustainable option given that ~70 percent of the retail selling price that consumers currently pay for fuels is already accounted for by taxes. Besides, the States already charge high sales taxes on petrol and diesel.
The Centre and especially the states must look for alternative sources of recurring receipts that can substitute for the loss in oil receipts and bolster their finances in the long run. The current crisis provides an opportunity to introduce such a measure. The Centre and the States could initiate this in the guise of the withdrawal of the COVID-19 related fiscal impulse over the next few years.
- Secondly, the government should use this opportunity to push for bringing petroleum products within GST, removing a long-standing anomaly. This will help reduce the median GST rate as the situation normalizes and leave some more money in household pockets. In any case the Centre and States are working together to fight Covid and the government can sweeten the deal using Covid-stimulus for getting states on the table.
(with inputs from Rahul Agrawal)
Sachchidanand Shukla is Chief economist, M&M Group. Views are personal.
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