Oil, budget and economic sentiment
There is some merit in the argument that inflation is a bigger dampener on economic sentiment in India than low growth rates. Traditionally, Union budgets have mattered for people at large because of two reasons: prices of goods and income tax rates. With the roll-out of the Goods and Services Tax (GST) in 2017, the Budget has lost its importance as a determinant of prices. The GST has subsumed central and state indirect taxes on most domestically produced goods and rates are decided in the GST Council. However, the budget still has a major influence on the price of an important commodity: fossil fuels such as petrol and diesel. What the forthcoming budget does regarding prices of petrol and diesel will have important implications for the economy. Here are four charts which explain this in detail.
Petrol-diesel taxes were increased post-pandemic
As the world came to a standstill after the pandemic, consumption of petroleum products crashed. This led to a sharp fall in petroleum prices as well. Brent crude – the international benchmark for crude oil prices – fell to $9.12 per barrel on April 21, 2020, the lowest level in 21 years. The price of India’s Crude Oil Basket (COB) fell to $19.90 in the month of April 2020, the lowest level in 18 years. The government saw an opportunity in this development and significantly increased taxes on petrol and diesel. Because the base price was very low, retail prices did not increase despite the sharp rise in taxes. This is best seen in petroleum ministry statistics on price build-up of petrol and diesel.
High taxes brought a fiscal windfall, but mostly for the Centre
Numbers speak for themselves. Data from the petroleum ministry shows that contribution of the petroleum sector to the exchequer increased from ₹5.55 lakh crore in 2019-20 to ₹6.73 lakh crore in 2020-21. It needs to be underlined that this happened when overall GDP actually saw a contraction in India. Provisional estimates for the first half of 2021-22 put this number at ₹3.5 lakh crore. However, it was the Centre which enjoyed most of these windfall gains from petroleum taxes. While the Centre’s earnings from the petroleum sector increased from ₹3.3 to ₹4.5 lakh crore between 2019-20 and 2020-21, the states actually saw a minor fall in their earnings from the sector from ₹2.21 lakh crore to ₹2.17 lakh crore. To be sure, the fall in headline numbers for states’ earnings should not be used to infer that the states did not raise taxes. It needs to be remembered that consumption of petroleum products itself saw a large fall in 2020-21, and barring the rise in taxes by states, the overall earnings would have fallen even more. One reason why the Centre’s gains in petroleum taxes did not accrue to states is that the additional taxes were kept in the category of cess, not included in the divisible pool of taxes.
But retail prices started rising as crude prices recovered and taxes were not lowered
Monthly average of petrol-diesel prices reached a record high in Delhi – prices vary across most districts – in October 2021. India’s COB was priced at $82.11 in that month. This is significantly lower than the price of India’s COB between February 2011 and August 2014 when it was hovering above the $100 mark. However, retail prices of both petrol and diesel were significantly lower back then, largely because of the difference in tax burden. While indirect taxes on petrol-diesel were reduced in November 2021, the tax burden is still significantly higher than pre-pandemic levels. It remains to be seen whether finance minister Nirmala Sitharaman announced a further reduction in union excise duty on petrol and diesel or keeps them at current levels. While cutting taxes is likely to give a boost to economic sentiment (more on this later) bringing tax rates to pre-pandemic levels also means foregoing ₹1 lakh crore in revenues.
Oil prices have shown large volatility in the post-pandemic phase
Brent crude experienced one of its sharpest-ever rallies to reach $85.76 per barrel in October 2021 from its 21-year low of $9.12 during April 2020 when the pandemic broke out. It has shown an almost V-shaped trajectory in the last three-four months. Brent prices were at $84 per barrel in the beginning of November 2021 and they fell to around $71 in the beginning of December 2021 and are once again close to the $84 mark now. Whether crude oil prices stay at these levels, increase further or actually come back to pre-Covid levels matters a lot for the Indian economy. This is not just relevant for the amount of taxes the government can levy without fuelling inflation – fuel inflation is one of the most important contributors to retail inflation at the moment – but also determines the net impact on trade and therefore GDP. As oil prices have increased India’s petroleum deficit as a share of GDP has been rising gradually.
It is very likely that the question of whether or not to reduce petroleum taxes will come up many times when the finance minister and her colleagues are finalising the 2021-22 budget. While concerns of boosting economic sentiment demand that the taxes are lowered – contrary to popular belief the poor consume a large amount of petrol and diesel in India (https://bit.ly/3K1pLLz) – the budget will have to find ways to at least partially compensate the revenue loss from such a move.