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  • Fuel prices on fire: The what, why, how and what now

    Publish Date: September 25, 2018

    One can’t fault you if you get spooked at the sight of a petrol pump these days. With Halloween not very far away, it won’t be a surprise if you see schadenfreude enthusiasts decked in gas station-themed costumes just to make your heart skip.

    Why are petrol pumps giving us the chills?

    Because they have become exorbitant.

    Petrol and diesel prices have ballooned in the last few months. To give you a comparison, petrol prices were recorded at Rs 73.73 on April 1, 2018. Fast forward to September 24, petrol prices have breached Rs 90 per liter in Mumbai and 31 other towns in Maharashtra. Hyderabad and Delhi also reached record-high levels of Rs 87.7 and Rs 82.72 per liter respectively.

    Diesel prices were not far behind. It reached an all-time high of Rs 78.58 per liter in Mumbai on September 24. That’s not good news for any of us because high transport cost will eventually drive up prices of essential commodities.

    Related read: August inflation data was soothing, but will it last long?

    Diwali horror?

    Petrol prices may touch the Rs 100 per liter mark before Diwali, according to a few analysts quoted by Times of India.

    Even if it is not during Diwali, oil traders expect petrol prices to touch the dreaded Rs 100-mark by the end of the year. That’s because global crude oil prices, which are trading at over $80 per barrel right now, are expected to go even higher during the winter months. In fact, commodity merchants like Trafigura forecast global crude prices to be around $100 per barrel before 2019.

    It follows: Reasons for spike in fuel prices

    Past data suggest that prices of crude oil in the international market and auto fuel in India are interlinked. Invariably, a rise in global crude oil prices drives up petrol and diesel prices in India as well. There are two main reasons for this:

    High import bill: India buys more than 80% of its oil requirements from overseas. So, if global crude oil prices go up, the cost of importing oil becomes exorbitant too.

    To make matters worse this time, India’s rupee has weakened by around 12% against the US dollar. Therefore, a combination of rising crude prices and a weak rupee has meant that India is effectively paying 47% more in actual rupee terms this year. The government has also informed that the oil import bill would be at least 26% higher this year.

    Iran sanctions: Iran is India’s third-biggest crude oil supplier. But that may be a thing of the past from November 4. That’s because tough US sanctions on Iran has forced India to shop for oil elsewhere.

    The sanctions are bad news for New Delhi. Until now, New Delhi had found importing from Tehran to be cheaper as they could pay for oil in Indian rupees. Plus, the two countries had a long-standing barter for wheat and oil.

    Related read: How will the Iran dilemma impact India?

    But now, India will have look to buy crude in US dollars, which is a more expensive option. They have urged the OPEC countries to bring down the oil costs, but those pleas have fallen on deaf ears. That’s bad news for the Indian economy as a whole.

    Kotak Institutional Equities reckon that the country’s macro situation would deteriorate if global oil prices remain above $80 per barrel. Furthermore, a $10 increase in oil prices would increase the country’s current account deficit by 50 basis points and push up inflation by 30 basis points. Therefore, high oil prices would result in fiscal slippages, which would be damaging for an economy that is already reeling under currency depreciation and inflationary pressures.

    Related read: What does high current account deficit mean to investors?

    Can the Indian government exorcise the fuel demons?

    The government can surely reduce the price of petrol and diesel by reducing taxes. But that looks unlikely because taxes on petrol and diesel are a key source of revenue for the government.

    As per an Indian Express report, the central government raised Rs 2.29 lakh crore in 2017-18 and Rs 2.42 lakh crore in 2016-17 through excise duty. Currently, the excise duty on petrol is Rs 19.48 per liter and on diesel is Rs 15.33 per liter. But even a rupee cut in excise duty would cost the Indian exchequer around Rs 13,000 crore.

    Therefore, any cut in excise duty can be damaging for India’s fiscal consolidation. That’s because the Indian government is already grappling with widening fiscal deficit and currency account deficit threats.

    While the government at the Centre levies excise duty, state governments impose VAT on petroleum products. In total, state governments collected Rs 1.66 lakh crore in 2016-17 and Rs 1.84 lakh crore in 2017-18. However, a reduction in VAT would deeply impact their revenue.

    There is one option though: petroleum products can be brought under the GST since the highest tax bracket is 28%. That would be lower because the central government and state governments currently tax about 47.2% of petrol price and 38% of diesel price.

    However, Sushil Kumar Modi, a member of the GST Council, doesn’t feel bringing petroleum products under the GST would have much impact as state governments will levy additional charges to increase their revenue.

    What now?

    In short, avoid petrol pumps (and Halloween parties). Besides that, all you can do is to wait for the government to take measures to rein in auto fuel prices. The market expects the government to take effective measures now, especially because the country is heading to polls next year. However, since slashing excise duty has been ruled out, the central government may have to persuade state governments to reduce VAT… and hope global crude oil prices settle down to manageable levels

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