Why the Price of Petrol is Racing Towards Rs 100 Per Litre

If there are two things that get people of this country interested in economics, they are the price of onion and the price of petrol racing towards Rs 100 per kg or litre, respectively.  Currently, the price of petrol is racing towards Rs 100 per litre in large parts of the country. In fact, in some parts, it has already crossed that level.

So, what’s happening here? Let’s take a look at this pointwise.

1) Take a look at the following chart, which plots the average price of the Indian basket of crude oil since January 2020.

Source: Petroleum Planning and Analysis Cell.
*February price as of February 18, 2021.

What does the above chart tell us? It tells us that as the covid pandemic spread, the price of oil fell, falling to a low of $19.90 per barrel in April 2020. It has been rising since then. One simple reason for this lies in the fact that as the global economy recovers, its energy needs will go up accordingly and hence, the price of oil is going up as well.

The other reason has been the massive amount of money that Western central banks have printed through the beginning of 2020. Oil, as it had post 2008, has emerged as a hard asset of investment for many institutional and high-networth investors, leading to an increase in its price. As of February 18, the price of the Indian basket of crude oil stood at $63.65 per barrel, having risen by close to 220% during the current financial year.

2) Now let’s look at the average price of the Indian basket of crude oil over the years.

Source: Petroleum Planning and Analysis Cell.
* Up to January 2021.

What does the above chart tell us? It tells us that the Narendra Modi government has been very lucky when it comes to the price of oil, with the oil price on the whole being much lower than it was between 2009 and 2014.

In May 2014, when Modi took over as the prime minister, the price of oil averaged at $106.85 per barrel. By January 2016, it had fallen to $28.08 per barrel.

Even after that, the price of oil hasn’t touched the high levels it did before 2014, in the post financial crisis years, which also happened to be the second term of the Manmohan Singh government.

A major reason for this lies in the discovery of shale oil in the United States. In fact, as Daniel Yergin writes in The New Map – Energy, Climate and the Clash of Nations: “In the autumn of 2018, though it was hardly noted at the time, something historic occurred: The United States overtook both Russia and Saudi Arabia to regain its rank as the world’s largest oil producer, a position it had lost more than four decades earlier.” This has been a major reason in the lower price of oil over a longer term.

The question that then crops up is why hasn’t petrol price in India seen low levels? The answer lies in the fact that between 2014 and 2021, the taxes on petrol, in particular central government taxes have gone up dramatically.

In short, the central government has captured a bulk of the fall in oil prices. Now when the oil price has gone up over the course of this financial year, the high-price of petrol has started to pinch.

3) Take a look at the following table. It plots the price of petrol in Delhi as of February 16, 2021 and in March 2014.

Source: https://iocl.com/uploads/priceBuildup/PriceBuildup_petrol_Delhi_as_on_16_Feb-2021.pdf
and https://www.ppac.gov.in/WriteReadData/Reports/201409231239065062686Snapshot_IOGD_MAR.pdf.

The above table makes for a very interesting reading. As of February 16, the price of petrol charged to dealers was Rs 32.1. Over and above this, the central government charged an excise duty of Rs 32.90 per litre on petrol. Add to this a dealer commission of Rs 3.68 per litre, and we are looking at a total of Rs 68.68 per litre.

On this the Delhi state government charged a value added tax of 30% or Rs 20.61 per litre. This leads to a retail price of petrol of Rs 89.29 per litre. Given that the state government charges a tax in percentage terms, the higher the price of petrol goes, the more tax the state government earns. The vice versa is also true.

Let’s compare this to how things were in March 2014. The price of petrol charged to dealers was Rs 47.13 per litre, much lower than it is today. On this, the central government’s tax amounted to Rs 10.38 per litre. The dealer commission was Rs 2 per litre.

Adding all of this up, we got a total of Rs 59.51 per litre. On this, the Delhi state government charged a value added tax of 20%, which amounted to Rs 11.9 per litre and a retail selling price of petrol of Rs 71.41 per litre. Interestingly, the state government’s tax was more than that of the central government at that point of time.

4) The above calculations explain almost everything. In March 2014, the price of petrol at the dealer level was higher than it is now, but the retail selling price was lower. Both the central government and the state government have raised taxes since then.

The total taxes as a percentage of dealer price now works out to 167% of the dealer price. In March 2014, they were at 47.3%. It is these high taxes which also explain why petrol prices in India are higher than in many other countries.

Of course, a bulk of this raise has come due to a rise in taxes charged by the central government. As mentioned earlier, the central government has captured a bulk of the fall in price of oil.

5) The calculation shown here will vary from state to state, depending on the value added tax or sales tax charged by the state government and the price at which petrol is sold to the dealers. States which charge a higher value added tax than Delhi will see the price of petrol reaching Rs 100 per litre faster than Delhi, if the price of oil continues to rise.

6) Of course, the governments can bring down the price of petrol by cutting taxes. In fact, four state governments have cut taxes providing some relief to oil consumers. But any substantial relief can be provided only by the central government. The trouble is that tax collections have fallen this year. Only the collection of excise duty has gone up by 54% to Rs 2.39 lakh crore, thanks to the higher excise duty charged on petrol and diesel.

The interesting thing is that the excise duty earned from the petroleum sector has jumped from Rs 99,068 crore in 2014-15 to Rs 2.23 lakh crore in 2019-20. The government has become addicted to easy revenue from taxing petrol and diesel. This year its earnings will be even higher than in 2019-20.

7) The central government also fears that if it cuts the excise duty on petrol and diesel, the state governments can step in and increase their value added tax, given that like the centre, they are also struggling to earn taxes this year.

Also, what needs to be kept in mind here is that the central government doesn’t share a good bit of what it earns through the excise duty on petrol and diesel with the states. This is because a bulk of the excise duty is charged in the form of a cess, which the central government does not need to share with the states.

Let’s take the overall excise duty of Rs 32.90 per litre of petrol currently. Of this, the basic excise duty is Rs 1.40 per litre and the special additional excise duty is at Rs 11 per litre. The road and infrastructure cess is at Rs 18 per litre (also referred to as additional excise duty) and the agriculture and infrastructure development cess is at Rs 2.50 litre. Clearly, the cess has a heavier weight in the overall excise duty.

8) One reason offered for the high price of petrol is low atmanirbharta or that as a country we have to import more and more oil than we did in the past. In 2011-12, the import dependency was 75.9%. This jumped to 77.6% in 2013-14 and has been rising since. In April to December 2020, this has jumped to 85%.

The explanation offered on this has been that oil companies haven’t carried out enough exploration activities in the past. Let’s take a look at the numbers of ONGC, the government’s biggest oil production company (or upstream oil company, as it is technically referred to).

The total amount of money spent by the company on digging exploratory wells in 2019-20 stood at Rs 4,330.6 crore. This had stood at Rs 11,687.2 crore in 2013-14. Over the years, the amount of money spent by ONGC on exploration has come down dramatically. This explains to some extent why the crude oil production in India has fallen from 37.8 million tonnes in 2013-14 to 30.5 million tonnes in 2019-20, leading to a higher import dependency.

Of course, not all exploration leads to discovery of oil, nevertheless, at the same time unless you explore, how do you find oil.

The reason why ONGC’s spending on exploration has fallen is primarily because the company has taken on a whole lot of debt over the past few years to finance the acquisition of HPCL and a majority stake in Gujarat State Petroleum Corporation’s (GSPC) KG Basin gas block. The money that ONGC borrowed to finance the purchase of HPCL from the government was used by the government to finance the fiscal deficit. Fiscal deficit is the difference between what a company earns and what it spends.

The borrowing has led to the finance costs of the company going up from Rs 0.4 crore in 2013-14 to Rs 2,823.7 crore in 2019-20. The cash reserves of the company are down to Rs 968.2 crore as of March 2020 from Rs 10,798.9 crore as of March 2014.

All this explains why the price of petrol is racing towards Rs 100 per litre. At the cost of sounding very very very cliched, there is no free lunch in economics. Somebody’s got to bear the cost.

It will be interesting to see if the central government continues to hold on to the high excise duty on petrol and diesel (whatever I have said for petrol applies for diesel as well, with a different set of numbers) leading to  a high petrol and diesel price and lets these high rates feed into inflation in the process.

Keep watching this space.

Why Indians Pay Such a High Price for Petrol and Diesel

At the end of every month, the Controller General of Accounts (CGA) declares the revenue and the expenses of the central government up until the last month. Hence, on September 30, the CGA declared the revenue and the expenses of the central government between April 1 and August 31.

Take a look at the following chart. It plots the decrease in gross tax revenue between April and August 2020 in comparison to the same period in 2019. The major taxes collected by the central government are income tax that you and I pay, corporate tax (income tax paid by corporates), customs duties, central goods and services tax, goods and services tax compensation cess and excise duties.

They all fall down


Source: Centre for Monitoring Indian Economy.

As can be seen in the above chart, the collections of all taxes have come down. The gross tax revenue is down 23.7% to Rs 5.04 lakh crore. Only one tax and that is excise duty, has grown during the course of this year. The growth is a huge 32.05% to Rs 1 lakh crore.

Given the economic contraction this year, it is hardly surprising that tax collections have crashed. The question is how has the collection of excise duties increased by almost a third?

This is primarily because of the central government increasing the excise duty it charges on petrol and diesel. This has been done twice in 2020. First in March and then again in May.

The excise duty on petrol stood at Rs 19.98 per litre, when it was increased by Rs 3 per litre in March and then again by Rs 10 per litre in May and now stands at Rs 32.98 per litre. When it comes to diesel, the excise duty on it stood at Rs 15.83 per litre in March. It was increased by Rs 3 per litre in March and Rs 13 per litre in May.

Take a look at the following table. It provides the price build up of petrol in Delhi as of March 1 and as of October 1.

High and low.

Source: Indian Oil Corporation.

This table makes for a very interesting reading. Let’s first understand how the mathematics of this works out using the data as of October 1.

The price charged to dealers is Rs 25.68 per litre. On this, the central government charges an excise duty of Rs 32.98 per litre. There is a dealer commission of Rs 3.69 per litre. Adding the price charged to dealers (Rs 25.98), the excise duty (Rs 32.98) and the dealer commission (Rs 3.69), we get a price of Rs 62.35 per litre. On this the local Delhi government charges a value added tax of 30%. This works out to Rs 18.71 per litre in this case.

Adding the value added tax, we get the retail selling price of Rs 81.06 per litre. The maths for the price as of March 1, works similarly, the difference being in the numbers and the taxes.

In March, the price of Indian basket of crude oil was around $55 per barrel. The latest price of the Indian basket of crude oil is around $41 per barrel. This is reflected in the fact that the price charged to dealers as of October 1, stood at Rs 25.68 per litre, lower than the Rs 32.93 per litre charged in March.

Despite the higher price charged to dealers, the retail selling price of petrol in March was at Rs 71.71 per litre as against Rs 81.06 per litre in October. The price as of today is 13% higher than that in March.

What’s happening here? Let’s take a look at it pointwise.

1)  The total excise duty on petrol was at Rs 19.98 per litre in March. It has since gone up to Rs 32.98 per litre, Rs 13 per litre extra. This adds to the retail price.

2) The value added tax charged by the Delhi government has also increased from 27% to 30%. This also adds to the retail price though not as much as the increase in excise duties.

3) As of March 1, taxes amounted to Rs 35.23 per litre (excise duties + value added tax). This was against a price charged to dealers of Rs 32.93 per litre. Taxes amounted to 107% of the price charged to dealers.

As of October 1, taxes amount to Rs 51.69 per litre (excise duties + value added tax). This is against a price charged to dealers of Rs 25.68 per litre. Taxes now amount to 201% of the priced charged to dealers. This explains the higher retail price of petrol, despite the lower price charged to dealers, thanks to a lower oil price.

4) There is another way of looking at this data. In March, the total taxes amounted to around 49% of the retail price. In October, they amount to around 64% of the retail price. There has been a substantial increase in taxes.

5) The reason behind this increase is that the central government needs to meet its expenditure from somewhere. One point that often gets made on the social media is that the central government shares the increase in excise duties with the state governments. This isn’t totally true.

In May, the excise duty on petrol was hiked by Rs 10 per litre. Of this hike, the hike in road and infrastructure cess (additional excise duty) was Rs 8 per litre. Given that this is a cess, it need not be shared with the state governments. Hence, the bulk of the increase has stayed with the central government.

Now let’s take a look at diesel pointwise. In this case, I am taking diesel price in Delhi as of February 12. I couldn’t find the data for March 1. But the logic remains entirely the same.

1) The price of diesel as of February 12 was Rs 64.87 per litre. As of October 1, it stands at Rs 70.53 per litre. This despite lower oil prices.

2) The total excise duty on diesel back then was Rs 15.83 per litre. Currently, it stands at Rs 31.83 per litre. This has added to the price of diesel.

3) As of February 1, the price charged to dealers was Rs 36.98. The excise duty was Rs 15.83 per litre. The value added tax worked out to Rs 9.56 per litre. Hence, total taxes (excise duty + value added tax) worked out to Rs 25.39 per litre or around 69% of the price charged to dealers.

As of October 1, the excise duty is at Rs 31.83 per litre whereas the value added tax works out to Rs 10.37 per litre. Hence, total taxes work out to Rs 42.2 per litre or 164% of the price charged to dealers.

4) Total taxes amounted to 39% of the retail price in February. They now work out to 60%.

5) In May, the excise duty on diesel was hiked by Rs 13 per litre.  Of this hike, the hike in road and infrastructure cess (additional excise duty) was Rs 8 per litre. Given that this is a cess, it need not be shared with state governments. Hence, the bulk of the increase has stayed with the central government.

This explains why you and I are paying a higher amount per litre of petrol and diesel, despite oil prices being lower from the time the covid-pandemic struck. Also, it needs to be mentioned here that the consumption of petroleum products has fallen every month between April and August. The following chart plots the same.

The Great Fall

Source: http://164.100.24.220/loksabhaquestions/annex/174/AU1274.pdf

The interesting thing here is that thanks to a higher excise duty per litre of petrol and diesel, the collection of excise duties has risen, despite fall in consumption. Also, the other interesting bit here is that the consumption decline was at 8.4% in June. The situation has worsened since then.

In the last six years, the government hasn’t passed on the fall in the price of oil to the end consumer. In May 2014, when Narendra Modi took over as prime minister, the average price of  the Indian basket of crude oil during the month was $106.85 per barrel. The following chart plots the average price of the Indian basket of crude oil during a particular year, over the years.

Oil not on boil

Source: Petroleum Planning and Analysis Cell. (https://www.ppac.gov.in/content/149_1_PricesPetroleum.aspx).  *Between April and August 2020.

The above chart makes for a very interesting reading. The average price of the Indian basket of crude oil in 2020-21 at $35.74 per barrel, has been the lowest since 2003-04. But that is clearly not reflected in the retail price of petrol and diesel, thanks to higher taxes, particularly higher excise duties.

A May 2020 report by the Press Trust of India points out: “The tax on petrol was Rs 9.48 per litre when the Modi government took office in 2014 and that on diesel was Rs 3.56 a litre.” The Modi government has captured a bulk of the fall in price of oil over the years. This is clearly reflected in the following chart, which plots the excise duty earned by the government from petroleum products.

Up, up and away. 

Source: Petroleum Planning and Analysis Cell. (https://www.ppac.gov.in/content/149_1_PricesPetroleum.aspx). *Between April and June 2020.

As can be seen from the above chart, the excise duty earned from petrol and diesel has more than doubled over the years. While, the government has captured a bulk of the fall in oil prices, there are no guarantees that it will protect the consumer, if and when oil prices start to go up again.

Also, this is a very easy way for the government to collect revenue. It allows them to go slow on more difficult ways, like selling stakes in public sector enterprises (PSEs), selling the massive land owned by PSEs, shutting down the badly run PSEs, fixing the badly implemented goods and services tax system, and so on.

Take a look at the following chart which compares India’s petrol and diesel prices with that of our neighbouring countries.

The Indian high


Source: Websites of oil companies in these different countries. Nepal prices from local newspapers.
(I would like to thank Chintan Patel for putting this table together).
Prices as of October 1, 2020.

The above chart clearly shows that the petrol and diesel prices are the highest in India. And as they say, there is no free lunch in economics. You and I are paying this higher price, not just when we buy petrol and diesel directly, but also when we pay for almost every product that is produced somewhere and delivered to where we are.

Winter and Money Printing are Coming to India, In a Few Months

The Controller General of Accounts publishes the state of government finance at the end of every month. This data is published with a gap of one month. Hence, on 31st August, the data as of 31st July, was published.

This data, not surprisingly, doesn’t make for a good reading. The fiscal deficit, the difference between what a government earns and what it spends, for the period April to July 2020 stood at Rs 8.21 lakh crore. The fiscal deficit that the government had plans to achieve during the course of the current financial year (2020-21) stands at Rs 7.96 lakh crore. Hence, at the end of July, the actual fiscal deficit of the government was 103.1% of the budgeted one.

But given the state we are in this is hardly surprising. Nevertheless, there are several reasons to worry. Let’s take a look at it pointwise.

1) Tax collections have collapsed. Between April and July 2020, the gross tax revenue, which brings in a bulk of the money for the central government and which it shares with the state governments, is down 29.5% to Rs 3.8 lakh crore, in comparison to the same period in 2019.

Let’s look at the different taxes collected by the government between April and June this year and the last year.

They all fall down


Source: Controller General of Accounts.

 

As can be seen from the above chart, the collections of all major taxes are down big time.

Take the case of central goods and services tax. (GST) or the part of GST that ends up with the central government. During April to July 2019, the total collections of the central GST had stood at around Rs 1.41 lakh crore. During the same period this year the collections have fallen by 34% to Rs 92,949 crore. Other taxes have fallen along similar lines.

The fall in GST collections is a reflection of a massive slowdown in consumption. A slowdown in consumption ultimately reflects in a slowdown in income of individuals as well as incomes of companies. Ultimately, one man’s spending is another man’s income.

But there is something that the above chart does not show, the excise duty collections of the central government. They are up year on year by 23.8% to Rs 67,895 crore. This despite the fact that the consumption of petroleum products between April and July is down 22.5% in comparison to 2019.

So, how have excise duty collections gone up? The central government has increased the excise duty on petrol from Rs 22.98 per litre to Rs 32.98 per litre. The excise duty on diesel has been raised from Rs 18.83 per litre to Rs 31.83 per litre. Also, a substantial part of this duty is a cess, leading to a situation where the central government does not have to share the revenue earned through the cess with the state governments.

In the process, the central government has captured a bulk of the fall in oil prices.

2) As mentioned earlier, the central government needs to share a part of the money it earns with state governments. Between April and July it shared Rs 1.76 lakh crore with states, against Rs 2 lakh crore, during the same period last year. This is 12% lower, during a time when the states are at the forefront of fighting the covid-epidemic.

The ability of the state governments to raise taxes, after having become a part of the goods and services tax system, is rather limited. Take the case of petrol and diesel. The central government has raised excise duty by such a huge extent that the state governments aren’t really in a position to raise the value added tax or the sales tax on petrol and diesel, which they are allowed to charge, without having to face political repercussions for it.

3) The central government has more ways of raising money than the states. One such way is disinvestment of its stakes in public sector enterprises. This year the government plans to earn a whopping Rs 2.1 lakh crore through this route. The original plan included the plan to sell Air India. Whether that happens in an environment where the airlines business has been negatively rerated in the aftermath of covid, remains to be seen.

The other big disinvestment plan was that of the government selling its stake in the Life Insurance Corporation of India through an initial public offering. There are one too many regulatory hurdles that need to be removed, before a stake in India’s largest insurance company can be sold to investors. Long story short, it looks highly unlikely that the government will get anywhere near earning Rs 2.1 lakh crore this year, through the disinvestment front.

Having said that, the government can always resort to some accounting shenanigans, like getting one public sector enterprise to buy another, and pocketing that money. This is likely to happen in the second half of the year.

Over and above this, the government earns a lot of money from the dividends that it earns from public sector enterprises as well as banks and financial institutions. The target for this year is around Rs 1.55 lakh crore. Public sector banks will continue to remain on a weak wicket through this year, hence, their ability to pay dividends is rather limited.

The only way the government can make good this target is by raiding the balance sheet of the RBI for money. Also, the government is likely to raid the cash balances of public sector enterprises which have them, by asking them to pay special dividends.

4) The money that gets invested into various small savings schemes, which includes schemes like Post Office Savings Account, National Savings Time Deposits ( 1,2,3 & 5 years), National Savings Recurring Deposits, National Savings Monthly Income Scheme Account, Senior Citizens Savings Scheme, National Savings Certificate ( VIII-Issue), Public Provident Fund, KisanVikas Patra and Sukanya Samriddhi Account, net of the redemptions, is a revenue entry into the government budget.

This time it has been assumed that the government will get Rs 2.4 lakh crore through this route. Between April and July, Rs 38,413 crore or just 16% of the targeted money has come in. Last year, during the same period, 38% of a much lower target of Rs 1.3 lakh crore had been achieved. Clearly, this target is also going to be missed.

5)  Of course, the government understands this and which is why in early May it increased its borrowing target from Rs 7.8 lakh crore to Rs 12 lakh crore, by more than 50%. The government borrows money to finance its fiscal deficit.

What this means is that the government wants to at least keep the fiscal deficit to around Rs 12 lakh crore. The question is will that happen? Gross tax revenues are already down 30%. Of course, as the economy keeps opening up, this number will look better. Having said that, even if tax revenues are down by 15% as of the end of the year, we are looking at a shortfall of Rs 2.5 lakh crore for the central government. The other big entries of disinvestment and the net-revenue from small savings schemes, are also looking extremely optimistic in the current situation.

Even if the government achieves a fiscal deficit of Rs 12 lakh crore and the economy shrinks by around 10% this year, we will be looking at a central government fiscal deficit of 7% against the targeted 3.5%.

In this scenario, it is now more than likely that the RBI will resort to direct financing of government expenditure by printing money and buying government bonds. The government sells bond to finance its fiscal deficit.

This isn’t to say that the RBI hasn’t printed money this year. It has. But it has chosen to operate through the primary dealers. But the mask might come off in in the time to come and the RBI might decide to buy bonds directly from the government.

Winter and money printing are coming to India, in a few months.

 

What You Pay For When You Pay for Fuel

narendra modi
The Prime Minister, Shri Narendra Modi addressing the Nation on the occasion of 71st Independence Day from the ramparts of Red Fort, in Delhi on August 15, 2017.

Narendra Modi, took over as the prime minister of the country on May 26, 2014. On that day, the global price of the Indian basket of crude oil was $108.05 per barrel. Back then, one litre of petrol cost Rs 80 in Mumbai. Diesel in the city was being sold at Rs 65.21 per litre.

Three years have gone by since then and meanwhile, the global oil scenario has changed completely. On September 14, 2017, the price of Indian basket of crude oil was at $54.56 per barrel, around half of what it was when Modi took over as prime minister.

At Rs 79.5 per litre, the price of petrol in Mumbai as on September 14, 2017, in Mumbai, was more or less same as it was when Modi took over as prime minister. Diesel at Rs 62.46 per litre was slightly lower.

What is happening here? While, the price of crude oil has halved, the price of petrol and diesel, which are by-products of crude oil, continues to remain more or less the same (This argument may not hold all across the country, given that different states levy different taxes and different rates of taxes on petrol and diesel).

The gain because of fall in price of oil, has been captured majorly by the central government and the state governments, by increasing the different taxes that are levied on petrol and diesel. Lately, the commission given to pumps which sell petrol and diesel, has also gone up.

A small-scale industry has emerged lately, trying to defend the high taxes that consumers pay on petrol and diesel. Here are the arguments on offer:

a) India imports 80 per cent of the oil that it consumes. Given this, prices of petrol and diesel need to be high, in order to discourage people from consuming more and more of it. The assumption is that at lower price levels, people will consume more petrol and diesel.

b) We need to respect the environment. Petrol and diesel pollute the environment, and hence, taxes on petrol and diesel need to be high.

c) The high taxes on petrol and diesel have helped the government bring down its fiscal deficit without having to cut on its expenditure. This is something that is required in an economic environment where growth is slowing down and hence, government spending needs to be strong. Fiscal deficit is the difference between what a government earns and what it spends.

d) High taxes on petrol and diesel help the government earn enough money in order to fund the physical infrastructure that the country badly needs.

e) High petrol and diesel prices push demand towards more fuel-efficient cars. Also, by taxing petrol more than diesel, the government is ensuring that the private modes of transport (which largely use petrol) are taxed more than the public modes of transport (which use diesel).

f) The oil marketing companies need the flexibility to price their products on a day to day basis. It is this flexibility that reflects in the healthy valuations that their stocks currently enjoy in the stock market.

g) High taxes help the government finance the oil marketing companies which can then sell domestic cooking gas and kerosene at lower prices.

Each of these arguments is largely correct (I mean just because a small scale industry has emerged, doesn’t mean they are wrong) except for the last one. The subsidies on domestic cooking gas and kerosene are now down to around Rs 25,000 crore, which isn’t much in comparison to the petroleum subsidy of the past years. Hence, high taxes on petrol and diesel are clearly not required to fund the subsidy.

But there is one point that these economic commentators and analysts do not talk about. High taxes on the petrol and diesel makes the government lazy and helps it to continue favouring the status quo. Allow me to elaborate. It is worth remembering here that money is fungible. Just as high taxes on petrol and diesel allow the government to fund physical infrastructure, they also allow it to do a lot of other things that a government shouldn’t be doing. Let’s look at the points one by one:

a) Between 2010-2011 and 2015-2016, Air India has lost close to Rs. 35,000 crore, and yet it continues to be run. The losses are not surprising, given that the airline business is a very competitive business and the government clearly doesn’t have the wherewithal to run it. The question is where does the money to keep bankrolling Air India come from? The high taxes on petrol and diesel.
Lately, there has been talk of selling the airline. Let’s see, if and when that happens.

b) Or take the case of Hindustan Photo Films Manufacturing Company Ltd. It is the fourth largest loss-making company among the loss making public sector units. It made losses of Rs 2,528 crore in 2015-201 Between 2004-2005 and 2015-2016, the company has made losses of close to Rs 15,000 crore. As mentioned earlier in 2015-2016, the company lost Rs 2,528 crore. It employed 217 individuals. This meant a loss of Rs 11.65 crore per employee. Where does the money to run this company come from?

c) In total, high taxes on petrol and diesel allowed the government to run 78 loss making public sector enterprises in 2015-2016. Between 2011-2012 and 2015-2016, the loss making public sector enterprises have made losses of Rs 1,33,400 crore. Where is the money to finance these losses coming from?

d) Between 2009 and now, the government has spent roughly around Rs 1,50,000 crore, recapitalising public sector banks. The public sector banks have a humungous bad loans portfolio, as they keep writing off the bad loans, their shareholders’ equity keeps coming down and the government as the largest owner, needs to recapitalise them. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more. Take a look at Table 1.

Table 1:

 

 Gross non-performing advances ratio
Indian Overseas Bank24.99%
IDBI Ltd.23.45%
Central Bank of India19.55%
UCO Bank18.83%
Bank of Maharashtra18.00%
Dena Bank17.39%
United Bank of India16.56%
Oriental Bank of Commerce14.49%
Bank of India14.20%
Allahabad Bank13.72%
Punjab National Bank13.20%
Andhra Bank12.91%
Corporation Bank12.14%
Union Bank of India11.77%
Bank of Baroda11.15%
Punjab & Sind  Bank10.80%
Canara Bank10.00%

Source: Author calculations on Indian Banks’ Association data.
As on March 31, 2017.

Table 1 tells us that 17 public sector banks have a bad loans ratio of 10 per cent or high. This basically means that of every Rs 100 of loans that they have given, a tenth or more, is not being repaid. The government currently owns 21 banks, after the merger of the associate banks of State Bank of India and the Bhartiya Mahila Bank, with the State Bank of India.

Some of these banks like the Indian Overseas Bank are in a particularly bad state. This bank has a bad loans ratio of close to 25 per cent i.e. one fourth of its loans have been defaulted on.

Where is the money to keep these banks going, coming from? In a world where money wasn’t free flowing because of high taxes on petrol and diesel, banks like the Indian Overseas Bank, UCO Bank, United Bank of India, Dena Bank, etc., would have already been shutdown or perhaps been sold off. These banks are too small on the lending front to make any substantial difference to the total lending carried out by banks in India. But their losses do hurt the government a lot. Every extra rupee that goes towards funding these banks is taken away from something more important areas like education, health and agriculture.

e) Also, given the different taxes implemented by different states, the price of petrol and diesel tend to vary across the country. Take the case of the government of Maharashtra charging a drought cess of Rs 9 every time one litre of petrol is bought in the state. Why is this cess even there during a time when there is really no drought in the state? It is just an easy way for the government to raise money. Most people don’t even know that they are paying for something like this, every time they buy petrol.

Hence, to introduce a sense of equality among citizens living in different states, petrol and diesel need to be taxed under the GST (They are already a part of it, with zero percent tax rates).

The high taxes from petrol and diesel also helps the government to continue running many inefficient firms as well as banks. Any plan of closing down these firms and banks is likely to met with a lot resistance and also, lead to a lot of hungama (for the lack of a better word). Given this, it makes sense for the government to take the easy way out, maintain the status quo and continue running these firms and banks.

As Donald J Boudreaux writes in The Essential Hayek: “People’s intense focus on their interests as producers, and their relative inattention to their interests as consumers, leads to press for government policies that promote and protect the interests of producers.”

Any idea of shutting down or selling an inefficient public sector enterprise or banks, is likely to be met with a lot of protests from the employees as well as the trade unions representing them. The political parties are likely to join in. Hence, it is easy for the government to maintain the status quo and not make any difficult decisions.

But the money that goes towards keeping these individuals happy, is taken away from other areas like education, agriculture, health etc. People who lose out because of this, do not have the kind of representation that people working for government run firms have.

Of course, all this does not mean that there should be no taxes on petrol and diesel. With the right to govern comes the right to tax people. But these taxes should be at a reasonable level. Also, with lower taxes, people will spend more money on personal consumption and that will help economic growth. And the impact of people spending money, on economic growth, is always greater than that of the government.

To conclude, it is worth remembering that every coin has two sides, and it doesn’t always land up heads.

 

A slightly different version of this column appeared on Pragati on September 19, 2017.

Happy new year folks: The govt has increased excise duty on petrol and diesel again!

light-diesel-oil-250x250Dear Reader,

While you, me and everybody else was busy celebrating the new year, the government quietly increased the excise duty on petrol and diesel, again. This increase was announced on January 1, 2016 and came into effect from the next day.

This is the seventh increase in the excise duty on petrol and diesel since November 2014. Also, the government has increased the excise duty thrice in quick succession over the last two months (between November 6, 2015 and now). Since November 2014, the excise duty on unbranded petrol has gone up by Rs 6.53 per litre, with latest increase being of 37 paisa per litre. This is a massive jump of 544%.

During the same period the excise duty on unbranded diesel has gone up by Rs 6.37 per litre or 436%, with the latest increase of Rs 2 per litre. In the process, the government has captured a major part of the fall in oil prices.

On November 11, 2014, when the excise duty on petrol and diesel was increased by the Narendra Modi government for the first time, the price of the Indian basket of crude oil was at $79.11 per barrel. As on December 31, 2015, the price of the Indian basket of crude oil stood at $32.9 per barrel, a massive fall of 58.4% since November 2014.

In the same period the price of petrol and diesel in Mumbai has fallen by only 3.6% and 9.9% respectively. What this tells us loud and clear is that the government has captured most of the fall in oil prices, without passing on the benefit to end consumers. The surprising thing here is that there has been no protest on this, either from the opposition parties or the citizens.

There are a number of issues that crop up here. First comes the question, why is the government doing this? In fact, there is a clear trend in the government increases of the excise duty on petrol and diesel. In 2014-2015, the last financial year, the increases came on November 11, 2014, December 2, 2014 and January 1, 2015. These increases were in the period close to the annual budget which is presented in end February.

The same trend is playing out this time as well. The three recent increases have come on November 6, 2015, December 16, 2015 and January 1, 2016. In the run up to the budget which will be presented in end February 2016, the government is sprucing up its finances. Estimates suggest that the three recent increases will bring in an extra Rs 10,000 crore into the coffers of the government.

In the budget presented in February 2015, the government had targeted a fiscal deficit of Rs 5,55,649 crore or 3.9% of the gross domestic product(GDP). Fiscal deficit is the difference between what a government earns and what it spends.

It is important to figure out how this calculation was carried out. In 2014-2015, the nominal GDP was at Rs 12,653,762 crore. Nominal GDP is essentially GDP which hasn’t been adjusted for inflation. It was assumed that during 2015-2016, the nominal GDP would increase by 11.5% to Rs 14,108,945 crore. A fiscal deficit of Rs 5,55,649 crore amounts to 3.9% of this projected GDP of Rs 14,108,945 crore.

So there are two things that the government needs to keep track of here. The absolute fiscal deficit as well as the nominal GDP. The trouble is that the nominal GDP hasn’t grown at the projected rate. The nominal GDP for the first six months of the financial year (April to September 2015) has grown by only 8.2% instead of the projected 11.5%. And this has thrown the fiscal deficit calculations of the government for a toss.

As the Mid-Year Economic Analysis released in December 2015 points out: “It is true that the decline in nominal GDP growth relative to the budget assumption will pose a challenge for meeting the fiscal deficit target of 3.9 per cent of GDP. Slower-than-anticipated nominal GDP growth (8.2 percent versus budget estimate of 11.5) will itself raise the deficit target by 0.2 percent of GDP.”

In order to ensure that it meets the fiscal deficit target, the government has increased the excise duty on petrol and diesel thrice in the last three months. On November 6, 2015, when the first of the three increases came in, the price of the Indian basket of crude oil was at $45.07 per barrel. Since then it has fallen to $32.9 per barrel, a fall of 27%. Hence, every time there has been a fall in oil prices, the government has moved in and increased the excise duty.

What this tells us is that on the finance front, the government has essentially turned out to be a one-trick pony. The easy money that the government has managed to raise from falling oil prices has led to a situation where it has totally given up on all other measures to spruce up its revenues as well as cut its expenditure.

The loss making public sector units continue to operate as they had in the past. The government continues to own stakes in companies like ITC, Axis Bank and L&T, worth thousands of crore.

The irony is that the government spends a lot of money in telling people that consumption of tobacco is injurious to health and at the same owns a 11.17% stake in ITC through the Specified Undertaking of the Unit Trust of India. How do the finance minister Arun Jaitley and prime minister Narendra Modi explain this dichotomy? (Like P Chidambaram and Manmohan Singh before them).

Jaitley has also talked about a stable tax regime in the past to woo foreign investors to invest in India. How about offering the same stable tax regime to the Indian consumer as well?

The Indian economy as well as the government finances have benefitted a lot during the course of this year due to falling oil prices. Sajjid Chinoy, chief economist at JP Morgan India, has estimated that lower oil prices gave a 1.3 percentage points boost to growth in the last four quarters.

The question is will this continue? If it doesn’t, does the government have a Plan B in place?

What will happen once oil prices start to rise? How will the government finance its expenditure? Will the government be able to maintain the excise duty that it is currently charging on petrol and diesel and allow their respective prices to rise? If the government raised excise duty in an era of falling oil prices, it is only fair that it cuts excise duty when oil prices are going up?

To conclude, falling oil prices have made the Modi government lazy on the revenue raising front. And that is clearly not a good sign as we enter 2016.

The column originally appeared on The Daily Reckoning on January 4, 2016.