Disinvestment

What’s the Real Story Behind High Petrol and Diesel Prices?

Vivek Kaul and Chintan Patel

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Between 2014-15 and now, taxes imposed by the central government on petrol and diesel have increased by 217% and 607%, respectively. The central government tax on diesel has gone up from Rs 4.50 per litre in 2014-15 to Rs 31.80 per litre currently. This is the real story. 

Petrol and diesel prices are at an all-time high across the country. When it comes to petrol, prices have crossed the 100-rupee-per-litre mark, in many states. As expected, the central government is being questioned on this price rise.

On July 2, the finance minister Nirmala Sitharaman said that no discussions were underway to arrest the rising price of petrol and diesel. Her response to a question on rising prices of petrol and diesel was: “When the international price of crude oil is higher, we have to increase the prices and when the international price is lower, we have to decrease the prices here too. This is a market mechanism which is followed by oil marketing companies. We have given them the freedom.”

Citing the financial burden of the central government’s efforts on vaccine procurement, health infrastructure, and free food to the poor, she added that “state governments can give relief by reducing taxes or levies on petrol.”

In fact, a couple of months ago, she had referred to the taxation of fuels as a “dharamsankat”.  So, what is this dharamsankat that Sitharaman bemoans?

Also, a lot of WhatsApp forwards have been going around explaining why it is impossible for the Narendra Modi government to cut petrol and diesel prices. One reason being offered is that the government needs to repay oil bonds issued by the previous UPA government. As we had explained on an earlier occasion this isn’t true. It’s just propaganda, albeit excellently run.

In this piece, we take the story forward with the hope that it can tackle some of the WhatsApp propaganda around petrol and diesel prices that is currently on.

Price breakdown

In most situations in business, a product is sold at a price which includes the cost of manufacturing the product, the taxes that the company has paid in the process of manufacturing it and the profit margin that the company hopes to earn. Of course, the taxes aren’t a major portion of the overall price.

That’s not true for petrol and diesel in India. Taxes, as we shall see, form a significant part of the overall retail price. The retail price or the price we pay for petrol and diesel at the pump, is made up of four components – a) The price at which the dealer buys petrol and diesel from the oil marketing companies like Indian Oil, Bharat Petroleum or one of the private companies. This price includes the cost of producing petrol and diesel and getting it to the pump where it is sold. It also includes the profit margin of these companies. b) The central government tax. c) The state government tax. d) Dealer commission.

Of the four components, the price at which the dealer buys petrol and diesel from the oil marketing company, is the biggest variable. It is tied to the price of international crude oil. If the price of oil goes up, as it has since April 2020, the price of petrol and diesel also go up. In April 2020, the average price of the Indian basket of crude oil had fallen to $19.9 per barrel.

In June 2021, it averaged at $71.98 per barrel. As of July 13, it had risen to $74.97 per barrel. This, as Sitharaman said, is the main reason for the increase in petrol and diesel prices in the recent past. We would like to say that this is not the reason, but a reason. We will explain the details as we go along.

India produces very little oil of its own. In fact, the overall import dependency in April and May this year was at 85.4%. We are heavily dependent on oil imports. Hence, if price of oil goes up internationally, the price of petrol and diesel also go up within the country.

Now getting back to the components of the retail price of petrol and diesel. The second component is the central government tax, which is the central excise duty. This is fixed and only changes when the government decides so. (The central excise duty has further components, but we won’t get into that in this piece).

Then comes the state government tax on petrol and diesel. Some states refer to it as sales tax and in some other states it is called the value added tax. This tax is over and above the central excise duty and varies from state to state.

The pumps through which petrol and diesel are retailed also need to make some money. They earn a dealer commission, which is also a part of the per litre retail price . Having said that, the dealer commission is a small fraction of the total price, and mostly inconsequential in affecting the final retail prices of petrol and diesel.

Let’s look at the retail price breakdown of petrol and diesel in Delhi as of  July 1, 2021. The following table shows us that.

 Table 1. Price breakdown of petrol and diesel
(in Rs per litre): July 1, 2021 (Delhi)

Source : https://hindustanpetroleum.com/documents/pdf/pb/petrol.pdf

Let’s consider the price of petrol and try and understand this structure in detail. The price charged to the dealer is Rs 39.33 per litre. On this the central government charges an excise duty of Rs 32.90 per litre. Then there is a dealer commission of Rs 3.82 per litre.

These three entries add up to Rs 76.05 per litre. On this price, the Delhi government charges a value added tax of 30%, which works out to Rs 22.82 per litre. This is added to Rs 76.05 per litre and it adds up to a retail selling price of Rs 98.87 per litre of petrol.

It is interesting to note, the value added tax of the state government is charged on Rs 76.05 per litre, which also includes a central excise duty of Rs 32.90 per litre. This means that when you and I buy petrol we are paying a tax on a tax.  This is true across the length and breadth of India and not just in Delhi.

Also, it is worth mentioning that the value added tax or the sales tax of the state governments is ad valorem, which means it is a certain proportion of the sum of the dealer price, central excise duty and dealer commission.

So, if the dealer price goes up or the central government decides to increase the excise duty, the state governments earn a higher tax per litre of petrol sold. What is true for petrol is also true for diesel, though the numbers change and so does the calculation accordingly.

Now let’s look at what proportion of the retail sales price do each of the four components form. Figure 1 and Figure 2 show that for petrol and diesel, respectively. The data is as of July 1.

Figure 1


Source : https://hindustanpetroleum.com/documents/pdf/pb/petrol.pdf

Figure 2

Source: https://hindustanpetroleum.com/documents/pdf/pb/petrol.pdf

Figure 1 and Figure 2 make for a very interesting reading. In case of petrol, the dealer price forms 39.8% of the retail price of petrol. The rest are largely taxes, imposed both by the central government and the state government. The taxes added up to 56.4% of the retail selling price of per litre of petrol in Delhi as of July 1.

Along similar lines, the dealer price makes for 46.8% of the retail price of diesel. The rest are largely taxes. Taxes amount to 141.7% of the dealer price for petrol and 107.3% of the dealer price for diesel. So, taxes form a significant portion of the price of petrol and diesel.

The interesting thing is that the central excise duty on petrol and diesel has been raised over the years. Up until early May 2020, the excise duty on petrol was Rs 22.98 per litre. It was raised to Rs 32.98 per litre. When it comes to diesel, the excise duty was raised by Rs 13 per litre, from Rs 18.83 per litre to Rs 31.83 per litre.

From February 2, 2021, the total excise duty on petrol and diesel has stood at Rs 32.90 per litre and Rs 31.80 per litre, respectively. Clearly, a significant proportion the increase in price of petrol and diesel over the last one year has been due to an increase in the excise duty charged by the central government. Hence, it’s not just about global oil prices going up, as Sitharaman would like us to believe.

In fact, in May last year, India had the distinction of being the highest taxer of auto fuels in the world, a whopping 69%.  Since then, the portion of petrol and diesel prices that goes towards taxes, to both the central government and the state governments, has come closer to 50%, although the retail price at the pump has increased. Irrespective of whether it is 69% or 50%, taxes on petrol and diesel in India are high. Has it always been like that, or is it a recent development?

Let’s examine. Figure 3 plots the breakdown of the retail price of petrol over the years in Delhi (We are not obsessed with Delhi. But regular data in the public domain is only available for Delhi, hence, limiting our choice). For the sake of avoiding visual clutter, we have considered only the price in the month of May every year. In fact, petrol prices change frequently, sometimes several times a month due to fluctuations in crude oil prices.

Also, the central excise duty has been hiked more than once during some years. Thus, the chart below does not capture every price point over the last eight years but is still a good representative of the overall trend.

Figure 3

Source: Petroleum Planning and Analysis Cell

Now let’s try and understand this in detail. A look at the above chart tells us very clearly, the central government taxes on petrol have gone up over the years, from Rs 10.39 per litre in May 2014 to Rs 32.90 per litre in May 2021. This is a jump of around 217%. The state government value added tax in Delhi has also gone up from Rs 11.90 per litre to Rs 21.81 per litre, a jump of around 83%.

Clearly, taxes on petrol, more at the central government level than the level of state governments, have gone up over the years, and this has pushed up the retail selling price. Take a look at Figure 4 and Figure 5. They plot the proportion of each component in the retail selling price of petrol and diesel in May 2014 and May 2021, respectively.

Figure 4


Source: Petroleum Planning and Analysis Cell

Figure 5


Source: Petroleum Planning and Analysis Cell

As can be seen from Figure 4 and Figure 5, the price charged to the dealer, which was 66% of the retail selling price of Rs 71.41 per litre in May 2014, has since fallen to around 38% of the retail selling price of Rs 94.49 per litre in May 2021.

The central excise duty as a part of the retail selling price of petrol has jumped from 14.5% to 34.8%. This shows again that the increase in central excise duty has been a major reason for the increase in the price of petrol over the years. The increase in state government taxes have also played their role.

In fact, the dealer price of petrol in May 2014 was Rs 47.12 per litre in comparison to Rs 35.99 per litre in May 2021. Despite this, the retail selling price of petrol in May 2014 was at Rs 71.41 per litre, which was significantly lower than Rs 94.49 per litre in May 2021.

All that is true for petrol is also true for diesel. Figure 6 plots the price breakdown for diesel over the years. As can be clearly seen, the central government tax has gone up from Rs 4.50 per litre in May 2014 to Rs 31.80 per litre in May 2021, a jump of around 607%.

Meanwhile, the state government tax has almost doubled from Rs 6.61 per litre to Rs 12.50 per litre. When it comes to the dealer price for diesel, it was at Rs 44.98 per litre in May 2014 and at Rs 38.49 per litre in May 2021. Despite this, the retail selling price of diesel in May 2014 was at Rs 57.28 per litre, which was significantly lower than Rs 85.38 per litre in May 2021.

Figure 6


Source: Petroleum Planning and Analysis Cell

Let’s take a look at some interesting insights that emerge from the data above:

1) The price paid to the dealer was the highest in 2014. Since then, the dealer prices have come down, although not in a linear fashion. This is primarily because the average price of the Indian basket of crude oil in May 2014 stood at $106.85 per barrel. The oil price has seen a largely downward trend since then.

2) There have been some ups and downs when it comes to the dealer price, with the lowest prices for both petrol and diesel recorded in 2020, when they were around half of the price in 2014. This was on account of the price of the Indian basket for crude falling to $30.61 per barrel during May 2020, the lowest in any May since May 2014. Compared to the lows of 2020, dealer prices have risen by over 60% which explains the recent price surge at the pump. As explained earlier, retail prices have also gone up due to a massive increase in the central excise duty on petrol and diesel by Rs 10 per litre and Rs 13 per litre, respectively, in early May 2020.

3) From 2014 to 2021, taxes imposed by the central government have increased by around 217% on petrol and around 607% on diesel. The bulk of these increases were over two periods – from 2014 to 2015, and from 2019 to 2020, either by co-incidence or by design, both these periods were immediately following Narendra Modi’s election victories.

4) The first round of hikes in central excise duty in 2014 was effectively done to capture the gains from the drop in crude oil prices. The average price of the Indian basket of crude oil in May 2014, the month in which Modi was elected the prime minister, had stood at $106.85 per barrel. By January 2016, it was down to $28.08 per barrel. Instead of passing on lower prices to the consumer, the government decided to bolster tax revenues when global oil prices fell. Thus, the end consumer did not see a price decrease from the fall in crude oil prices.

5) After that, from 2015 to 2019, the central government tinkered with the central excise duty with marginal increases or decreases to keep the retail price somewhat bounded. In fact, in October 2017 and October 2018, the excise rate on both petrol and diesel was cut by Rs 2/litre and Rs 1.50/litre, respectively, to counter the increasing oil prices. The 2019 general elections also likely influenced these cuts.

6) The next big hike in central excise was in early May 2020, again around the same time when global oil prices plummeted in the aftermath of the covid pandemic, when the duty on petrol was increased by Rs 10/litre and that on diesel by Rs 13/litre. The price of the Indian basket of crude averaged at $19.9 per barrel in April 2020. It has since risen to more than $70 per barrel. But with a rise in oil prices in 2021, the excise tax has not been reduced. Hence, a higher oil price and a higher excise duty have both contributed to the rise in pump prices of petrol and diesel.

7) The charts above are for Delhi. As explained earlier, each state has a different value added tax or sales tax when it comes to petrol and diesel and a slightly different trend over the last eight years. A detailed analysis of every state is outside the scope of this piece. Nevertheless, the broader point stays the same. A major reason for the increase in the retail selling price of petrol and diesel, and the fact that petrol is selling at more than Rs 100 per litre in many states, is because the central excise duty on petrol and diesel, has been increased majorly over the years. The increase in state government taxes have also had a small role to play.

Officials in both the central government and state governments know that the current petrol and diesel prices are placing a high burden on the end consumer. Both sense discontent brewing on this issue, which can ultimately cost at the ballots. So, both stand to gain, if taxes are cut and prices fall.

Crucially, both have the ability to reduce the retail price, by lowering their portion of the tax. But the way things are currently it seems that the state governments would prefer the central government reducing excise duty, and the central government would prefer the state governments reducing the sales tax or the value added tax.

Given that both sides are standing firm, the consumer has ended up teary-eyed. Also, as we have seen, the central government taxes on petrol and diesel have gone up significantly more than the state taxes. Clearly, the ball is in the central government’s court.

To add more intrigue to the petrol and diesel tax saga, there is one other thing to consider. A part of the central excise duty is shared with the states. This part is referred to as the divisible pool. Much of the increase in central excise since May 2014 has been in the form of surcharge and cess, which are not shared with the states. We have discussed this in detail in an earlier piece.

As of 2021, only Rs 1.40 of Rs 32.90 collected through the central excise duty on per litre of petrol, and only Rs 1.80 of the Rs 31.80 collected through the central excise on per litre of diesel, goes to the divisible pool.

Since the states get 42% of the revenue from the divisible pool, they end up getting 59 paisa per litre which is a mere 1.8% of excise duty collected by the central government on per litre of petrol.  For diesel, the states’ share comes to 76 paisa per litre amounting to 2.4% of the central excise duty per litre of diesel.

Given that the central government has employed such a strategy of actively undercutting states’ revenue from the central excise duty collections on petrol and diesel, it is a tad optimistic to expect the state governments to be enthusiastic about a coordinated approach, where both the central government and the state governments reduce the taxes they collect on sale of petrol and diesel at the same time.

Central government dependence   

In the last couple of years, the central government has become overly dependent on the central excise duty that it earns on the sale of petroleum products (primarily petrol and diesel). In 2014-15, the central government had earned Rs 99,068 crore from this. This jumped to Rs 2.23 lakh crore in 2019-20. It jumped to an all-time high of Rs 3.72 lakh crore in 2020-21.

This compensates for the massive fall in corporate tax or the income tax paid on corporate profit. This had stood at Rs 6.64 lakh crore in 2018-19. In 2020-21, it fell to Rs 4.57 lakh crore, a drop of about a third. This happened because in September 2019, the government reduced the base rate of corporate tax to 22%, from the earlier 30%. Hence, the collections of corporate taxes fell in 2020-21, despite the massive increase in profits of listed corporates during the year.

Over and above this, a badly designed and run Goods and Services Tax has not brought in the amount of taxes it was expected to. As the Fifteenth Finance Commission Report put it: “In terms of government finances, [GST] was expected to improve the overall tax-GDP ratio in the medium term and lead to higher Union [central government] transfers to States.” But that hasn’t happened. This can clearly be seen in Figure 7.

Figure 7


Source: Centre for Monitoring Indian Economy.

There is no free lunch in economics. The costs of a fall in corporate tax collections and weaker than expected GST collections, are being borne by everyone who buys petrol and diesel in a direct way. In an indirect way, we are paying for it in the form of higher inflation.

This is why the central government cannot reduce excise duty on petrol and diesel. Their finances have become too reliant on the revenue generated by the excise duty on petrol and diesel.

The economy was already on weak footing when Covid hit. The pandemic triggered a massive reduction of economic activity – one that is still on going, which has reduced tax inflow from other sources. The fact that corporate income tax was cut hasn’t helped either.

Additionally, there are more financial demands on the government than the past. The government needs money to finance pandemic-induced expenses like vaccine procurement and improving healthcare delivery. All this could have been easily done if corporate income tax rates hadn’t been cut or GST had been launched and run properly.

In such an environment of decreased income, the government is unable to wean itself off  taxes it earns from the sale of petrol and diesel. In many ways this dilemma is self-imposed since this government’s original sin was its economic mismanagement before the pandemic hit. You construct a house poorly and a storm hits. Now you are drenched due to a leaking roof. Is the storm the only one to blame?

Good policy, bad policy

As a thought experiment, say the central government reduces the central excise duty on petrol and diesel by Rs 10/litre. The immediate knock-on effect will be one of the following three scenarios. One, the government will have to scale back spending to make up for the loss in revenue. Two, the government will increase a different tax (as we said earlier there is no free lunch). Three, the government takes on a higher fiscal deficit (the difference between its annual expenditure and revenue).

Given this, the government has decided to continue with the high central excise duty on petrol and diesel. But is that the best option available?

High prices of petrol and diesel cause misgivings in a large section of the electorate, especially the middle class and the poor. That the Modi government is willing to risk this public sentiment speaks to their confidence in assuaging voters through other avenues. While it’s for the government to figure out its politics on this issue, the economics of the decision though, can be debated.

As always, the economic argument on general topic of taxation of petrol and diesel is nuanced.  An increase in taxes on petrol and diesel (such as the central excise) has two negative economic impacts.

One, this leads to a higher inflation. Most goods need to be transported from where they are produced to where they are consumed, and the primary mode of transport of goods in India are trucks that run on diesel. So, when diesel prices go up, due to higher taxes or otherwise, price of most goods also increase. Inflation has its impact on consumption and that in turn slows down economic growth.

Two, a higher tax on petrol and diesel, is the opposite of a consumer stimulus i.e., it takes money out of people’s pockets. Higher fuel costs mean lesser disposable funds for other purchases, which then depresses demand for goods and services.  

One criticism of India’s economic response to the covid pandemic has been that most of the government actions have been directed towards suppliers and firms, instead of the consumers. Most developed nations have put money directly in the hands of citizens  to revive consumer demand.

Whether India’s fiscal situation allows for a meaningful stimulus is debatable, but surely a negative stimulus (which is what the higher central excise duty on petrol and diesel works out to), cannot help with the economic revival.

Given that the government has been addicted to taxes it earns from petrol and diesel, for more than a few years now, it has gone slow on disinvestment of its stakes in public sector companies as well as the land owned by them. The revenue that could potentially come in from here, could reduce the dependence on taxes coming in from the retail sale of petrol and diesel. But that hasn’t happened.

On the flip side, there is an argument in favour of higher taxes on petrol and diesel, related to environmental impact. Given the negative impact of fossil fuels on carbon emissions and global warming, higher taxes on petrol and diesel could/should in theory dampen their demand. However, in India, this line of reasoning is not very convincing.

Figure 8 shows the annual consumption of demand of petrol and diesel.

Figure 8

Source: Petroleum Planning and Analysis Cell

Other than 2020-21 which was affected by lockdowns and curfews, the demand for petrol and diesel has increased each year, despite changing prices. Moreover, diesel makes up for most of the fuel consumption, and it is particularly insensitive to price fluctuations since it is used for commercial transport and so the cost is passed on to the end consumer.

As RS Sharma, former chairman of ONGC said in 2018: “Demand for diesel is typically inelastic as most of the rise in price is borne by the end consumer and can be seen to directly impact inflation.”

Of course, one can’t rule out the possibility that if petrol and diesel prices had not increased due to a higher central excise duty, the demand would have grown even more. One cannot even quantify how the increased prices may incentivise adoption of alternative sources of energy, electric vehicles and such.

The trade-off between economic development and environmental stewardship is the ultimate dharamsankat of our times and taxes on petrol and diesel do lie in that realm. But we doubt that is on Sitharaman’s mind.

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More Than Half of Govt Taxes Will Go Towards Paying Interest on Past Loans

As I keep saying, the union budget at its heart is the presentation of the financial accounts of the government or to put it simply, on what it plans to spend money on, during the course of a year and how does it plan to earn and arrange for that money.

Given this, a lot of analysis happens on the issue of what the government plans to spend money on, during the course of a particular year. A similar thing has happened this time around as well, with journalists, analysts and economists, digging into the budget in trying to figure out where exactly is the government planning to spend money in 2021-22 and where it has spent its money in 2020-21.

The trouble is that like previous years this year as well most analysis has missed out on the biggest expenditure item in the government budget, which is interest payments. Almost every government spends more than what it earns and the difference is referred to as the fiscal deficit. This deficit is largely financed through the government borrowing by issuing bonds. An interest needs to be paid on these bonds every year.

This interest is the largest expenditure in the government’s budget, even though it rarely gets talked about.

Take a look at the following graph, which plots the interest payments on the outstanding borrowing of the union government.

Source: Centre for Monitoring Indian Economy.
2020-21 – Revised estimate.
2021-22 – Budget estimate.

As can be seen from the above chart, the interest payments have been going up over the years and are expected to be at around Rs 8.1 lakh crore in 2021-22 . Now Rs 8.1 lakh crore on its own sounds like a large number, but just looking at the absolute number is not the right way to go about things in this case.

Let’s look at what proportion of overall expenditure of the union government have interest payments formed over the years.

Source: Author calculations on data from Centre for Monitoring Indian Economy.

As per this graph, interest payments in 2020-21 formed a little over one-fifth of total expenditure and this is an improvement on the situation that prevailed before. But this interpretation is wrong, simply because the overall expenditure of the government also includes money that it does not earn.

Hence, a government can always borrow more and spend more in a particular year leading to a higher expenditure number and thus, the interest payments as a proportion of overall expenditure will come down. But that doesn’t mean things have improved.

Let’s look at another chart. This plots the interest payments as a proportion of net tax revenue earned by the union government. Net tax revenue is what remains with the central government after sharing a certain proportion of the gross tax revenue (or to put it simply overall tax collections) with the state governments.

Source: Author calculations on data from Centre for Monitoring Indian Economy.

The above chart gives us a clear picture of the prevailing situation. In 2017-18, the interest payments formed 42.6% of the tax revenues earned by the union government. They have been rising since then and in 2020-21 and 2021-22 are expected to touch 51.5% and 52.4%, respectively.

What does this mean? It means that more than half of the government’s taxes are going towards paying interest on its outstanding loans, leaving very little money for anything else, unless the government earns money through other ways or borrows money or uses other ways to finance the fiscal deficit.

One way for the government to earn more money is through the sale of its stakes in public sector enterprises. In 2020-21, the government had hoped to earn Rs 2.1 lakh crore through this route. This turned out to be a very ambitious target and the government is now hoping to earn Rs 32,000 crore through this route during 2020-21.

The disinvestment target for 2021-22 has been set at Rs 1.75 lakh crore. It is very important for the government to earn this money else it will have to borrow more to meet the expenditure. This will mean higher interest payments in the years to come which will either lead to the government having to cut expenditure or having to borrow even more to meet the expenditure. More borrowing will lead to even more interest on the outstanding debt.

This will have to be paid by implementing higher taxes on the taxpayers and many of these taxpayers will be newer ones, just entering the workforce. This is precisely the way the current generation passes on its liabilities to the next one.

Also, as the outstanding debt matures and needs to be repaid, the government will have to borrow more to repay this debt. Hence, a greater proportion of the borrowing will just go towards repaying debt which is maturing. This will become a debt spiral and needs to be best avoided.

There is another thing that is happening and needs to be brought to notice. The government finances a major part of the fiscal deficit through borrowing. So, let’s take the case of 2020-21. The fiscal deficit for the year is expected to be at Rs 18.49 lakh crore.

A bulk of this deficit will be financed by borrowing Rs 12.74 lakh crore from the market. Where does the remaining money to fill the gap come from? A bulk of it comes from the small savings schemes.

The small savings schemes currently in force are: 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, Public Provident Fund, KisanVikas Patra and Sukanya Samriddhi Account.

The money coming into these schemes net of disbursements that happen during the course of the year, is used to finance the fiscal deficit of the union government.

This has been rising at an astonishing pace over the years, as can be seen from the following chart.

Source: Centre for Monitoring Indian Economy.

In 2012-13, the amount had stood at Rs 8,626 crore and it has since risen to more than Rs 4.80 lakh crore. While this amount does not end up as a debt of the government, it is a liability that the government does need to repay over the years.

Also, this is money that is coming from the public savings at the end of the day. In order to ensure that money keeps coming into these schemes, the government will have to continue offering a higher rate of interest on these schemes in comparison to bank fixed deposits.

Hence, the perpetual complaint of the bankers is likely to stay, given that the government needs this money to continue financing its high fiscal deficit. The other option is to borrow directly from the market and increase its outstanding debt figure, which the government wants to avoid beyond a point.

What this tells us is that all hasn’t been well on the government finances front over the last few years, and covid has only made it worse. One reason for this lies in the constant fall in the taxes collected by the government as a proportion of the gross domestic product (GDP), over the years.

The net tax revenue of the union government stood at 8.97% of the GDP in 2007-08. It has since fallen and was at 6.67% of the GDP in 2019-20. In 2020-21, it is expected to be at 6.90% of the GDP. The figure is higher in 2020-21 simply because of the size of the Indian economy, as represented by the GDP, is expected to contract more than the taxes collected by the government during the year.

This fall in tax collections and the dependence of the government on other ways of financing its fiscal deficit, also leads to the question whether the size of the Indian economy or its GDP, is being properly measured. Over the years, the informal part of the Indian economy has seen huge destruction and the question is, does this destruction reflect properly in the GDP figures being published over the years. This is a question well worth asking given that if the GDP is growing why have tax collections been falling?

To conclude, it does seem the government understands the financial situation it is headed towards. Hence, an ambitious target for disinvestment has been set. Over and above this, it also has plans of monetising physical assets including surplus land. Hopefully, this will take off soon. .

PS: Of course, you will not find this kind of analysis anywhere in the mainstream media or even digital publications which charge a fee. Hence, it is important that you support my work. You can do it here. 

“We have spent, we have spent and we have spent” – But Where Madam FM?

Those of you who read me regularly would know that I look at the government budget more as a statement of financial accounts and not much as an actual policy document, as many people do.

The reason is simple. The government has an opportunity to do right policy 365 days a year. But the annual budget numbers are released only once a year.

Keeping this in mind, in this piece I will look at the massive fiscal deficit that the union government will run this year and try to  analyse it in different ways and try connecting it to what it means for the economy as a whole and the ability of the government to spend money.

We will also look at whether the government is spending more money in order to get the economy going, as it has claimed to.
Let’s take a look at this pointwise.

1) The fiscal deficit for 2020-21 is projected to be at 9.5% of the gross domestic product (GDP). This is the highest fiscal deficit figure between 1970-71 and now (The fiscal deficit data is available in the Centre for Monitoring Indian Economy database from 1970-71 onwards). While this shouldn’t be surprising, the spread of the covid pandemic is not the only reason for it.

Fiscal deficit is the difference between what a government earns and what it spends and it is expressed as a percentage of GDP. Somehow, once expressed as a percentage of GDP, the fiscal deficit never sounds big enough.

In absolute terms, the fiscal deficit for this year is expected to be at Rs 18.49 lakh crore. Now that is one big number. Especially if you compare it to the fact that the fiscal deficit expected when the budget for this year was presented in February 2020, was Rs 7.96 lakh crore. The deficit turned out 132% more than what was forecast before the year began.

2) There is another interesting way to look at fiscal deficit. You might think that I am torturing numbers here and you are right to some extent, but I am only trying to show how big this fiscal deficit actually is.

Take a look at the following chart. It plots the fiscal deficit as a percentage of total government expenditure, over the years.

Source: Author calculations on data from Centre for Monitoring Indian Economy.

What does this chart tell us? It tells us that in 2020-21, the fiscal deficit as a percentage of government expenditure will be at 53.6%. This is the highest ever level. Hence, a bulk of the government expenditure during 2020-21 will not be financed by its earnings. This tells us how high the fiscal deficit really is.

3) The question is why has the fiscal deficit jumped to such a high level? The simple answer is that the government hasn’t earned the total amount of tax it had projected, thanks to the spread of the covid pandemic. Let’s start with the net tax revenue or what is left after the government has shared the tax collected with the state governments.

The government expected to earn a net tax revenue of Rs 16.36 lakh crore this year, when the budget for this year was presented in February 2020.  It now hopes to earn Rs 13.45 lakh crore. This is Rs 2.89 lakh crore or 17.8% lower. This explains a part of the jump in the fiscal deficit from an expected level of Rs 7.96 lakh crore to Rs 18.49 lakh crore. But it still doesn’t give us the complete story.

4) In 2020-21, the government expected to earn a significant amount of money by selling or disinvesting its stakes in public sector enterprises. The amount it expected to earn through disinvestment was Rs 2.1 lakh crore. It has now been revised to just Rs 32,000 crore or 15.2% of the expected amount. There is gap of Rs 1.78 lakh crore here and this has also majorly pushed up the fiscal deficit.

The government’s excuse for this is covid. While, that might have been true for the first half of the year, it just doesn’t work for the second half of the year, when the stock market has gone from strength to strength and the government could easily have divested its stakes in public sector enterprises.

The only possible explanation here is that the government, as usual, has moved very very slowly on the procedural formalities required to disinvest its stakes in public sector firms.

5) A lower tax collection of Rs 2.89 lakh crore and lower disinvestment receipts of Rs 1.78 lakh crore, still only add up to around Rs 4.67 lakh crore and doesn’t totally explain the huge jump in the fiscal deficit.

There is a third major reason. I write about it in detail here. And I urge you click on this link and read it. I will offer a short summary here. The Food Corporation of India (FCI) buys rice and wheat directly from farmers at a minimum support price announced by the government. It then sells this rice and wheat through the public distribution system at a much lower price, in order to meet the needs of food security.

The government has to compensate the FCI for this difference. It does that by allocating money towards food subsidy in the budget. Over the years, the money allocated towards food subsidy has never been enough. In 2019-20, the FCI ‘s food subsidy bill was close to Rs 3.18 lakh crore. The government gave it Rs 75,000 crore.

Much of this gap was filled by FCI taking on loans from the National Small Savings Fund, where all the money collected under the various small savings schemes, ends up. As of March 2020, the FCI owed NSSF Rs 2.55 lakh crore.

The accounting jugglery over the years, essentially helped the government to declare a lower expenditure and hence, a lower fiscal deficit.

The government has now decided to end this and take on the total food subsidy offered by FCI as an expenditure. Hence, in February 2020, when the budget for this year was presented the allocation of food subsidy to FCI had stood at Rs 77,983 crore. It has now been revised to Rs 3.44 lakh crore. In fact, the overall food subsidy has been increased from Rs 1.16 lakh crore to Rs 4.23 lakh crore. This is a good thing that has happened because ultimately the main aim of the government budget is to present financial accounts as correctly as possible.

This has added Rs 3.07 lakh crore  (Rs 4.23 lakh crore minus Rs 1.16 lakh crore) more to the government expenditure and hence, to the fiscal deficit as well. Hence, the three reasons discussed up until now increased the fiscal deficit by Rs 7.74 lakh crore (Rs 2.89 lakh crore + Rs 1.78 lakh crore + Rs 3.07 lakh crore). This still doesn’t explain the total difference.

6) Other than taxes and disinvestment, the government also earns money under the heading non tax revenue. This includes dividends that the government earns from public sector enterprises, public sector banks, financial institutions like the Life Insurance Corporation of India and the dividend from the Reserve Bank of India. It also includes many other ways of making money.

The non tax revenue that the government had hoped to earn this year was Rs 3.85 lakh crore and it ended up earning Rs 2.11 lakh crore, which was Rs 1.74 lakh crore lower. This was primarily on account a massive fall in dividends earned.

If we add this to the earlier Rs 7.74 lakh crore, we get Rs 9.48 lakh crore. The fiscal deficit went up from a projected Rs 7.96 lakh crore to Rs 18.49 lakh crore primarily because of these four reasons.

Three of these reasons, lower tax collections, lower disinvestment receipts and lower non tax revenue, are on the earnings side. And one reason, higher food subsidy is on the expenditure side.

7) The finance minister Nirmala Sitharaman in her post budget interaction with the media said the government has spent a lot of money in order to get the economy going. The Business Standard reports her as saying, we have spent, we have spent and we have spent. The logic here is that in an environment where personal consumption has slowed down and industrial expansion is not happening, the government has to become the spender of the last resort, in order to get the economy going again.

The business media today is full of headlines around the government spending its way out of trouble. But do the budget numbers really reflect that?

Let’s try and see what the numbers tell us. The total government expenditure budgeted for 2021-22 is Rs 34.83 lakh crore. This is just a little more than the Rs 34.5 lakh crore the government expects to spend this year.

Here’s the interesting thing. In 2021-22, the government expects to spend Rs 8.1 lakh crore on paying interest on its outstanding debt. Once we adjust for this, the total government expenditure in 2021-22 stands at Rs 26.73 lakh crore (Rs 34.83 lakh crore minus Rs 8.1 lakh crore).

In 2020-21, the government expects to spend Rs 6.93 lakh crore on paying interest on its debt. Once we adjust for this, the total government expenditure in 2020-21 stands at Rs 27.57 lakh crore (Rs 34.5 lakh crore minus Rs 6.93 lakh crore).

Hence, the year on year, overall government spending next year will actually come down and not go up. Having said that, the capital expenditure in 2021-22 is budgeted to be at Rs 5.54 lakh crore, which is 26.2% more than the Rs 4.39 lakh crore, the government expects to spend in 2020-21. This is some good news, but doesn’t deserve the emphatic spend, spend, spend, statement.

The extra Rs 1.15 lakh crore (Rs 5.54 lakh crore minus Rs 4.39 lakh crore) works out to 0.5% of the GDP projected for 2021-22. While something is better than nothing, it clearly isn’t much.

8) What about the current financial year? The government plans to spend a total of Rs 34.5 lakh crore. This is 13.4% more than the Rs 30.42 lakh crore it had planned to spend when it presented the budget. Once we adjust for the fact the food subsidies have been properly accounted for and that has added Rs 3.07 lakh crore to the government expenditure, the actual expenditure goes down to Rs 31.43 lakh crore (Rs 34.5 lakh crore minus Rs 3.07 lakh crore). This is around 3.3% more than the amount budgeted of Rs 30.42 lakh crore, at the time of the presentation of the budget.

In fact, if we look at the food subsidy paid during April to December 2020, it amounts to Rs 1.25 lakh crore. With the budgeted amount being at Rs 4.23 lakh crore, close to Rs 3 lakh crore of food subsidy still remains unpaid. This will be paid during the last three months of 2020-21.

This money has already been spent by FCI and other agencies during this year and years gone by. Once FCI receives this money, it will pay off the money it owes to NSSF. Hence, there is really no extra spending happening here.

9) Now let’s compare, the spending in 2020-21 with that in 2019-20. The total expenditure in 2019-20 had stood at Rs 26.86 lakh crore. Once we take the increase in food subsidies out, the total expenditure in 2020-21 stands at Rs 31.43 lakh crore (Rs 34.5 lakh crore minus Rs 3.07 lakh crore). The spending in 2020-21 is thus around 17% more than the last financial year. But much of it was budgeted for in February 2020, when the budget for this year was first presented.

Hence, the increase in spending in 2020-21, or the fiscal stimulus as economists like to call it, hasn’t been because of the covid pandemic, it was happening anyway.

To conclude, it is clear that the government is not spending more in 2021-22 on the whole, though there is some increase in capital expenditure and that’s good. In 2020-21, the government has actually spent more, but then much of it was planned before covid and not after it.

It also tells us that once we take the real fiscal deficit into account, there isn’t much that the government can do to spend its way out of trouble. The good thing is that the government has decided to clean up its books. And that will have repercussions on the total amount of money it is able to spend during the course of this year and the next. The mistakes that we make in our past always come back to haunt us.

Dear Reader, clearly this piece should tell you how nuanced numbers can get, if one decides to dig a little deeper. Of course, you won’t get such a nuanced reading of the budget numbers anywhere in the mainstream media.

Hence, it is important that you continue supporting my work.

India might grow by 30% early next year, but that won’t mean much.

छोड़ो कल की बातें, कल की बात पुरानी
नए दौर में लिखेंगे, मिल कर नई कहानी
हम हिंदुस्तानी, हम हिंदुस्तानी
— Prem Dhawan, Usha Khanna, Mukesh and Ram Mukherjee in Hum Hindustani. 

The Indian economy contracted by 7.5% during July to September 2020, in comparison with the same period in 2019.  When compared with a contraction of 23.9% during April to June 2020, a contraction of 7.5% looks significantly better.

Hence, there has been a lot of song and dance from the establishment and its supporters, on how quickly the Indian economy is recovering, especially when most economists expected the economy to contract by 10% during July to September and it contracted by only 7.5%. Terms like a V-shaped recovery have been bandied around a lot, over the last few weeks.

Nonetheless, India continues to remain in the bottom quartile, when it comes to economic growth/contraction of countries between July to September this year. Greece with an economic contraction of 11.7% is right at the bottom.

In fact, the song and dance of the establishment is likely to continue in the months to come and will reach its peak sometime in the second half of the next year, after the gross domestic product (GDP) figure for the period April to June 2021, is published. GDP is a measure of the economic size of a country.

It is worth remembering here that the GDP during the period April to June 2020 contracted by nearly a fourth. The GDP during the period was Rs 26.90 lakh crore. In comparison, the GDP during April to June 2019 was at Rs 35.35 lakh crore.

So, the GDP during April to June 2021, will grow at a pace which has never been seen before. If it comes in at Rs 30 lakh crore, the growth will be around 11.5%. Given that, the GDP during the period July to September 2020 was already at Rs 33.14 lakh crore, the GDP during April to June 2021, is likely to be higher than that.

At a GDP of Rs 35 lakh crore, the economic growth during April to June 2021 will come in at a whopping 30.1%. Nevertheless, this is just an impact of what economists like to call the low-base effect.

A central government which can use a contraction of 7.5% to market itself, imagine the possibilities of what it can do if the economic growth rate crosses 30% in the first quarter of the next financial year.

While, some song and dance can do no harm to the economy, the real story needs to be understood and told as well. The real GDP in April to June 2021 will be more or less where it was during April to June 2019. In that sense, we will be where we were two years back.

Hence, the economic slowdown which started in mid 2018, along with the contraction that has happened post the spread of the corona epidemic, has pushed the Indian economy back by at least two years. Obviously, this can’t be good news.

Other than talking, the central government hasn’t done much to get the Indian economy going. Between April and October 2020, the government spent a total of Rs 16.61 lakh crore. In comparison, it had spent Rs 16.55 lakh crore during the same period in 2019. The difference being, this year we are in the midst of an economic contraction.

In a scenario where the corporates as well as individuals are going slow on spending money, government spending becomes of utmost importance. Between March 27 and November 20, the non-food credit of banks has gone up just Rs 26,496 crore.

Banks give loans to the Food Corporation of India and other state procurement agencies to buy rice and wheat, directly from the farmers. Once these loans are subtracted from the overall lending of banks what remains is non-food credit.

In comparison, the deposits of banks have gone up by Rs 8.03 lakh crore during the same period. This means just 3.3% of the fresh deposits that banks have got post March have been lent out.

What does this tell us? It tells us that both corporates and individuals are largely sitting tight and saving money. This is an indication of the lack of confidence in the near economic future. While the corporate executives might keep going gaga in the media about an economic revival, these numbers tell us a different story.

What hasn’t helped is the fact corporates have reported bumper profits by driving down their raw material costs, input costs and employee costs. This basically means that along with employees, the suppliers of corporates have also seen an income contraction. This can’t be good news for the overall economy.

The government’s inability to spend, comes from the lack of tax revenues, something that is bound to improve in 2021-22. Other than that, the government hasn’t gotten around to selling its stakes in public sector enterprises. Of the targeted Rs 2.1 lakh crore just 3% has been achieved. This is bizarre given that the stock market is at an all-time high-level.

Hopefully, the government will make up on this in the next financial year. Also, it can look at selling some of the land that it owns in prime localities in Indian cities.

All this can be used to put more money in the hands of consumers through an income tax cut and a goods and services tax cut, encouraging them to spend.

People who pay income tax may form a small part of the population but they are the ones who actually have some purchasing power. And once they start spending more, the chances of it boiling down the hierarchy are higher. Do remember, at the end of the day, one man’s spending is another man’s income.

A slightly different version of this piece appeared in the Deccan Herald on December 20, 2020.

The Rs 90,000 crore Consumer Spending Kicker That the Govt Missed Out On

 

light-diesel-oil-250x250The Narendra Modi government has increased the excise duty on petrol and diesel nine times since November 2014.

This has ensured that the benefit of falling oil prices has not been totally passed on to end consumers in the form of lower petrol and diesel prices. What has not helped is that the state governments have also increased their share of taxes on petrol and diesel and ensured that the benefits of lower oil prices have not been totally passed on to the citizens of this country.

A press release put out by the Bhartiya Janata Party in February 2016 said that all state governments except Mizoram, Assam, Tamil Nadu, Chhattisgarh and Gujarat, had increased the value added tax on petrol and diesel.

Hence, the increase in excise duty on petrol and diesel, is not the only reason for an increase in the price of petrol and diesel.

Having said that, what would have happened if the benefit of lower oil prices had been totally passed on to the end consumers in the form of lower petrol and diesel prices? Dr Soumya Kanti Ghosh, the chief economic adviser of State Bank of India, has done an in-teresting calculation on this.

As he writes in a recent research note titled If Wishes Were Horses: “Even though international oil prices are at a decade low, yet Government has increased excise duty both in petrol and diesel. So, we made an attempt to calculate total savings of the consumers if Government would not have hiked the excise duty on petrol and diesel products.”

So what does Ghosh’s calculation tell us? As he writes: “By removing only additional central excise duty from petrol and diesel retail selling prices, the hypothetical petrol price per litre would be Rs 47.63 (Actual: Rs 59.63), and diesel would be Rs 38.96 a litre (Actual: Rs 44.96)…If we assume that the consumption of petrol and diesel in FY16 of 95.28 MMT (Apr-Jan: 79.4 MMT), this would have translated into Rs 90,000 crore of savings for the consumers, which could have provided additional demand in the economy to the extent of 1% of GDP….In effect, this means that if wishes were horses, the decline in oil prices in itself may have provided the much needed impetus to demand and we may not have to wait for the pay hikes!” (MMT = million metric tonnes).

This means that if the central government wouldn’t have increased the excise duty on petrol and diesel, consumers would have benefitted to the tune of Rs 90,000 crore. This money would have been spent and pushed up consumer demand to the extent of 1% of GDP. And that would have been a huge thing. As is well known the multiplier effect of consumer spending is significantly better than that of government spending, where leakages are huge.

Of course, if the government did do things along these lines, it would have meant that the fiscal deficit of the government would have gone up. The fiscal deficit is the difference between what a government earns and what it spends. If the government gave up taxes to the tune of Rs 90,000 crore (actually lesser than this, but I will come to it), it’s earnings would have fallen, leading to an increase in its fiscal deficit.

Actually, the increase in fiscal deficit would be lower than Rs 90,000 crore. This is because the increase in consumer demand due to excise duty on petrol and diesel not being raised, would also bring in some money to the government in the form of both direct and indirect taxes.

Further, there were other ways through which the government could look at bringing down its fiscal deficit. For starters, it owns 11.19% stake in the cigarette maker ITC. This stake as on March 21, 2016, was worth a little over Rs 29,600 crore. Why does the government, which runs anti-tobacco advertisements, continue to own a cigarette maker? (I know I keep repeating this point like a broken record).

This stake could have been sold and a significant portion of the increase in fiscal deficit could have been covered. Those who like to support the government on all issues like to point out that ownership of shares of ITC brings in a dividend for the government. Hence, why let go of this regular income?

The question to ask here is what is the dividend yield of ITC? The dividend of ITC is 1.7%. Dividend yield is the total dividend the company has paid out during the year divided by its current market price. The dividend yield of ITC is less than half of the return of 4% available on a savings bank account. Given this, the dividend argument clearly does not work.

Also, the government continues to run many loss making companies. The Economic Survey for 2015-2016 released before the budget points out that public sector enterprises have accumulated losses of Rs 1.04 lakh crore. The government keeps bearing these losses. And the funny thing is that some of these losses are not even a part of the budget.

As economist Jaimini Bhagwati recently wrote in the Business Standard: “Funds will be provided to support continued losses in public sector undertakings including Indian Railways, some of which are not part of the Budget.”

If these loss making companies are shut down and their assets (primarily land) gradually monetised, it will tremendously benefit the government. The government has made some noises along these lines.

As the finance minister Arun Jaitley said in his budget speech: “A new policy for management of Government investment in Public Sector Enterprises, including disinvestment and strategic sale, has been approved. We have to leverage the assets of central public sector enterprises(CPSEs) for generation of resources for investment in new projects. We will encourage CPSEs to divest individual assets like land, manufacturing units, etc. to release their asset value for making investment in new projects.” Let’s hope this doesn’t just end up as a paragraph in a finance minister’s speech.

The disinvestment target at the beginning of the year was set at Rs 69,500 crore. Only Rs 25,312.60 crore was achieved. Hence, if the government had made an effort to earn money through these routes, it wouldn’t have had to increase the excise duty on petrol and diesel, nine times since November 2014.

Also, it needs to be pointed out here is that not all the savings on account of lower petrol and diesel prices, on account of government not raising the excise duty, would have translated into consumer spending.

Some of it is bound to have found its way into bank accounts and other financial savings instruments. Even that is a good thing given that household financial savings have been falling over the years. In 2007-2008, the household financial savings had stood at 11.2% of the gross domestic product (GDP). By 2011-2012, they had fallen to 7.4% of GDP. Since then they have risen marginally. In 2014-2015, the household financial savings stood at 7.7% of GDP.

A higher household financial savings ratio would have worked towards lower interest rates over the long term. Further, the government may not have been able to fund the entire shortfall of Rs 90,000 crore through these ways. Nevertheless, a good portion could have been filled in through the methods highlighted above.

This means that the government would not have had to increase the excise duty nine times. Possibly, four or five times would have been enough. Nevertheless, making money by simply raising excise duty on petrol and diesel was the easy way out, and who doesn’t like to take the easy way out.

The column appeared in Vivek Kaul’s Diary on March 22, 2016