How GOI is taking advantage of record low oil prices-Must Read

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It wouldn’t appear on the face of it but of the many economic and political situations which the govt. has handled in a messy way, leverage of falling crude oil prices is one area where government has shown remarkable acumen. This isn’t one of the out of box solutions implemented, just a traditional method of taking advantage of a favorable situation.
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Before that, a look at why or how it appears that govt. has failed to take advantage of the low crude prices. In July 2008, when Crude oil was at it’s peak at 147$ per barrel the diesel price was Rs 34.86/litre, petrol was at Rs 50.62/litre. From its peak in July 2008, crude prices started sliding down but the petrol and diesel prices continued to increase (especially the increase in the 2 year period June 2010 – May 2012) was the highest as petrol jumped from Rs 47.93 to Rs 73.18 for a litre, even when Oil prices fell to a low 89.5$ per barrel, going below 90 for the 1st time in several months. The underlying crude oil price, is an important factor in determining the price of end products like petrol, diesel and other petroleum derived products, however there are other factors that work at play. With current crude oil prices hovering around 30$ per barrel, one would believe that petrol price should be not over Rs 20 per litre while diesel should trade at an even lower price
A detailed look at what caused, petrol-diesel prices to increase in India, despite crude oil going down in 2010-2012 or for the period 2014-2016 when crude oil has plummeted to record lows. Please be informed that this is not the reason why crude oil prices have gone down from 140s to 30s. That is a separate topic and deserves a more detailed attention. This piece is only about how govt. is leveraging record low prices and why petrol and diesel prices in India are not moving in the same proportion as crude oil prices.
1. Exchange Rate – In July 2008, 1 US$ equaled approx Rs 42. Currently one needs to spend Rs 67.5 for a dollar. Oil and petroleum market operates only on one currency (other than a few exceptions). So if the prices of 1 barrel remained at 100 dollars per barrel. While in 2008, one would have needed to pay Rs 4200 for a barrel, as per the current rate he would have needed to pay 6750, Indian rupees, a whopping increase of 61%. Hence the huge reduction in crude oil prices has been nullified by a weakened INR. When crude fell from 147$ in 2008 to 90$ in 2012, the rupee went much weaker and hence the govt. could not capitalize the fall in prices, because for them, effective price actually increased. Same has been the situation in last 2 years, the Indian rupee has further weakened against US $.
2. Production & Distribution Costs – Crude Oil undergoes several processes before final products are distilled/extracted. The same then needs to be distributed across India. The costs for both production and distribution has gone up in the last 7 to 8 years. Hence the price of final products i.e. petrol, diesel need to factor in these increased costs.
3. Excise Duty – Tax receipts are the largest source of Government revenues, which is in turn used to fund planned as well as unplanned expenditures. Of the taxes, indirect taxes nearly contribute to the half of it. Excise duty, other than Customs duty and Services tax are the 3 key components of Indirect taxes. Within excise duty, excise from petroleum products have historically contributed anywhere between 25% to 45% of the overall excise duty. With an estimated weakened manufacturing, the bulk of ‘increased’ excise duty collection has to come from increase in excise duty of petroleum products. Excise duty from petroleum products is therefore a key source of government revenues and hence the govt. has kept on increasing the excise duty of diesel and petrol with each instance of fall in crude prices. When crude oil prices fall, a part of it is transferred to the end consumer as a benefit by way of reducing prices, while a part of it is used by increasing the excise duty. Let’s assume due to latest fall in crude, diesel should get cheaper by 1 rs. Govt. would reduce the prices of diesel by 70 paise and then increase the excise duty by 30 paise. SO the benefits are shared.
Why is government not passing 100% of the benefits to the end consumer and just a part of it?
A) Fiscal Prudence – To give an estimate, govt’s tax earning in the year 2014-15 was above Rs 14 lakh crores. Of this share of all the State govt was above Rs 5 lakh crores, which leaves the Central govt. with little above Rs 9 lakh crores. Non tax revenues were approx Rs 2.25 lakh crores. Both of them combined would be close to rs 12 lakh crores. On the other hand, govt. expenditure (planned as well as unplanned) were over Rs 17 lakh crores. Even if capital recepits are included, govt. needs to take huge amounts of borrowings to fund its expenditures. Thus Fiscal deficit has been at an alarming situation ever since earlier UPA govt. increased expenditures to woe populist voters. NDA cannot reduce the expenditures, especially on these Socialist sectors, to avoid risking vote loss, so the only way to overcome and achieve a prudent, acceptable level of fiscal deficit is to increase the revenues. Petroleum excise duty is just one way to do it.
B) Price Instability – Crude Oil prices are lower than ever before, however things may not remain the same. Iran and Saud Arabia (2 large OPEC nations) are involved in a proxy war in Yemen. it might escalate into a full scale war. Syria and Iraq are staring prolonged political instability due to the rise of Islamic state and its control on many oil fields in Iraq. US oil companies are pressurizing and lobbying hard for an increase in the prices. After the removal of export ban in USA, it wouldn’t make sense for them to sell oil at such low prices, which conspiracy theorists believe is a US game plan to bleed Russia. It is uncertain if US will be pressurized by the lobby of its oil exporting companies. Emerging markets are not growing fast, hence their demand is sluggish. Future growth may push the demand side of these nations, leading to an increase in Oil/petroleum consumption. Hence the prices which are currently at 30 US$ per barrel could double up to 55-60 US$ per barrel in a very short time. If govt. were to reduce petrol-diesel prices proportionately, it would have to nearly double those prices when crude prices go up in 2017 or 2018. With a load of state and central elections lined up in the next 3 years, such a step (of doubling prices) could be catastrophic in a country driven by Populist economics. Hence this price uncertainty has kept drastic reductions by the govt. in check.
C) Currency Wars – Powerful emerging economies are indulged in a tug of war. China has a fixed exchange rate to boost exports as the country is a export driven economy. India has a ‘pegged’ exchange rate (different from fixed and floating). with the emphasis on ‘Make in India’, it is important for India to keep the US$-INR levels at attractive rates so that it propels Global investors and manufacturers to set up plants in India and boost organic growth. If China offers better alternative in terms of currency exchange, returns, human capital etc, India is bound to lose a lot to China, as it has in the recent decades. Manufacturing sector and jobs market cannot afford this, hence in future there will be intense currency wars among major Asian Economies like China, India, Indonesia. This uncertainty in turn ensures that too much change in petrol/diesel prices is undesirable. However govt. has taken a few small steps to counter this, but that is not going to be enough. When Russian President Putin visited India last year, Indian PM Modi made a deal with him to import 10 bn. US$ worth petroleum every year at a fixed exchange of Rs 61000 crores (1 US$ was at 61 INR then). So each year, India would make payment in Indian Rupees and not US$ for the oil. irrespective of US$-INR exchange, India would pay Rs 61000 Crores and buy the same oil which would be worth 10 bn. US$ for the next 10 years.
D) Future Expectations – The expectation of India’s largely populist voters is set. They would not expect a sharp fall in petrol/diesel prices. Towards election (1 to 1.5 years before Central elections), if the crude prices increase drastically, govt. can then reduce the excise duty so that petrol/diesel prices remain stable or do not increase by a very high percentage. Thus a good and acceptable fiscal deficit target in this year would help govt. to even go to an unacceptable range in the election years. If situation however is more favourable and crude oil prices, remain low for the next 2.5 to 3 years, govt. can not only reduce petrol/diesel prices but also reduce direct taxes (such as Income tax) and other indirect taxes (like service tax), on account of increased tax collection in the preceding years.
So it is fair to say that on this account, govt. has played its cards well, by better planning, better tax management and setting the expectations on the right course.

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