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What Led to the Recent Rise in Fuel Prices in India?

Editor, TRANSFIN
Feb 20, 2021 9:36 AM 4 min read
Editorial

The recent hike in fuel prices in India has poured more oil into the pandemic waters. To be fair, the pandemic had, in a way, put a lid on international oil prices for a while, thanks to reduced demand and mobility in civilian transport caused by the lockdowns.

However, the holiday seems to be over and prices are taking a lift for the worse in India, especially in the last six weeks, with all-time highs (scaling above ₹100/litre) recorded in certain cities across the country.

The Government has blamed this hike on the policies of the previous governments and the rise in international fuel prices. While those reasons may be partly true, the issue runs way deeper in facts and formulations. 

Two-Pronged Analysis 

The immediate rise in fuel prices can be chiefly attributed to two reasons: 

First, the rise in international crude prices. Brent was trading at $65.09 a barrel when this piece was published. Compare that to the historic low of $19 a barrel in April 2020 and one can see why the price hike was long coming. OPEC+ countries had temporarily cut production by 9.7 barrels a day in May 2020 but their decision has seen a gradual reversal since December 2020 when the impacts of the pandemic began to weaken.

Second, increase in central and state taxes. This includes an increase in two major tax categories during the pandemic. 

One was the hike in excise duty which was raised to ₹32.98 (from ₹19.98 on petrol) and to ₹31.83 (from ₹15.83 on diesel) per litre respectively. Another was the rise in VAT which is under the state governments' discretion, a power which many states exercised successfully to increase VAT rates on fuel. For instance, in Delhi, VAT on fuel was increased to 30% from 16.75% earlier. 

An interesting discrepancy was witnessed last year when the price of diesel (that has traditionally trailed the price of petrol in India) became almost equal to the price of petrol. Although diesel prices have remained high globally due to increased costs of production, in India, the skewed duty structure has ensured it stays lower than petrol (i.e. Passenger vehicle owners cross-subsidising commercial vehicles, in a way), till now. 

 

The Layers Underneath the Fossil Costs 

There are a multitude of factors which determine price hike of fuel in India - components like import costs, refinery margins, processing costs, freight charges, dealer commission, OMC margins, taxes, the ₹/$ conversion rate, inflation etc. 

The following table should help simplify this pricing chain.

Source: Bloomberg Quint 

In Delhi, taxes alone contribute to around 60% of the retail petrol price and 55% of the retail diesel prices. On February 18th, petrol and diesel prices were hiked by 34 paise and 32 paise respectively. 

Out of this, dealer commissions accounted for only ₹3.68 and ₹2.51 a litre on petrol and diesel, which indicates VAT and excise duty contributing to the chunk of the price. Some reports state that state and central taxes combined together amount to 180% and 141% respectively of the base price of petrol and diesel in the capital city. 

FYI: The above is keeping in mind that fossil fuels have been kept out of the GST purview. 

 

Extent of Government Control on Fuel Prices 

The Government deregulated petrol and diesel prices in 2010 and 2014 respectively. Prior to that, the retail price fixation of these fuels fell under the state's discretion. Now, this discretion extends to OMCs like IOC, HPCL, BPCL etc. 

However, kerosene and LPG still fall under a subsidised regime, albeit in a different way. In the event of a wide fiscal deficit (as the one currently faced by the Government), state-owned OMCs are expected to bear a part of the Government's subsidy burden. The Union Budget 2020-21 provided for ₹39,264cr ($5.4bn) in total subsidies for LPG and kerosene. In such a circumstance, the shortfall borne by OMCs in covering subsidy dues could very well push them to increase base prices of other fuels (i.e. Petrol and diesel) further as they require and see fit.

And even though the state of deregulation might have freed up fuel prices, Government influence still extends to the same through imposition of taxes and cess.

That would still make sense if the crude oil prices had steered the recent hikes. But the situation today is quite the opposite. Whenever there is a drop in crude prices, the Government uses the opportunity to fill up its coffers (pandemic-depleted coffers, so to speak) by pumping up taxes but when crude prices rise, there is no intervening mechanism in place to prevent trickling of the price burden to the consumers. 

What About Effect on Other Countries? 

Taxes on fuel were at around 65% in Germany and Italy, 62% in the UK, 45% in Japan and under 20% in the US, needless to mention in sharp contrast to India. 

In fact, even in neighbouring countries, retail prices per litre are way below India - ₹60.29 in Sri Lanka, ₹69.01 in Nepal, ₹51.12 in Pakistan and ₹76.43 in Bangladesh (for petrol) - which incidentally testifies the remark of MP Subramaniam Swamy in the Parliament earlier this month, saying that petrol prices in India were "higher than the price in Sita's Nepal and Ravan's Lanka"

As many urban consumers have resumed commuting since the lockdowns, the recent increase in fuel price is certain to affect a major part of the population. The declining food inflation has appeared as a silver lining by counterbalancing the rising fuel inflation. However, with increased reliance of rural population on mechanised farming (translation: diesel dependance on irrigation and other practices), it is likely that the fuel price hike will extend its reach over a greater section of the population soon.