Petrol and Diesel Prices: The Wild Card that Can Disrupt Great Indian Growth Story

‘Higher Crude Prices Leading to an Inflationary Pressure in the Indian Economy will Hamper Growth.’

?The Indian economy has witnessed a V-shaped recovery and most sectors that were affected due to the pandemic have bounced back faster than anticipated and Indian as well as foreign investors have shown their faith in the Indian recovery by investing billions of dollars in the stock markets and start-up ecosystem. With Petrol and Diesel crossing INR 100 in most cities in India would be the biggest risk to the Indian growth story.

?The Indian economy has passed through very turbulent times in the last 18 months. With India witnessing one of the most stringent lockdowns in the world which was the need of the hour keeping in mind high population density and relatively poor health, infrastructure, as a result the economy had taken a huge hit and multiple sectors had got affected to a very large extent. However once the economy opened up, the bounce back was very strong and fast and there was a huge demand pull witnessed across the economy. During these challenging times, there was adequate support on the fiscal as well as the monetary side that helped create a solid foundation for the economy to rebound and grow in double digits for many years to come.

?The most important aspect of the Indian economic revival is the low interest rates that are present in India today. With credit for loans like home loans available at around 6/6.5% p.a. these are record low rates of interest that the Indian economy has ever witnessed. With these low interest rates and push from the Central Government and RBI, the credit off-take has increased in India thereby helping in overall growth.

?The RBI has been able to boost this economic growth and keep interest rates low as the inflation over the last 12-15 months has well been under control and well within the RBI inflation target and thereby the interest rates have fallen to a record low in India. However, with the price of Petrol and Diesel crossing INR 100 in most cities in India, this has become a real threat to rising price rise and excess inflation. This inflation will lead to rising interest rates in the economy which in turn will derail the overall growth and robust recovery prospects of the Indian economy.

?Diesel constitutes about 65-70% of operational costs in the form of variable cost. Transport sector provides direct and indirect employment to about 20 million and 120 million Indians respectively. With India being dominated by small truckers, over 85% of total fleet operators and transport companies with a fleet of 10 trucks or lower, the rise in diesel prices has a huge impact on overall business variability, profitability and severe cash flow impact. Transporters and freighters are seeking a 10-15% increase in freight costs leading to an inflation spike and most importantly will affect the fiscal deficit of the country which in turn could well have an impact on overall sovereign rating of India.

India imports around 157.5 crore barrels of crude annually. With every dollar decrease in crude prices the yearly saving would be USD 1.6 billion. With every USD 10 decrease in oil price, the corresponding decrease in consumer price inflation is by 0.6-0.7 percentage points. It also estimates that a similar fall betters India’s current account balance by 0.4% of the GDP. Reduction in excise duty on petrol and diesel by INR 1 per litre lowers collection to the tune of 0.08% of the GDP. With the Rupee coming under pressure, our overall oil import bill should fall. With every USD 10 a barrel decline in oil prices would mean a saving of USD 15 billion in India's net oil import bill. India spent USD 111.9 billion on oil imports in 2018-19, up from USD 87.8 billion in the previous fiscal year.

?In 2018-19 India’s oil import dependence was 83.7%. This has gone up from the figure of 2015-16 which was at 80.6%, thereby clearly illustrating the huge dependence on import of crude for India. By 2018-19 the import has jumped to 226.6 metric tonnes, having paid USD 65.6 billion in 2015-16 for crude imports as against USD 114.2 billion in 2018-19.

?The Cascading Effect of Higher Crude Oil Prices

?·????????Higher oil imports → higher current account deficit

·????????Rising oil prices → fiscal deficit

·????????Higher oil price → higher input costs → higher overall inflation

·????????Higher input costs → lower profitability for several industries

·????????All above factors → depreciating INR

·????????Depreciating INR → fall in stock markets

·????????Fall in stock markets → loss of wealth

·????????Loss of wealth → slow investment cycle

·????????Slow investment cycle → slow productivity growth

·????????Slow productivity growth → slowing GDP

As petroleum products are not included in the Goods and Services Tax regime, states levy differing VAT rates. Some also add cesses, such as for road maintenance, and some also offer rebates. More than half the price consumers pay per litre of fuel goes to tax, of which the lion's share goes to the Central Government. For instance, for every litre of petrol, 57% of the payment goes to tax (34% to the Central Government and 23% to the State Government), 39% is for the fuel itself and 4% is the dealer's commission. Around 65% of the tax collected from fuel is used for overall infrastructure and social development work by the Government.

?Along with these taxes with the international price of crude is already crossing USD 80 a barrel and Rupee moving to INR 75/USD have resulted in imports being even more expensive with import bill jumped from USD 8.5 billion for the quarter ended June 2020 to USD 24.7 billion for the quarter ended June 2021.

?The price of international crude is not under the control of the Government but the taxation on petrol and diesel is something that the Government can relook at with getting petroleum products under GST.

?Landed cost of petrol is INR 40.78, including freight charges. To this add INR 32.90 excise duty, INR 3.84 dealer commission, and INR 23.35 in VAT on dealer commission. The entire selling price would be INR 101.19. Under GST, VAT and excise tax will not be applicable if the prices fall under the GST system. Instead 28% GST will be paid on the base price, which is roughly INR 11.50. With a dealer commission of INR 3.84, the price of petrol will be INR 56.44. Under GST, even under the 28% tax slab, states will earn a lot less compared to what they currently earn from petrol and diesel sales as Value Added Tax (VAT), thereby making it a big challenge to get it under the ambit of GST.

?Major state Maharashtra charges 40% on petrol while Andaman and Nicobar charges just 6% ad valorem. The effective sales tax on diesel ranges from 6% to 29%. This means that each hike in crude oil price brings more revenue to the states. The Centre charges a fixed amount of INR 19.48 on per litre of petrol and INR 15.33 on diesel across the country. The total levies put together are nearly 60%. If the Central levy and dealers commission is added, the amount goes up to nearly 100% over the real cost of fuel. Now, if petroleum is included in GST, then the Revenue Neutral Rate (RNR) could be as high as 100%.

?Investors should keep an eye on the crude prices. If crude prices move up further close to USD 100/ barrel it could well be a right point that market would take to correct from their all-time highs. A 5-7% correction should not be ruled out. At the same time getting Petroleum under GST would be a massive structural reform that the Government will eventually undertake before election 2024, which could well be the next trigger point for the market to rise higher post the intermediate correction.

?_Farzan Ghadially.

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