Petrol & diesel pricing

We need to do a rethink if arbitrary levies, which effectively double fuel prices, bring about a net improvement in public welfare

Why do we pay so much for petrol and diesel in India? Essentially, because of taxes and levies. The government seems to treat containing the fiscal deficit as the highest priority, with other public interest criteria being less important. Let’s explore this assumption to see if it is reasonable. The question is, what is the net effect on public welfare from arbitrary costs/levies that effectively double the price of fuel, compared with the benefits.  

Rising petroleum prices in India are causing significant distress, both at the macro level in terms of slowing growth as well as in living conditions for most people, excepting those at the highest income levels. This is primarily because of India’s dependence on imported fuels without commensurate strength in exports. Additional factors are: The value of the rupee against the dollar, and the effect of the extent of taxes on petrol and diesel on living conditions.

To recap briefly, when the price of crude dropped from 2014, the government increased taxes nine times through January 2016. But when prices rose thereafter, taxes were not reduced. This has resulted in exorbitant retail prices, and much higher government revenues. Chart 1 shows the price of India’s crude basket in dollars per barrel, and petrol prices in rupees per litre.

For every additional rupee in tax, the government gets Rs 130 billion more revenue (as reported by PTI) while according to the Economic Survey 2017-18, for every $10 per barrel increase in crude prices, GDP growth is reduced by 0.2-0.3 per cent. It was estimated to be more than double that by the Institute of Energy Economics, Japan, in May 2012.  

Chart 2 shows the effects of rising oil prices on importing nations. Both producers and consumers suffer the ill effects of rising oil prices. In India’s present circumstances, these negative effects need to be set off against the positive effect of containing the deficit to some extent, which will presumably temper inflation and so on.  

This set of factors reduces nominal GDP ($2.65 trillion in 2017) by an estimated 0.2 to 0.3 per cent at least ($5.3-7.95 billion, or if it is indeed nearer 0.7 per cent, by $18.55 billion). Another set of factors is the rationale that people who use vehicles must pay high taxes for these reasons:

• As a disincentive to restrict the use of petroleum products, to control pollution as well as the level of imports.
• As a source of revenue for other beneficial public use.  

On the other hand, the rationale for passing on the benefits of lower taxes and prices to users is:

• To restrict inflation by keeping input costs low, which is presumably important in terms of lower financing, input and transportation costs for the economy. 
• To boost consumer demand, thereby also contributing to growth.

Perhaps there needs to be a rethink from the ground up — an ab initio approach to define critical objectives in the public interest. Should higher taxes be imposed on inputs such as transportation fuel in the absence of public transport alternatives? Are there other effective ways of curtailing pollution and excessive consumption (apart from the necessary and systematic development of public transport), while retaining the enabling aspects of inputs such as transportation?

A study of the energy cost share of GDP in the US from 1950 to 2013 found that expensive energy was a drag on the economy.1  If the cost share was higher than a threshold (above 4 per cent of GDP for the US data), the economy was likely to do less well.  In India, petrol and diesel costs as a percentage of GDP are far higher than in many other countries. While retail petrol is priced about the same in India, China and Brazil (see http://www.mytravelcost.com/petrol-prices/), a litre of petrol is nearly 20 per cent of daily per capita GDP in India, whereas in Brazil and China, it is only a fifth of that, at about 4 per cent.

From a completely different perspective, consider how keen political parties and candidates are in election mode to appease or cajole voters. This happened in the run-up to the Karnataka Assembly elections in April. Local newspapers ran headlines about petrol and diesel prices held steady for nearly three weeks until May 14 despite rising international prices. Only then were prices allowed to soar (Chart 3).  

Since keeping fuel prices in check is recognised as a palliative for elections, what could be the reason for avoiding a decrease in taxes and levies when the price of crude rises? Presumably, concern about the deficit. Perhaps what needs to be thought through is the benefits of reducing input costs to increase collections from higher growth.

The management and use of petroleum for energy is one dimension of our multifaceted requirements that has to be addressed. Other necessary dimensions include emphasis on the development of renewable fuels such as cellulosic ethanol for transportation2, of electric batteries for vehicular use, and apart from transportation, of solar power generation, and for large plants, integral solutions such as association with pumped storage power where possible.  

Above all, rational pricing of inputs by reducing taxes is a desirable beginning that can be acted on immediately. 

shyamponappa@gmail.com

1. Michael Aucott and Charles Hall: www.mdpi.com/1996-1073/7/10/6558/pdf 

2. Kirit Parekh: http://indianexpress.com/article/opinion/columns/fuel-for-thought-petrol-price-hike-tax-two-wheelers-5204001