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Fiscal implications of crude oil price increase

by Mahesh Vyas

The recent increase in crude oil prices could impact the fiscal deficit in two direct ways. It could lead to a fall in tax revenues if the government tries to lower the price of petrol and diesel. And, it could lead to a greater subsidy outgo for kerosene and LPG. We try to understand the impact of both these.

Prices of petrol and diesel have risen sharply after elections in Karnataka. These prices were kept unchanged during the elections. Between 14 and 29 May 2018, prices have been rising at 0.3 per cent per day.

These price changes have raised worries about their political fallout in an election year. If prices of these fuels continue to rise they could lead to resentment that could spur popular political movement against the government. Therefore, if crude oil prices keep rising and keep feeding an increase in petrol and diesel prices, the government may be forced to cut excise duties on these and take a fiscal hit.

The government had raised excise duties on these systematically after the price of crude oil fell in August 2014. Instead of passing on the benefit to consumers, the government decided to retain the gains from falling crude oil prices for itself by raising the taxes on fuels.

Excise duty on petrol was Rs.9.48 per litre in September 2014. This was raised to Rs.11.02 per litre in October and then progressively to Rs.21.48 per litre by July 2017. The duty therefore more than doubled in less than three years. In the case of diesel, the duty was raised from Rs.3.56 per litre to Rs.17.33 per litre over the same period.

Total excise duty collected from petrol and diesel was Rs.733 billion in 2014-15. This more-than doubled to Rs.1,546 billion in 2015-16. It is likely that this rose further by a handsome 56 per cent in 2016-17 to Rs.2,409 billion due to sharp rise in the excise duty per litre. And, in 2017-18, collections may have inched up by less than two per cent to Rs.2,450 billion as the rates per litre were cut in October 2017. Download data in excel

A cut of Re.1 per litre in the excise duty on petrol and diesel would lead to a revenue loss of Rs.148 billion, This is based on an assumption that petrol consumption would be of the order of 27.8 million tonnes and diesel consumption would be 84.5 million tonnes. A higher cut in excise duty would lead to a correspondingly higher loss of revenue.

But, average petrol price in 2017-18 was lower than it was in 2012-13 or 2013-14. And, the price of diesel in 2017-18 was 26.7 per cent higher than it was in 2012-13, implying a reasonable increase of 5.1 per cent per annum. So, there are no compelling reasons to actually cut duties. Consumption of these fuels are price elastic and a cut in prices will lead to an increase in consumption.

Kerosene and LPG come under GST and so the effective duty on these was raised with the introduction of GST. Both are subsidised by the government. In 2017-18, the government provided a subsidy of Rs.10 per litre on kerosene and Rs.173 per 14.2 kg LPG cylinder.

Consumption of kerosene has been falling steadily as the government has been aggressively promoting a transition to LPG as the cooking fuel. While kerosene consumption fell by 21 per cent and 29 per cent in the last two years, consumption of LPG grew by 8-10 per cent during these two years.

We expect kerosene consumption to decline by another 14 per cent in 2018-19 and LPG consumption to grow by about 3.6 per cent. Overall consumption of these fuels is expected to rise by about a per cent.

Crude oil prices rose sharply during May 2018 and average price is expected to rule 32 per cent higher in 2018-19. Crude oil price during 2018-19 is expected to average at USD 75 per barrel compared to USD 57 per barrel in 2017-18.

We expect the government to subsidise most of this increase in price for consumers of kerosene and LPG. As a result, the subsidy for kerosene is expected to go up from Rs.10 per litre to Rs.16.5 per litre and that for LPG to go up from Rs.173 to Rs.200 per 14.2 kg cylinder.

As a result, the subsidy requirement for kerosene is likely to increase from Rs.48.5 billion in 2017-18 to Rs.66 billion in 2018-19. Similarly, the subsidy requirement for LPG is expected to rise from Rs.285 billion to Rs.341 billion. This implies a total subsidy requirement of Rs.407 billion on kerosene and LPG for 2018-19 against a provision of Rs.249 billion made in the budget.

The central government may therefore have to bear an additional burden of Rs.158 billion on account of subsidies for kerosene and LPG if the average price of crude oil increases to average USD 75 per barrel in 2018-19.

An increase of Rs.158 billion in subsidies for kerosene and LPG and a possible increase of Rs.148 billion because of a possible Re.1 per litre cut in excise duty on petrol and diesel could add Rs.306 billion to this. This would be about 0.16 per cent of GDP. It could potentially, raise the GFD/GDP ratio for 2018-19 to 3.9 per cent from 3.7 per cent projected by us in March 2018.

It is apparent from the above that if crude prices average no more than USD 75 per barrel in 2018-19, the impact on the government finances would not be too debilitating.