As we enter the next financial year, perhaps one that might help us shed the baggage from the dreadful year FY2020 has been, the government- state and Centre ensure that the citizens have sleepless nights over fuel prices. What compels the government to take such a polarizing position and be on the wrong side of the current situation, especially with a dire need to douse the socio-political tensions which ensued post introduction of the three farm bills which drew flak from the farming community?
Who controls the price of fuel in India?
Companies like Indian Oil Corporation Limited (IOCL) and Oil and Natural Gas Corporation Limited (ONGC), the upstream players responsible for exploration, extraction, and refining serve a simple purpose – ensuring a steady domestic supply of various forms of fossil fuels: petrol, diesel, natural gas and a number of products manufactured by downstream players. Aspects such as production, supply, distribution, marketing as well as pricing are undertaken by the Ministry of Petroleum & Natural Gas (MoPNG) with an estimated annual budget of INR 42,000 Cr. India imports over 82% of its crude oil and 45.3% of LNG, making it not only one of the largest markets for these products but also highly vulnerable to fluctuations in crude oil prices.
However, crude oil prices globally and domestic petroleum product prices do not follow simple correlation. Until a decade ago, fuel prices were regulated, and state-owned oil companies ensured a subsidized supply of fuels thereby absorbing a portion of increasing price of crude oil. Government also controlled the pricing mechanisms adopted by distribution agents. Post 2010 and 2014, fuel price decontrols aimed to bring better transparency in domestic sale prices which seem to factor any incremental prices based on global prices. This though, does not mean that benefits of declining prices are passed on to consumers.
What goes up, goes down. Right?
Market trends have indicated not just steep uptake in crude oil prices as witnessed after 1970’s OPEC ban on US or steady rise in crude oil price prior to the market crash of 2008, prices have also crashed owing to a variety of factors including surplus supply such as in 2014 when prices crashed by over 59% over 7 months.
A contributing factor to this has been the fiscal policy adopted by the Indian government. When crude oil prices go up, the government ensures the consumer pays extra; when they go down, additional taxes are levied by the centre or state to take advantage of a temporary plunge in prices.
Baggage from the past
While the Berlin wall fell and Chernobyl triggered a chain reaction that nearly bankrupted USSR, India dabbled with its own challenges prior to the economic liberalization in 1991. It had faced sluggish growth in GDP for more than a decade which is often dubbed as ‘Hindu rate of growth’ a period which is taunted as a time of dull pessimism and little effort to leverage the human capital available.
Economic liberalization came at a cost. India had to sell its gold reserves worth 20 tonnes and pledge more gold for raising the capital necessary to counter the fiscal imbalances over the 1980s which were exacerbated by events such as the Gulf war which resulted in lack of adequate remittances and a liquidity crisis. Gross fiscal deficit slipped consistently in the 1980s and foreign exchange reserves were insufficient to sustain ongoing imports. The true cost of liberalization was borne by Indian rupee which devalued by about 18%. Although this was not the first time Indian currency plunged against the fiat, events in 1991 made sure India took a new path, albeit with a pinch of salt. However, the policy reforms in 1991 ensured industrial deregulation that made Indian industries more competitive. But that was not an overnight journey.
Interest rate liberalization made the banking sector competitive and reduction in reserves requirement ensured positions were leveraged. Trade policies were reframed, and tariffs were rationalized to make way for international trade. Industry policy was also made inclusive by abolishing licencing and repealing retrograde laws such as the Monopolies & Restrictive Trade Practices (MRTP) Act which made the market particularly appealing to larger players.
Capital markets brought inflows of institutional and individual capital, incentivizing foreign direct investments and a devalued rupee made India an attractive destination for investors.
What does any of this have to do anything with fuel prices in 2021, three decades later? The heavy cost of liberalization meant two things –
i. Fiscal deficit must not grow uncontrollably or managing deficit can be a slippery slope that we must avoid,
ii. Our economic policy was not ready for the new century and had barely kept up with the progress made over half a century.
But what could enable responsible budgetary decisions? The need for addressing structured decision making that target deficits was imminent.
Fiscal Responsibility and Budget Management
In 2003, the Indian parliament passed the Fiscal Responsibility and Budget Management Act (FRBM) which ensured the mistakes made in the 1980s could be avoided through fiscal prudence. Any demand-side monetary policy such as the FRBM introduces policy changes that target fiscal deficit, revenue deficit and aims to put a leash on controllable expenditures. In other words, it introduces a short-term target for the government to borrow and spend within its ability to repay through existing income sources.
FRBM allowed the government to set targets – fiscal deficit target, the difference between income and expense, and revenue deficit target, the difference between realized net income and projected income or budgeted revenue. The economy did well as the global economy thrived and both deficits declined. The crash of 2008 and its aftermath snowballed into a global recession that dried up free capital globally.
In 2018, the political party responsible for passing the FRBM, abandoned the revenue deficit targets. What is also more striking is the increasing Debt to GDP ratio, a measure of leverage and the government’s ability to repay its borrowings.
Even before the pandemic, India’s Debt to GDP ratio was on the higher side compared to its BBB rated peer countries (rating as per S&P global, a rating agency). When the government looks at its increasing debt expenditures, it also must improve the tax collections. The gross tax collection in Union budget 2020-21 was projected to be over INR 24.23 Lac Cr whereas a revised estimate based on tax receipts was INR 21.63 Lac Cr, a ~11% deficit which further highlights the dire positions of policy makers and governments. This is not merely the pandemic at play. Revisions in estimated tax collections have always been a factor the government has to deal with, albeit with a lower deficit.
Although this is an extremely macroscopic view of current decision constraints, it is important to note that a large part of the deficit stems from our fundamental demands where energy takes a precedence. Petroleum imports contributed to over 25.1% of the gross imports (in terms of value) while exports as a percentage of gross exports were just over 11.4% in 2019-20 making the trade deficit fairly critical to solving long-term challenges in India.
This brings us to the crude oil prices, another short-term solution that is often leveraged to bring in additional tax revenue. Typically, India imports about 5 Million BPD (barrels per day). When we look at the government’s record in direct tax collection, it looks at petroleum-based products, as a source of consistent revenue that can help shrink the fiscal deficits. So, instead of easing the common man’s burden when crude oil becomes cheaper, the government levies value added taxes to leverage the situation.
For a commodity like petrol where in the month of February, the government-imposed taxes exceed the base price of petrol. States also look at crude oil as a potent opportunity to reduce state deficits.
The state of our economy is not the same as pre-2014 level under a different regime, when deficits were on the lower side and centre had the liberty of levying lower taxes. What is in it for the common man? Additionally, the prices of a commodity like crude oil are likely to have a trickle-down impact on derived commodities. Agri-commodities, FMCG goods and other such commodities, are directly affected as transportation becomes more expensive. This spirals into inflationary rise in prices and although prices increase, the common man’s development is easily short-changed.
The decision to levy these taxes is not a merely politically motivated decision. Every paisa earned by the government helps us bridge the deficit gap.It becomes a tug-of-war between short term solutions versus long term solutions, a policy call that can have infinite probable solutions, with none guaranteeing redemption.
An example of short term solutions include the stimulus package - a INR 20 lakh Crore package that aimed to boost the economy by focused solutions for Micro, Small and Medium Enterprises, Power sector, Defense sector. The cost of this stimulus to a large extent came from slashing Capital Expenditure allocations towards projects like Smart cities, Atal Mission for Rejuvenation and Urban Transformation, National Ganga Plan among others. However, Capital Expenditures are capable of generating future revenues whereas stimulus packages exist as a one-time solution.
The struggle to find the right balance of increasing prices of crude oil products vs reduction in deficits is not unique to India.
All of India’s bordering neighbours price petrol between 24.7% and 44.8% lower than India, making Indian petrol extremely expensive for domestic consumption. Interestingly, Nepal, where the price is 24.7% lower than India relies on India’s Indian Oil Corporation (IOCL) for crude oil imports, but IOCL passes it on to Nepal Oil Corporation at purchase price and additional processing charges (which are nominal). The countries in the sub-continent that have limited crude oil production are largely dependent on crude oil imports from OPEC nations. Media coverage focuses on the limited field of vision daily price fluctuations allow them to have. Public sentiment is affected by the direct impact of price changes. However, we must examine this situation from a macroeconomic policy perspective to fundamentally address the policy gaps that have allowed this situation to escalate to the current situation.
Long term measures such as investing in electric vehicles, capacity building to systematically solve the demand-side problem of heavy crude oil imports will take an industry policy change. India has introduced an Electric Vehicles Policy that can help solve the long-term shift towards an electric future from crude oil and its derivatives.
There are two paths that can be looked at to minimize deficits – austerity measures, aimed to cut expenditures that can be postponed and increasing taxes thereby relying on tax buoyancy for debt servicing. These temporary measures can help us balance any deficit that may be incurred by lowering taxes on petroleum products.
If austerity measures are to be introduced, the most obvious candidates include capital expenditures which are not immediate and are unlikely to yield immediate tax revenues. Subsidies and welfare schemes are often lower than the budgets. Additionally, large capex-based ministries such as Road Transport & Highways, Railways and Housing & Urban Affairs spend less than 70 percent of their allocation owing to factors such as project delays or delays in release of funds due to clerical reasons.
The government should consider curtailing budgetary expenditures on ambitious schemes such as UDAN and the Central Vista Redevelopment Project which may revamp the parliament building at the cost of common man’s welfare. Alternatively, road development, which is aggressively undertaken should be prioritized as per revenue impact of connecting regions. Any avenue that may help negotiate long-term sustainability must be a priority right now.
Coincidentally, the year that liberated India and set it on a progressive journey was also when Japan experienced not just a market crash but what is popularly known as the beginning of ‘Lost Decade’ or Ushinawareta Jūnen, a period of stagflation triggered by aggressive loans, speculative asset prices and unprecedented debt that crippled the economy for over a decade. The collateral damage to this situation was the banking sector which was practically crippled owing to extremely low interest rates, which meant no institutional credit could be sought.
Obviously, Japan and India are at different ends of the development curve. However, it is essential to look at the repercussions of poor fiscal policies that end up hurting people more than they hurt institutions which are, more often than not, deemed too big to fail and rescued from the verge of failure.
Indian policy makers have difficult choices ahead - increasing debt, a burden of deficits and compounded problems caused by the pandemic. The situation that can be eased by increasing duties on domestic sale prices of commodities that can have a cascading effect on dependent commodities. With domestic prices of petrol and diesel that exceed corresponding prices in the entire subcontinent, policy makers must be cognizant of the transient nature of our fundamental fiscal policies. There are lessons to be learnt from the past, our history as well as countries that have lost a lot to the poor fiscal policies.
Austerity supplemented by a robust trade and industries policy seem like the best bet for now. The present government has never really appreciated austerity measures and never shied away from taking bold steps even in the face of evident risks. With the government keen on focusing on demand driven economic reforms, whether the government is open to this approach is a different story altogether.
REFERENCES:
1. https://oilprice.com/Energy/Energy-General/The-Two-Countries-Dictating-Oil-Prices-In-2020.html
2. https://www.indiatoday.in/diu/story/nearly-two-third-of-the-price-you-pay-for-petrol-goes-to-centre-and-states-1771944-2021-02-22
Author: Aditya Gupte
Editor: Aarushi Kataria