• Sarthak Agarwal

Costly Ride- Understanding Rising Fuel Prices in India

At a time when gasoline prices across the world have seen drastic reductions, India has been an outlier. The country is reeling from some of the highest fuel prices it has ever seen. Even more incredible is that countries buying refined petrol from India have lower domestic prices than India itself! The reason? Taxation.

Last year, the government dropped its policy of revising petrol prices every fortnight. Instead, it authorized oil companies to decide their own prices daily to transfer the benefit of International Crude Prices to consumers more effectively- popularly called de-regulation. However, it’s not just market forces, there’s a lot more to surging petrol and diesel prices in India than meets the eye.

Petrol Prices of Neighboring Countries

So, why are petrol prices so high in India?

Petrol and Diesel are among the few commodities that were kept outside GST regime- a newly instituted unified indirect tax system. Contrary to the GST structure, therefore, petrol pricing follows a different structure with central taxes and varying state taxes being levied on the commodity. The price of petrol thus includes the cost of crude oil, refining cost, excise duty, VAT, dealers’ commission, and freight and margins which together form the RSP (Retail Selling price) of petrol that consumers pay.

Crude Oil – India imports roughly around 75% of its crude oil demand while the rest is extracted domestically by state-owned companies like Oil India Ltd and ONGC, and private players like Reliance and Cairn India. These companies, commonly known as ‘Upstream Companies’, are in the business of extraction of crude oil. The price of Brent Crude, which is the international standard, was around $77 per barrel, at the time Polemics & Pedantics went to press.

Oil Marketing Companies – Oil marketing Companies (OMCs) such as Indian Oil Limited, Hindustan Petroleum Corporation Ltd. etc., are firms which purchase crude oil from upstream companies, refine it into petrol, diesel and other products using a process called fractional distillation and eventually sell the products through various distribution channels. Popularly known as ‘Downstream Companies’, the major component of their business comes from Marketing of Oil, while refining is another significant revenue generator. The costs they bear usually include freight charges, price of crude purchased from refining companies as well as losses arising from distribution, such as theft etc.

Dealers Commission – The dealers, who sit at the end of the supply chain entitled to a commission – this is usually around Rs.3.63 per litre (competition among marketers keeps it virtually the same for every dealer) - which is finally added to the Retail Selling price of Petrol and Diesel.

VAT and Surcharges – The most controversial aspect of pricing. Taxes on fuel are of two kinds, an ad valorem (percentage based) Value Added Tax (VAT) – levied by states at different rates – and taxes levied by the Union Government. It is important to note that unlike state taxes, the central government taxes – Road & Infra Cess at Rs.8/lt; Basic Excise Duty of Rs.4.48/lt; and, Additional Special Excise Duty of Rs.7/lt – are levied flat and are not in proportion to the price of petrol.

Additionally, it is also important to point out that, from 2015-16, when international crude prices witnessed a dramatic drop, the Central Government had dramatically increased taxes to mop up a substantial amount of benefit that would have otherwise accrued to the consumers. At the time, the logic given by the Finance Minister of India, Mr. Arun Jaitley, was that the revenue was needed to compensate OMCs for the artificially low prices in the previous years (when crude was around USD 100/ barrel), and was a temporary measure. The Economic Survey of India 2016-17, hailed it as a ‘Climate Tax’ designed to further India’s commitments to the Paris Accords.

Source: The Indian Express

How will these differ under GST? If the petrol prices are brought under the GST regime, the prices will fall dramatically even if it is taxed under the 28% slab. Given below is a calculation of Petrol and Diesel Prices under a hypothetical GST of 28%. Readers would be advised to note that in all the following calculations, IGST has been omitted since it would only be valid for states where refineries are not located – its impact, however, would not be substantial in any case as it constitutes a very small percentage of tax. A second assumption here is that the tax would be equally shared between Center and the States.

Source: Own Calculations

From the figures, it is discernable that GST would have a significant downward impact on fuel prices. However, given that the policy has not been effected – despite the fact that it leads to a very favorable result for any government facing an election 10 months hence – it is important to consider the reasons behind the hold up. The answer? States.

State Governments earn a huge amount of money from various taxes they levy on petrol and its products – making up for their otherwise dismal revenue sources and bloated expenditures. According to the Petroleum Planning and Analysis Cell (PPAC), a Central Government policy board, total tax collected by states from Petro-products was around Rs.1.90 lakh crores (USD 28bn approx.) for FY 2016-17. This money is used to finance a number of development and welfare related expenditures undertaken through infrastructure products, delivery of services, and the portion of central schemes for which states have to bear the costs. The divergence between a GST and a VAT regime is certain to cause significant disruptions in state finances. Consider for instance, the case of Kerala.

Source: Petroleum Planning and Analysis Cell (PPAC)

Source: Petroleum Planning and Analysis Cell (PPAC)

At present, the state levies 32.8% VAT on the Dealer Price (Rs.35.15/lt), along with an Additional Sales Tax of Rs.1/lt and a 1% cess. This effectively amounts to 34.06% of Dealer Price, or Rs.11.97/lt. If instead, 28% GST were applied – which would yield 14% SGST for Kerala (and all States) – the revenue would fall to Rs.4.92/lt for states causing a loss of around 59% to Kerala’s state treasury. The Central Government - which presently raises around Rs.19/lt on petrol – would also stand to lose a very significant amount, however, it possess a large number of other avenues to raise taxes (including Personal Income Tax and Corporate Tax), which are constitutionally unavailable to a state government.

According to Kerala's Finance Ministry, the fiscal deficit of the State was 3.5% of its GSDP for 2016-17. If 28% GST were to be implemented with equal revenue sharing between the Centre and States, Kerala's fiscal deficit would balloon to 4.4% of GSDP.

Using similar calculations, it is easy to determine which state would gain or lose in a GST regime. The following chart by the Reserve Bank of India shows that a GST regime in fuel would have the least impact on Delhi’s GSDP, while the worst hit states would include Punjab, Andhra Pradesh, Kerala, Madhya Pradesh and Rajasthan.

Source: Petroleum Planning and Analysis Cell (PPAC)

Evidently, there is not even a single state that would have null or a positive impact on its finances if fuel was to be subsumed into the GST regime. While this speaks volumes about the state of financial devolution in India, it also drives home the point that without the introduction of a new tax slab or a different tax sharing arrangement, GST on petrol will remain a pipe dream. Given that the central government too is unlikely to give up its windfall, petrol would continue to burn holes in India’s pockets for the foreseeable future.

Comments are welcome at polemicsnpedantics@gmail.com.

About The Author

Sarthak Agarwal is a student of Management Studies at the Shaheed Sukhdev College of Business Studies, Delhi University. He has won several national and international level business and strategy competitions, and also runs a blog where he decodes and explains articles published in The Economist Magazine.

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