India needs to cut fuel taxes to offset war-driven price surge

India needs to cut fuel taxes to offset war-driven price surge
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Highlights

It is time to gradually reduce the onerous taxes on oil products especially as many of these were imposed in 2014 and 2015 when international crude prices had fallen steeply

The Governor of the Reserve Bank of India (RBI), Shaktikanta Das, has predicted a minimal impact of the Ukraine conflict on the Indian economy. But international rating agencies like Moody's and Fitch have lowered their growth forecasts for the 2022-23 fiscal. In the case of Moody's, it has gone down from 9.5 to 9.1 per cent and Fitch has downgraded from 10.3 to 8.5 per cent. These contradictory perceptions highlight the lack of clarity on potential repercussions of European strife on the economy here. Much will depend on the time frame of the war. In case it is over quickly, supply chains will begin to operate normally once again though oil and metals prices may remain high. If it continues for a longer period, the consequences will obviously be much greater.

The central bank governor's sanguine comments seem to be supported by recent data on business activity right now. The Nomura India Business Resumption Index (NIBRI) rose to a record high of 126.4 for the week ending March 20 from 122.8 in the previous week. It has commented that the growth impact of the ongoing war seemed to be limited so far. Domestic reopening is aiding a fast catch up in services, according to the index. It did not take into account the latest hike in fuel prices, but highlighted the fact that inflationary pressures will affect growth.

Despite the fears over an inflationary spiral, Das was confident that the six per cent consumer price threshold will not be breached on a continuous basis. For the time being, however, the outlook looks ominous as the pass-through effect of fuel price hikes will be felt on the economy. The first round of price increases in petrol, diesel and cooking gas have just been announced and there may be successive hikes in the coming days. In addition, automobile and electronics manufacturers look set to hike prices as freight rates have shot up owing to disruption in supply chains both by air and sea. Prices of key metals like nickel and palladium that are mainly sourced from Russia are also soaring and the fall-out will be felt in higher prices of manufactured goods over the next few weeks.

The bigger question is, whether the impact of the Ukraine conflict will impede the growth impetus in the economy. So far there has been little visible impact of the crisis on economic indicators barring volatility of the stock markets and the recent rapid rupee depreciation. The stock markets have already stabilized while the RBI's intervention has also steadied the rupee. Another key economic indicator, GST collections is showing buoyant growth, with March recording an inflow of Rs 1.30 lakh crore, an 18 per cent rise over the same month last year.

Crude oil processing by the country's oil refining companies also rose by about ten per cent in February as demand has been rising over the past few months, indicating a resurgence in industrial growth. Throughput in February rose by 9.8 per cent to 5.35 million barrels per day. In fact, the country's fuel consumption rose by as much as 5.4 per cent during the month despite the soaring world oil prices. Other indicators like rail freight earnings have also risen over the past month. According to latest data, these increased by 7 per cent.

There is favourable news on the manufacturing front as well. According to the IHS Purchasing Managers Index, new orders rose to 54.9 during February from 54 in January. It marked the eight month in a row that the manufacturing sector had expanded, as per the index.

In other words, the past month has not shown any visible impact of the Ukraine conflict on the economy though higher rates of industrial goods will probably become evident shortly. In such a scenario, the policy options available with the government are limited as most issues are linked to the external environment. It has, however, been able to go ahead and buy oil at discounted rates from Russia. But these quantities are small, less than one per cent of the country's total requirements. It is clear that purchases will largely have to be made at the existing market prices which are now in the range of 100 to 115 dollars per barrel. On the plus side, crude prices have retreated from the peak of 137 dollars per barrel reached shortly after the Ukraine conflict had begun.

While even the current global rates are higher than earlier anticipated in the budgetary estimates, these are not likely to be sustained at such levels throughout the year. There could be a significant softening of the market in a few months, as soon as Iran reaches an agreement with western countries over withdrawal of sanctions. This will improve availability considerably, which should lead to a further decline in prices of the benchmark crudes. So even if prices fall to about 80 to 90 dollars per barrel, it should come as a relief to India as budgetary assumptions were pegged to a price of 70 to 75 dollars.

In this backdrop, it seems clear that the major threat from the Ukraine conflict is inflationary pressures. One way to reduce the cascading effect of fuel price increases could be to cut the heavy excise duties on petroleum products. This is a time when revenues are relatively buoyant so it should not be too difficult to carry out these reductions. Besides, it is time to gradually reduce the onerous taxes on oil products especially as many of these were imposed in 2014 and 2015 when international crude prices had fallen steeply. The scenario has now changed and duties need to be rolled back. In case the government opts to do so, it will soften the fall-out of the European war which is so far not significant on the economy.

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