A Matching VAT Relief on Petrol/Diesel by State Governments Can Pull Inflation Down by 14bp

The reduction in excise duty by INR2/litre on petrol and diesel has resulted in the retail price of these fuels declining by INR2.5/litre and INR2.25/litre, respectively, based on prevailing Delhi prices. The higher decline in retail prices than the one implemented by the government is due to the ad valorem nature of state value-added tax (VAT). Ind-Ra estimates that the excise duty cut would lead to a 9bp fall in retail inflation. Yet, the agency believes it will be around 4.5% by end-March 2018.

The likely hit on central government finances due to this reduction will be about INR130 billion and on aggregate state finances INR32.5 billion.

However, if state governments also make adjustment to VAT rates on petrol and diesel to match the cut in excise duty (INR1.5/litre on petrol and INR1.75/litre on diesel), the aggregate impact on inflation will be of around 14bp but the aggregate state revenue would be down by an additional INR97.5 billion. At the aggregate level, 16.6% of the states' own tax revenue comes from petroleum products. However, for some states such as Assam, Gujarat, Manipur and Rajasthan it is more than 20%.

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