Using flexibility in fuel pricing

The government control on pricing continues via tax tweaks

The fall in global oil prices over the past 10 days has heightened the expectation of cheaper fuel among retail buyers. But there is outrage against the Union government for milking this opportunity to earn some more revenue, and this outrage is also against government-owned oil marketing companies (OMCs). They are told they are non-transparent about pricing. This was said even when the government controlled the prices of diesel, petrol, LPG and kerosene and even now when OMCs are supposedly free to fix prices of the first three.

The Union petroleum ministry’s Petroleum Policy and Analysis Cell and OMCs do give out the price build-up of petrol, diesel and kerosene. For LPG, the NDA government has stopped the practice of giving information both on the price build-up and also on the subsidised rates of LPG cylinders. This may be because of the general distrust of the media and to mitigate criticism by giving less information out in the public domain. Nonetheless, the information on petrol, diesel and kerosene given out on their websites brings in pricing transparency which is absent in most other commodities across sectors. Do consumers know the price build-up of, say, hand wash products that are so much in demand these days?

Transparency aside, the criticism against the government is for raking in the moolah and not letting the consumers enjoy the full benefit of low global prices. Companies benchmark products to global prices on which freight, government tax and margins of both dealers and OMCs are added. The reason they are benchmarked to global prices and are not cost-based is because more than 80 per cent of India’s crude oil requirement is imported. Unlike the earlier practice, the benchmarking is not on full import parity but only 80 per cent since 2006 when the UPA government asked OMCs to move to trade parity pricing.

The fall in product prices, therefore, will never be in the same proportion to crude oil since neither are they benchmarked to crude prices nor is there a 100 per cent import parity with products. The falling rupee also plays a role but OMCs are hedged to a large extent because their products are linked to dollar rates of a particular product.

The most flexible component in petroleum pricing is the tax. While that does mean the government control on pricing via tax tweaks continues, there is need for flexibility. Ironically, this freedom to change the tax component came at the time of high global prices when the UPA government moved to specific duty from the ad-valorem (percentage) tax structure in 2008.

In 2005, the then finance minister P Chidambaram introduced an excise duty of 8 per cent plus Rs 5 for every litre of petrol, replacing 23 per cent excise duty; for diesel the excise duty was kept at 8 per cent along with an additional specific duty of Rs 1.25 a litre. So, the Centre only partially gave up on an ad-valorem duty which meant the government continued to take benefit of a fixed percentage of the price as tax when global prices went up. It worked the other way round, too. If prices fell, the collection from the ad-valorem component also fell.  

While presenting his Budget in 2008, Chidambaram completely did away with the ad-valorem component of the excise duty which meant the revenue collection from the Centre was fixed whether prices fell or rose. The state value added tax continues to be on an ad-valorem basis and they may now take cues from the Centre to increase tax.

It was a month after the full decontrol in diesel pricing that the NDA government in November 2014 started increasing the excise duty on both petrol and diesel which prevented full pass-through of the price fall to the consumers. Though a precedent was set and the government again followed this on March 14 when it raised the excise duty on petrol and diesel by Rs 3 a litre, the intention behind moving to fixed duty was precisely this flexibility. If the government does not use the excise tool by changing the fixed duty, its revenue will stagnate, and any increase in tax collection will solely depend on higher sales. Moving back to an ad-valorem structure will be bad for consumers since it will have a cascading effect on prices at a time of high global prices. For the government, too, it will lead to a fall in revenue in times like these when sale volumes are not expected to pick up because of slowing mobility.

The government is within its rights to use the fixed duty on petrol and diesel to its advantage. It is short of revenue because of the slowdown, some of which maybe of its own making. An additional revenue of around Rs 43,000 crore on an annualised basis could be put into public use while ensuring that the not-so-cheap fuel is used efficiently even though the price elasticity of cooking and automobile fuel is very less.

Consumers can take comfort from the fact that global prices will continue to be low and retail prices of petrol will continue to be around 8-10 per cent lower than the January level. They may become even cheaper despite the recent excise duty hike and even if excise duty is hiked further.