Chetan Dhawan

Crude oil prices have slumped from USD110/barrel in Feb 2014 to a 12 year low of nearly USD28/barrel today – a fall of nearly 75 percent. Compared to this, the price of retail petrol price in Delhi has changed from Rs 73.1/litre to Rs 60.04/litre during the same period – a change of only 18 percent. Consequently, a common man is not to be blamed if he is unaware of this fall in crude oil prices.





(Infographics: Sanjit Oberai)



The key reason why petrol prices in India have not seen the necessary price correction is due to the cost structure of retail petroleum prices in India. Taxes account for nearly 55 percent of the retail petrol sales price in Delhi – this figure could be higher for other states based on the VAT levied.



Taxation has had a significant role in dampening the benefit of falling oil prices – excise duty levied on petrol has increased from Rs 9.2/litre in November 2014 to Rs 20.48/litre today.

Excise duty and VAT currently accounts for over 55% of retail petrol prices in Delhi. Respective State Governments and the Central Government have seen falling crude oil prices an opportunity to increase revenue income without hurting voter sentiments. It is estimated that an Rs 1 levy by way of VAT/Excise Dutyon MS Petrol will augment annual revenue collection by Rs 16.2bn, while a similar increase in levy on MS Diesel leads to increased annual revenues of Rs 88.3bn [based on MS (Petrol) and MS (Diesel) consumption of in India in FY15].

While the fuel prices today do not seem to be hurting the consumer, fuel expense is a major part of household expenditure and accounts for nearly 6.3 percent of the total household spending, making it one of the top four items of household spendings. In fact, at 6.3 percent, India’s petroleum expenditure as % of household expenditure exceeds that of developed countries like Australia, Canada, France, Germany, Sweden, United Kingdom and United States, among others. This, in spite of the fact that India’s oil consumption per capita is at a miniscule level compared to the other economies.





The low consumption of oil per capita vis-à-vis the high contribution of petroleum to the household spending indicates the gravity of the petroleum burden on the Indian households. This is particularly alarming since the contribution of petroleum to household expenditure is estimated to increase as the oil consumption per capita will go up in the medium termdue to greater demand for vehicles, given the aspirations of the middle class to have their own vehicles and desire for a better lifestyle.



An unnoticed yet complementary effect of the high contribution of petroleum to household expenditure is the reduced amount available for spending on key necessities including, healthcare, education, housing, clothing and footwear, recreation and culture, etc.

Apart from improvement in fiscal and current account balances, lower petroleum prices have a considerable effect on inflation by way of reduction in transportation costs – which have a spiraling effect across the economy. Lower inflation leads to higher disposable incomes, thereby pushing higher consumer discretionary demand as well as improved corporate profit margins due to falling input costs. If the price benefits from the lower petroleum prices are passed on to the consumer, it will encourage private consumption and is likely to have a direct impact on household savings.



Household savings are likely to be invested into financial markets, deposits in banks, real estate etc. among others. As against this, when the government is appropriating the price benefit by way of taxation, the end use is not defined – the amount may make its way back into the economy by way of capital expenditure or ease the subsidy burden that the Government has to finance.In view of the shift to Basel III standards, it may even make its way into PSU banks to fund the capital shortfall that the banks are facing – although it may not yield the desired results in view of the falling market capitalization and increasing stressed assets of PSU banks.

Every USD10 per barrel fall in oil price can boost GDP growth by around 0.1 percentage points, according to Nomura. Consequently, it may not be an unwise move to pass on the benefits of lower crude oil prices into the economy; it may lead to increased discretionary spending which would have a multiplier effect. As per our estimates, a one rupee excise reduction in petrol and diesel would make available nearly Rs100.4bn annually as discretionary spending for the households.



Taking the multiplier effect into consideration, as much as Rs 800bn could be mobilized in the economy annually – which is no small amount considering the perennial calls to Dr. Rajan for rate cuts.While the government may have found an unnoticed yet easy solution to finance the budgetary deficit, the situation will not continue forever.



The government needs to device alternative funding mechanism to substitute for the levies on MS Petrol and Diesel once the prices begin to soar, and given the government’s commitment to reduce the fiscal deficit to 3.0 percent by FY18 (from the budgeted 3.9 percent in FY16). Given the limited funding avenues, the challenge appears to be fairly steep.



(The writer is Analyst, IRR Advisory Services)