What are the impacts of fuel inflation?

Petrol and diesel prices have been continuously rising for the last 1 month due to price hike by Oil marketing companies (OMCs). It is very easy for the present Government to blame the price rise on the OMCs. But it looks good in theory. The reality is quite the opposite. In this article, we will read about how fuel inflation impacts people and what Government should do to curb it.

What is fuel inflation? Why is it rising?

Fuel inflation, as the name suggests is the consistent increase in the prices of fuels like petrol, diesel etc. As a result, headline inflation also goes northwards since it considers all the volatilities of oil and gas prices along with other commodities. Government has a very good defense mechanism when it comes to fuel inflation. It shoulders away its responsibility by blaming on exporting countries and geo political tensions since prices of petrol and diesel are deregulated and are determined by the forces of supply and demand. As the economy is gradually normalizing after facing the shocks of Coronavirus, there is rise in demand of fuel but OPEC and other oil producing nations have voluntarily cut down the supply in order to make profits. Rising crude prices have a direct impact on Indian consumers since India imports approximately 80% of fuel from these countries.

What is the deregulated price mechanism of petrol and diesel?

Government of India deregulated the prices in step-by-step manner as it first freed up the prices of Air Turbine Fuel (ATF) in 2002, then the petrol in 2010 and then diesel in 2014. This deregulated system has removed the interventions of the Government in fixing the prices theoretically. This system provides the freedom of fixing the prices to fuel retailers such as Indian Oil, HPCL or BPCL. These fuel retailers fix prices by taking into consideration the costs of inputs which is nothing but the costs they incur by taking oil from companies such as ONGC Ltd, OIL Ltd. The oil companies derive their price benchmarks from global crude prices. The prices of petrol, diesel or ATF are expected to be the reflection of the price movements in Indian basket of crude oil which comprises of sour grade (Oman and Dubai average) and sweet grade (Brent).

One may argue that when global crude prices come down then also people have to pay the high prices for oil. Why is it so?

The simple reason for this is that oil price decontrol is a one-way street in India. This means that when global prices go north, then consumers bear most of the burden. On the contrary when global prices come down then also consumers do not get respite in fuel prices because Government increases the taxes on fuels. Taxes levied by the State Government and Central Government on fuel constitute major portion to the total revenue of Government.

Let us understand it by relating to the real situation that emerged during March 2020. Crude prices fell to $20 per barrel in March from $55 per barrel in February 2020. This happened due to lockdown that was announced all over the world in order to curb the Coronavirus spread. Since people were working from home and business were shut down for that period, there was minimal demand for crude oil which led to huge fall in the prices. But in India, retail prices shot up and kept frozen till 82 days i.e. consumers could not be benefitted from the slowdown in prices. At that time both Centre and some State Governments even hiked the taxes which again surged prices of petrol and diesel.

Central Government was able to collect INR 3,34,314 crore in 2019-20 while it was INR 1,72,065 crore in 2014-15. This shows how hiking the custom duty and VAT have been beneficial to the Government.

What is the impact of rising fuel prices on the economy at a whole?

As we have read above, that Government comes out to be a clear winner whether prices go south or go north. The other stake holders like consumers, Oil market companies are on the losing side.

Consumers

Consumers are the clear losers because they have to pay excessively huge prices for feeding their vehicles. It takes a toll upon their total earnings as larger share of earnings go into paying for petrol and diesels. Farmers who use tractors and other equipments which require fuel also face tough situation because of rising fuel prices. Logistics companies which are engaged in transportation of goods from one place to another experience fall in profitability whenever there is a rise in fuel prices.

Oil Marketing Companies (OMCs)

These companies are too on losing side because of the associated inventory losses. Whenever they source the crude oil at higher prices and later discovered that prices have come down by the time fuel reaches in refineries for processing. It took a hit on the earnings of these companies as well.

Why petrol and fuel are not the part of GST regime?

As the prices of petrol and diesel heads northwards, there is growing demand to bring them under GST regime in order to avoid multiple taxation system. These items were kept out of GST regime because there is a conflict of interest between State and Central Government. Each state has its own taxing mechanism and they are worried that they would lose their fiscal autonomy if petrol and diesel come under GST. The below mentioned table shows how revenue of both State and Central Governments went up from 2015 to 2020.

There is still a debate going on whether to keep petrol and diesel under GST or not. Government could think of reducing the taxes levied on these items as suggested by Reserve Bank of India

Conclusion

Rising fuel prices do leave consumers in a misery. Government should think of ways to reduce the excise and VAT otherwise the disposable income of the people would get curtailed. There would be less consumption and less demand for other goods and services as major portion of income goes into fuel. It will negatively impact the economy because income of households has already taken a hit due to Covid-19 crisis and taxing them more is not the viable option. Government should try to nudge the industries to produce more fuel in India thereby reducing import dependence. Additionally, it should import from nations which are not part of cartel rather than depending solely on OPEC and Russia.

#FuelInflation #EnergyPrices #InflationImpact #EconomicOutlook #FuelPrices #EconomicAnalysis #InflationaryPressures #ConsumerSpending #GlobalEconomy #EnergyMarkets