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Tuesday, Oct 26, 2021
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Crude Shock Awaits Centre’s Economic Planning Ahead Of Key State Elections In 2022

Goldman Sachs has raised its forecast for Brent crude oil prices to $90 per barrel from $80 by year-end. The forecast has been revised due to faster fuel demand recovery in the global economy.

Crude Shock Awaits Centre’s Economic Planning Ahead Of Key State Elections In 2022
Crude Shock Awaits Centre’s Economic Planning Ahead Of Key State Elections In 2022
outlookindia.com
2021-09-28T09:11:25+05:30

Even as the centre is looking for ways to meet its fiscal targets without compromising with its expenditure programme, there’s a danger lurking at the horizon that can put the centre in a difficult situation. That danger is the unexpected rise in international crude oil prices.

Goldman Sachs has raised its forecast for Brent crude oil prices to $90 per barrel from $80 by year-end. The forecast has been revised due to faster fuel demand recovery in the global economy.

In case the price of crude oil does reach the level predicted by Goldman Sachs, the government will have to take a call whether it wants to reduce the excise duty collected on petrol and diesel, or continue to earn a higher amount in revenue to meet its fiscal targets.

So far, most international agencies were expecting crude oil prices to hover around $80/barrel by the end of December 2021. 

Brent futures hit a three-year high last week due to global disruption. In the first six months of 2021, crude prices have surged more than 45% already. 

How crude shock can shake the centre 

Due to lower than expected collections under GST since its enactment in 2017, the NDA government has supported its expenditure programmes by levying high excise duty on petroleum products. When Covid led to a complete shutdown of the economy, expecting a veritable fall in its revenues, the centre further hiked excise duty on petrol from Rs 19.98 (in effect from July 6, 2019) to Rs 22.98 from March 14, 2020.

It was further hiked to Rs 32.98 a litre. While the opposition has criticised the centre for charging exorbitantly high taxes on fuel, the government, so far, has put up a brave front, risking a political narrative against itself to support expenditure on welfare schemes like MNREGA and food subsidies. Several state governments have used the same strategy to shore up revenue by keeping high VAT rates on an ad valorem basis on fuel prices. But, historically it’s the central government that takes the blame whenever fuel prices breach a certain threshold in India.

It’s due to high excise duties being charged by the centre along with several state governments that the price of petrol and diesel crossed the Rs 100 mark for the first time in the country earlier this year.

But now, if the crude prices go further up in the international market, the decision to not revise down the excise duties can push the price of petrol and diesel to unprecedented levels in the country. 

High prices of petroleum products directly contribute to higher CPI inflation. Transport and Fuel account for 4.4% of weightage in the consumer prices index. High petroleum prices also contribute to inflationary pressure on several other sectors, including FMCG, paints, fertiliser and automobiles among others.

Between a rock and a hard place

Reducing the excise duty will lead to other problems for the centre, though. If the government bites the bullet and goes for lower excise duty on petroleum products, its revenues may take a hit, jeopardising its ability to control the fiscal deficit. 

The only way to come to terms with low revenue realisation would then be to compromise with its welfare scheme just before the important state elections in the state of Uttar Pradesh and Punjab, among others.

It’s important to note that most international rating agencies have downgraded India’s sovereign ratings due to the centre’s inability to rein in fiscal deficit from 2017 onwards. Reports suggest that the centre is going to make a representation to international rating firm Moody’s to seek a rating upgrade. In June 2020, the agency had downgraded India’s foreign-currency and local-currency long-term issuer ratings to Baa3 from Baa2, which is the lowest grade for a sovereign. 

In its rating review in 2020, the agency has pointed out the weak implementation of economic reforms since 2017. Other reasons that led to the downgrade included low economic growth, high fiscal deficit and increasing stress in the country’s financial sector. 

The centre’s fiscal deficit in 2020-21 was 9.3% of GDP, as revenue from GST and other sources dried up. Had it not been for Rs 2.34 lakh collected through excise duty on petroleum products, the figures would have been much worse for the government. 

 The importance of high excise duties on petroleum is evident from the following figures: The average share of central excise duty on petroleum products was 12% in the gross revenue collection for the period 2017-18 to 2020-21. Share of central government’s excise duty on petroleum products for 2018-19, 2019-20 and 2020-21 stood at Rs2.35 trillion, Rs1.97 trillion and Rs3.44 trillion, respectively.

India imports over 80% of its crude oil requirements, making it one of the most vulnerable large economies to crude price fluctuations. 

According to RBI, a $10/barrel increase in crude prices leads to an additional $12.5 billion deficit, contributing to 43 bps of India’s current account deficit in the economy.

Given the current scenario, any rise in the price of crude oil will give nightmares to the centre. The only respite in this scenario can come from higher than expected GST collections in the coming quarters or other factors in international markets that do not allow crude oil prices to rise by $10/barrel in the next three months. 

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