Better Late than Never

The mercury was rising across India and so was the inflation rate in past two months. The whopping 14% plus increase in WPI already hit the headlines. Common man was feeling the heat of rising prices while purchasing their daily needs. It did not take much economics to realise that this rise in prices was primarily due to increase in oil price during the period. A quick glance into the crude petroleum market gave us the clear picture. In April 2021 the price of crude oil was hovering around USD 61.35 per barrel which increased to USD 76.99 in January 2022. And then it skyrocketed to USD 102.07 in April 2022. This implies a 66% rise in price of crude oil in just a span of one year and 32% hike in the last three months only. There was no doubt among economists regarding the transmission mechanism which was in action: complete pass through of surge in international price of crude oil to the consumers and retailers by the producers. It definitely triggered the inflation.

Inflation has been always under the surveillance of the RBI as it is one of the main objectives of any Central Bank (CB). In a situation like this, one can expect a contractionary monetary policy from RBI which will eventually raise the interest rates across the board and choke the rising inflation rate. And that’s what RBI did exactly on 4th May 2022 but at a much smaller scale than required. On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) decided to increase the policy repo rate under the Liquidity Adjustment Facility (LAF) by 40 basis points to 4.40 per cent with immediate effect. However, we must understand that RBI was not in a position to raise the rates by significant amount to combat inflation due to the following reasons. We know that the last two years have been difficult for the world economy on account of the COVID-19 pandemic. Repeated waves of infection, supply-chain disruptions and, lack in consumer confidence have created particularly challenging times for policymaking. On top of it the rate of investment in Indian economy has dried down since 2014. Even before being hit by the pandemic, investment in the Indian economy was not at its best. The Indian economy was already in slowdown which further faced hurdles during the pandemic. In order to jumpstart the economy several supply side reforms were
introduced by Central Government. These supply-side reforms included but not limited to deregulation of numerous sectors, simplification of processes, removal of legacy issues like ‘retrospective tax’, privatisation, production-linked incentives and so on in recent times.

Overall, the major macro-economic stability indicators suggest that the Indian economy is well placed to take on the challenges of 2022-23. Given this background it was very unlikely or challenging for RBI to raise the rate of interest by significant amount which would inevitably put a halt in the revival of the economy and not complement the efforts taken by government to put Indian economy back on track. In addition the intensifying of geopolitical tensions, widespread toughening of global commodity prices, the probability of protracted supply chain disruptions, disruptions in trade and capital flows, deviating monetary policy responses and instability in world-wide financial markets are conveying continuously substantial upside risks to the inflation and downside risks to domestic growth. Thus, on one side RBI would surely want to keep the interest rate low. On the other hand, the current spike in inflation demands a hike in the interest rate.

No doubt, the scenario was vulnerable. Economists recognized and suggested that one possible way to slowdown the northward movement of inflation in immediate short run can be achieved to some extent by reducing the prevailing massive taxes and surcharges on petrol and diesel. The components of petrol and diesel prices in India is comprised of price charged to dealers (includes freight charges), excise duty levied by centre, sales tax/Value Added Tax (VAT) imposed by state and dealer commission. Public sector Oil Marketing Companies (OMCs) modify the retail prices of petrol and diesel in India on a dayto-day basis, according to fluctuations in the price of global crude oil. The price charged to dealer includes the base price set by OMCs and the freight price. Last year on average the price charged to dealers makes up 42% of the retail price in the case of petrol, and 49% of the retail price in the case of diesel. On average, state governments collect 23% on every litre of petrol and 15% on diesel.

The Centre earned nearly Rs 8.02 lakh crore from taxes on petrol and diesel during the last three fiscal years, of which more than Rs 3.71 lakh crore was collected in financial year 2021 alone. It needs to be noted that unlike excise duty (levied by Centre), sales tax is an ad valorem tax, i.e., it does not have any fixed value, and is charged as a percentage of the price of the product. This indicates that while the value of excise duty element of the price structure is flat, the value of the sales tax component is dependent on the other three components, i.e., price charged to dealers, dealer commission, and excise duty and thus keeps on varying. On the other hand, centre’s excise duty is 33% and 34% on one litre of petrol and diesel respectively. Thus 56% of the price a consumer pay on petrol/diesel is nothing but tax. Undoubtedly these taxes increase the price of petrol and diesel. Thus, Central and State Governments had no choice but to reduce duties on petrol and diesel. Both Centre and state finally took the stand of reducing huge taxes and duties associated with petrol/diesel (better late than never!) for coming months till inflation cools off and there is a significant drop in oil prices in the international oil market. The decrease in taxes & duties in petroleum and diesel by both state and central governments surely offered some relief to consumers from soaring inflation without hugely troubling the key interest rates.

The article is written by Prof. (Dr.) Subaran Roy, Professor, Jindal School of Government and Public Policy.

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