Signage of Hindustan Petroleum Corporation Ltd. seen at one of its petrol pump station in Bengaluru, India. (Photographer Anirudh Saligrama/ BloombergQuint)

Fuel Price Cut: Inflation Relief But Fiscal Uncertainty Seen Rising

In a bid to rein in record-high prices of domestic fuel products, the central government announced an intention to reduce the cost of auto fuels by Rs 2.5 per litre. Of that, the central government will contribute Rs 1.5 per litre, while oil marketing companies are being asked to bear the rest of the burden. States, too, are being asked to cut taxes to provide further relief to customers.

While the announcement will add some uncertainty to the state of government finances, it will bring inflation relief to consumers, said economists.

The government’s decision to cut the excise duty will mean some relief for consumers, but at a fiscal cost...We expect the Reserve Bank of India to view the fiscal risks due to lower fuel taxes as outweighing any inflation benefits.
Sonal Varma, Chief India Economist, Nomura

Also read: Petrol, Diesel To Be Cheaper As Government, States Cut Prices

The Fiscal Math

Finance minister Arun Jaitley downplayed the fiscal implications of the price cut and said that higher direct tax collections would offset the impact. Economists, too, see only a marginal impact of the price cuts on the fiscal deficit.

Shubhada Rao, chief economist at Yes Bank, explained that a Rs 1 cut in excise duties levied on petroleum products leads to a loss of Rs 14,000 crore in revenue for the government. Going by that calculation, the Rs 1.5 cut could mean a loss of Rs 21,000 crore in annual revenue.

Considering that we are halfway through the year, the impact on fiscal deficit this year would be Rs. 10,500 crore, said Rao. Basic excise duty is split between centre and states with 58 percent to the centre and 42 percent to the states, she further explained. So net impact on the centre’s finances would be between Rs. 5,500 crore to 6,000 crore.

The government is targeting a fiscal deficit of 3.3 percent for FY19 compared to 3.5 percent of GDP in FY18. Last year, the government missed its initial fiscal deficit target of 3.2 percent of GDP.

At the end of August 2018, the fiscal deficit stood at Rs 5.91 lakh crore, according to the data released by the Controller General of Accounts. The gap was 94.7 percent of the budgeted estimate compared to 96.1 percent in August last year.

The Inflation Impact

The direct impact of the central government announced price cuts on inflation could be between 10-15 basis points, said economists. Should states start to match the tax cuts, as some have already done, the positive impact on inflation could be more pronounced.

The Rs 2.5 per litre cut in prices could bring down retail inflation by 9 basis points, said Devendra Pant, chief economist at India Ratings. A matching cut in value added tax by state governments would result in retail inflation declining by 16 basis points. Rao, too, expects an inflation impact of about 10 basis points.

The price cuts, however, may not be enough to alter expectations of a further increase in rates when the Monetary Policy Committee announces its decision on Friday. “The move is positive as it will placate prices and inflation. However, if the crude price continues to go up and the rupee falls, this would then have only limited impact,” said CARE Ratings in a report.

Consumer price inflation fell to 3.69 percent in August but is forecast to rise to 4.8 percent in the second half of the year, according to the RBI’s estimates.