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Fuel Tax Cuts Bring Inflation Respite, Fiscal Impact

Excise duty cuts could help pare headline inflation by 30 basis points, including second-round effects.

<div class="paragraphs"><p>A fuel pump nozzle sits in a vehicle at a Hindustan Petroleum Corp. gas station in New Delhi, India. (Photographer: Anindito Mukherjee/Bloomberg)</p></div>
A fuel pump nozzle sits in a vehicle at a Hindustan Petroleum Corp. gas station in New Delhi, India. (Photographer: Anindito Mukherjee/Bloomberg)

The government's decision to finally reduce the excise duty on petrol and diesel — matched by a number of states — will help bring down headline inflation and ease the burden of second-round price effects. While the burden of fuel price eases, other pressures such as volatile vegetable prices may continue to be a point of concern.

The Narendra Modi government cut excise duty on petrol and diesel by Rs 5 and Rs 10, respectively, on the eve of Diwali. The decision came after retail prices scaled new records almost every day on rising crude prices. But prices at the pump had also surged because the government had increased levies on fuel to shore up revenue during the pandemic.

Relief For Inflation, Demand

The paring of these duties will help bring down headline inflation by about 30 basis points, said Neelkanth Mishra, India strategist for Credit Suisse.

The oil tax cuts reroute the positive tax surprises ($30 billion for centre), and also cut Consumer Price Index inflation by 30 basis points, offsetting some of the built-up second-order inflationary pressures (e.g. bus/taxi fares). But, vegetable prices may be high till December as October rains were 30% above normal.
Neelkanth Mishra, India Strategist, Credit Suisse

According to Mishra, the sharp rise in prices of key energy imports like crude oil, gas, coal, palm oil, and fertilisers had meant a substantial worsening of India's terms of trade. Energy (and proxy) imports in the last three months are up 1.1% of gross domestic product over FY20 and 2.5% over FY21, he said. "Not only does the extra $41 billion per year take away from consumption, costlier dense energy is a drag on productivity and growth."

Nomura estimates that the tax cuts should lower CPI inflation by 14 basis points directly and by up to 30 basis points if indirect effects are included. There are offsets from elevated input costs, reopening pressures and an ongoing energy crunch, it said.

Reduced fuel prices should be positive for consumption, but we maintain our FY22 GDP growth projection of 9.2% year-on-year, as we see downside risks from supply-side bottlenecks due to chip and energy shortages.
Nomura

Impact On Fiscal Deficit

The actual impact on inflation will depend on tax cuts but also the trend of global fuel prices in November, said Gaura Sengupta of IDFC First Bank.

"Sensitivity analysis provides a rough rule of thumb of the impact on inflation due to cut in excise duty at around 13 basis points (decrease in headline CPI). The actual impact could be lower if global fuel prices continue to rise," Sengupta said.

Oil marketing companies, the research house said, haven’t fully passed on the rise in global fuel prices to consumers. "So, we could see a lower impact of the excise duty cuts on inflation." In 2021, India's crude basket has risen 69%, while retail petrol prices have risen 28% and diesel 32%, the note said.

The tax cuts, in turn, would entail an impact for government finances.

We estimate the gross revenue loss to the centre at Rs 49,500 crore or 0.2% of GDP for the remainder of FY22 (November to March). Incorporating the reduction in fuel excise duty revenues, we estimate centre’s FY22 fiscal deficit at 6.4% of GDP versus target of 6.8% of GDP.
Gaura Sengupta, IDFC First Bank

Nomura's estimates are similar.

"We estimate the tax cuts could cost the government 0.45% of GDP on an annual basis and 0.2% of GDP for the remaining months in FY22," it said. "We revise our estimate of the fiscal deficit to 6.5% of GDP (previously 6.2%) versus the budget target of 6.8%."