Here’s why the Indian government is not being able to cut fuel prices
Fuel pricesin India reached an all-time high again today partly owing to the continued depreciation of the rupee.
- Rather than cutting taxes on fuel, the government is instead trying to stem the slide in rupee by selling rupee-denominated bonds to foreigners and NRIs.
- A cut in fuel duties runs the risk of increasing the
fiscal deficitfurther, which will, in turn, lead to the rupee’s depreciation.
The central government, led by the BJP, has ruled out a cut in duties on fuel. In addition to a customs duty of 2.5%, the excise duty on fuel is currently ₹19.48 per litre while it is ₹15.33 per litre for diesel. The rates have been raised nine times and decreased only once since the BJP government came to power in May 2014.
The rising price of fuel is mainly due to the fact that India imports most of its oil and the rupee is currently at an all-time low against the dollar. Rather than cutting taxes on fuel, the government is instead focusing on trying to stem the slide in rupee by selling rupee-denominated bonds to foreigners and NRIs, which will make the rupee appreciate.
Why is the government refusing to cut fuel prices? While protests from the Opposition indicate that the central government has a choice in the matter of fuel duties, which it does in principle, the actual reality is that it is lodged between a rock and a hard place.
A affects B which affects C which affects A
The government is currently dealing with a large, and growing, fiscal deficit - which occurs when its expenses outweigh its revenues. It is able to keep this deficit in check (within the range of 3% of GDP) partly owing to the duties it imposes on fuel and fuel products.
However, if the government were to cut fuel duties and risk a widening of its fiscal deficit, the rate of yield on its rupee-denominated bonds would be higher in light of the increased risk associated with them. This, in turn, would make them less attractive to investors, potentially leading to further depreciation of the rupee. Hence, in order to cut fuel prices, the government would find itself in a position where the rupee was worse off than it was before, which would counteract the effects of the initial reduction in fuel duties.
However, this does not mean that the government will never be able to cut taxes on fuel. Once it is able to increase revenues from duties and taxes on non-oil products, which will follow heightened GST compliance and the continued crackdown on tax evasion, then its fiscal deficit will be able to bear the brunt of a reduction in fuel duties. Countries which feature a high rate of tax compliance usually have much lower duties on fuel, relative to India.
Rates can also be cut at the state level, wherein
Banking on RBI intervention
The Indian government has asked the RBI to intervene in capital markets and prevent the rupee from depreciating further. The central bank has been withdrawing funds from its foreign exchange reserves to prop up the rupee and prevent volatility in recent months, however this hasn’t proved an adequate solution. It will likely raise interest rates for the third successive time to keep inflation and check and to prevent capital outflows.