Oil price rise ends the party for Modi government

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With the oil price crossing $70 per barrel, it is well worth asking if the Narendra Modi government’s luck on the oil front, is running out? On April 25, the price of the Indian basket of crude oil stood at $71.40 per barrel.

Modi became the prime minister of India in May 2014. The price of the Indian basket of crude oil averaged at $106.85 per barrel, during the course of that month. After that, the oil price rose for another month and then started falling.

The average price of the Indian basket of crude oil stood at $84.16 per barrel in 2014-2015. In 2015-2016 and 2016-2017, the average price was at $46.17 and $47.56 per barrel, respectively.

This benefited the Modi government in different ways:

  1. The government captured the bulk of the fall in the oil price by increasing the excise duty on gasoline and diesel. This helped shore up government revenues. In 2014-2015, the revenue the government earned from the excise duty on gasoline and diesel stood at Rs1,158 billion. This jumped to Rs2,311 billion in 2016-2017. As a result, the retail selling prices of gasoline and diesel did not fall much. In fact, the state governments also cashed in on the falling oil prices by increasing their taxes on gasoline as well as diesel.
  2. India does not produce much of the oil that it consumes. In 2017-2018, its import dependency was at 82.8% of its total oil consumption. It was at 81.7% in 2016-2017. Hence, India imports the bulk of the oil it consumes.

Imports are a negative entry into the gross domestic product (GDP) number. Hence, they pull down the GDP to that extent. In 2014-2015, the total oil imports of India in terms of value stood at $124.9 billion. This fell dramatically to $73.9 billion in 2015-2016 and $80.8 billion in 2016-2017, respectively.  The oil-import bill came down by 41% and 35% respectively.

Of course, the falling imports helped in pushing up the Indian GDP to that extent, given that the value of the negative GDP entry on oil imports came down.

This luck now seems to be running out. The price of the Indian basket of crude oil on April 25 stood at $71.40 per barrel. The average price in 2017-2018 stood at $56.40 per barrel, higher than the previous years. This led to the oil import bill increasing to $100.8 billion in 2017-2018, a jump of around 25% in comparison to the previous year. Of course, this jump will pull down the GDP and GDP growth to some extent.

As the latest monetary policy report of the Reserve Bank of India (RBI) puts it: “First, crude oil prices (Indian basket) firmed up from US$56 a barrel in October 2017 to US$67 a barrel in January 2018. Thereafter, they have fluctuated between US$60 and US$67.” In fact, the average price of the Indian basket of crude oil between January and March 2018 has been around $64.8 per barrel. The RBI expects the baseline price of the Indian basket of crude oil to average around US$68 a barrel in 2018-19, which is higher than the average price in 2017-2018. This basically means that if the RBI’s prediction turns out to be true, the volume of oil imported this year will be substantially higher than the previous year. And that is clearly not good news for the Indian economy in general and the Indian GDP growth in particular. This will also put pressure on the value of the rupee against the dollar. In fact, it already is. One dollar was worth Rs63.84 at the beginning of this year (January 1). It is now worth around Rs66.8

Currently, gasoline and diesel are selling at higher prices than they were selling at in May 2014. This, despite the fact that oil prices in May 2014 averaged at close to $107 per barrel, whereas currently they are a little over $71.40 per barrel.

A major reason for this lies in the fact that both the central and state governments have increased taxes on petrol and diesel since May 2014. Interestingly, taxes made up close to 48% of the retail selling price of gasoline (Rs74.06 per liter in Delhi) as of April 16. In May 2014, they formed around 31% of the retail selling price of gasoline (Rs73.60 per liter in Delhi).

Despite oil being much cheaper now than in May 2014, the prices of gasoline are more or less similar. When it comes to diesel, taxes formed around 19% of the retail selling price (Rs57.84 per liter in Delhi) in May 2014. As on April 16, taxes formed around 38% of the retail selling price (Rs65.27 per liter in Delhi).

Given that governments captured the bulk of the fall in the price of oil, it is only fair that they protect the consumer to some extent in a scenario where oil prices are going up

Given that governments captured the bulk of the fall in the price of oil, it is only fair that they protect the consumer to some extent in a scenario where oil prices are going up. Further, with a few state assembly elections scheduled this year, it might be a politically expedient thing to do. While the higher gasoline and diesel prices do not add much to overall inflation, given their low weightage in the consumption basket, their higher prices do register in the minds of people and that is something that should and does worry politicians.

The question is, can the Modi government help consumers by reducing taxes on gasoline and diesel?

In 2018-2019, the Modi government expects to earn Rs2,070 billion through excise duties on gasoline and diesel (Basic and Special Excise Duties excluding Cess on gasoline and diesel + Duty of Excise on petrol and diesel (Road and Infrastructure Cess)). In a scenario where the collections of the Goods and Services Tax, hasn’t been robust, it will be very difficult for the Modi government to reduce the taxes on gasoline and diesel.

Also, 2018-2019 is the year before the next Lok Sabha elections are due (May 2019). In a pre-election year, it is very difficult for the government to cut down on its expenditure.

So what is the way out? In the past, the Congress government asked the government-owned oil companies (oil marketing companies as well as oil production companies) to bear the cost of higher oil prices and not increase the retail prices on gasoline, diesel, domestic cooking gas and kerosene oil, in line with increasing oil prices. Some of this under-recovery was compensated for by the government. A lot of it wasn’t. These companies then made losses and had to survive by taking on working capital loans.

From the looks of it, the Modi government seems to be headed the same way. At a recent energy summit, Modi said: “We need to move to responsible pricing, which balances the interests of both the producer and consumer.” Perhaps this statement serves as a hint of what is to come.

Predicting which way oil prices will head is always a very tricky business, given that so many factors are involved. Nevertheless, in the months to come, oil prices are expected to remain high, given that Saudi Aramco, the biggest oil company in the world, has an initial public offering scheduled. And they are likely to get a better valuation when oil prices are high.

The Modi government must be seriously hoping that this IPO happens sooner rather than later.

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