Why Isn't Fuel Getting Any Cheaper In India: GST And Other Burning Issues

Ever since news of oil prices falling below ground zero broke out, the common man has been expecting a steep drop in fuel prices back home as well. However, this is not something that we have seen happen, and neither has the government signaled anything favorable. This brings us to a very simple question: Why?

Let us try answering this today.

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India loves its oil. Crude oil in its various products and by-products is used for transportation, electricity generation, agriculture machinery, mobile towers, and many other areas. This has pushed India to being the third largest consumer of oil, and according to some reports, is even going to surpass China to stand firmly at second position.

According to the oil ministry’s Petroleum Planning and Analysis Cell, demand for oil in India stood at 211.6 million tonnes, out of which, India met a staggering 83.7% of its needs through imports, spending USD 111.9 billion. This accounts for almost 30% of India’s total imports.

Given these facts, intuitively, the average consumer of fuel in India would expect a strong positive correlation of fuel prices in India with crude prices in the international market. Not only this, they would also assume India to hold significant influence on oil producing nations, being such a large export destination for them. Also, although India’s crude oil production only covers ~17% of its requirements, ramping it up in staggered timeframes can be of use in negotiation. This negotiation would be of more importance, if India goes into strained relationships with its suppliers.

Brent crude prices have tumbled but the average Indian fuel consumer has not been able to gain any benefit out of this.

In view of all these facts, it seems that a decreasing oil price is nothing but good for a consumer country like India. India’s import bills will decrease and subsequently inflation can be kept under control as industry input costs decrease. There is however, a fine print that most of us fail to take note of. Beyond a point, decreasing oil prices no longer offer an advantage. The following is a simplistic flow of events aimed at explaining why the situation is not so favorable for India:

1. India receives remittances to the tune of USD 60-70 billion from major oil producing nations. These remittances are from overseas Indians pumping money into Indian economy through money transfers made for EMIs, purchases and investments.

2. Oil prices slashing to hurtful lows would cause a significantly decreased economic activity in oil producing countries.

3. This would result in a heavy reduction of remittances. Remittance is practically money raised by India, without having to invest its resources.

4. India would have to purchase additional US Dollar to buy Oil now.

While this looks reason enough for India to not want crude prices to fall too low and hence not pass the benefit of low prices to the end consumers, in the current scenario, there is one other factor that prevents the trickling down of benefit to the end consumer.

Under normal circumstances, the upstream companies are hit the hardest when the crude prices fall, while the downstream companies relish the profits. But this time around, even the downstream companies are walking on the thin ice.

Normally, Indian downstream or oil-marketing companies (OMCs) make good money when crude-oil prices show a downward trend. The benefits come in multiple ways – the marketing margins improve, the loss on selling fuel comes down, discounts from oil-producing nations go up. A benign crude means lower working capital and higher profits.

But this time around, the lockdown due to Covid-19 has added a dirty twist to the tale.

There has been a significant drop in demand and senior officials of Indian Oil Corporation (IOC) say retail sales have slipped more than 50% since the beginning of the year till the second week of April compared with the same period a year ago. Diesel sales are down 61%, while petrol and aviation turbine fuel (ATF) sales have declined by 64% and 94%, respectively.

WIth major drops in demand across fuel categories, Indian OMCs face huge losses even in the face of decreasing crude prices in the international markets.

It’s a double whammy for India. Its refiners and oil marketers can’t benefit from a benign crude as there is no demand in the economy due to lockdown. In fact, they are facing margin squeeze and heavy inventory losses. Upstream companies stare at low realisation per barrel and 80-90% dip in profit.

This essentially means that the benefits of the oil-price crash won’t reach the average Indian fuel consumer. But can we pin the entire blame on the closed lanes of lockdown?

The average Indian fuel consumer has not been getting the benefit of falling crude prices since almost a decade. Let's try and change that in the upcoming years.

The question raised here is ably justified by a simple example: By 2017, crude oil price had fallen by two-thirds in 9 years, but petrol price had risen by a half.

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Fuel, at this time does not fall under the GST regime. It still follows the old taxation system, where the centre levies excise duties and other tax on fuel and over it states impose a VAT.

State imposed taxes on fuel forms a huge part of their revenue. For example, Delhi charges a Value Added Tax of 27% on petrol. Similarly, Mumbai charges ~40% VAT on petrol. This clearly indicates how disparate and volatile the prices of fuel are across the country with each state exercising their own control over the prices.

Alongside, the Centre levies an excise duty by terms of value instead of percentage. For e.g. it is ~20 Rs. Per liter on petrol. Keeping tax as a value is another way of keeping the revenue flow constant. In this case, any price fluctuation of petrol would not make the Centre lose money. This would not have been the case if the taxation here was percentage based.

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It might be time for India to think upon including fuel under the GST ambit.

Including fuel under GST, and even putting it under the highest bracket of 28% GST would amount to a huge loss of revenue for state governments. Additionally, it will lead to control redistribution. A colloquium would now decide upon pricing and states would not be able impose their own set of taxes to keep their revenue stream unhindered. Also, a percentage-based tax could further hurt the chances of everyone coming to consensus on the topic.

However, it has certain advantages as well.

To start with, fuel prices across the country will be standardized. Oil companies have to operate with two sets of compliance based on product types GST and Excise Duty and VAT. This leads to increased compliance cost and bringing it under GST will help decrease it. These companies currently can also not apply for Input Tax Credit for having paid GST to companies providing capital goods. Being able to do that would bring another reduction in compliance costs and consequently consumer prices.

Being a part of GST will amend the break in the value chain of GST compliance from capital goods, oil production and refinement to consumption. Depending on the implementation rates, fuel being taxed with GST could also mean lower prices for end consumers. However, that is subject to tax rates, as a completely new system could be formed under GST to bring fuel under its ambit, which might or might not affect rates.

For government bodies, it is important to make this move to reduce their dependence on revenue generated through taxation on crude oil. It is evident that:

1. The external factors involved in pricing are highly dynamic and mostly uncontrollable. The first commodity to get affected due to any geopolitical stimulus is oil. With the most powerful countries involved it can often lead to a catch-22 situation for our country where they might have to decide between oil supply, optimum pricing and international relations. Additionally, oil purchase is dependent on oil prices. Any significant fluctuation in currency value brings a heavy change to India’s Oil import bill.

2. There is a practical end to fossil fuels’ supply and a heavy dependence on a single source of revenue like this is not a sustainable idea. Our revenue generation over the course of 15-20 years should gradually move towards lower dependence on fossil fuel.

However, paranoia of state and central governments over loss of revenue cannot be disregarded. Here, the GST council and the governments would have to come together and meet at a point where revenue generation is reasonable. Perhaps, a completely new rate structure for fuel and other by-products could be a suitable way of implementation. However, increasing it beyond a level would possibly not bring any change for the end consumer. Also, this requires states to practically lose their autonomy and to get anyone to do that is not easy. Higher say would have to be given to states in decision making.

The Centre here could play an instrumental role in not only implementing the decision, but making sure that a smooth transition happens and placating the states’ concerns. When GST was rolled out in 2017, states were ensured that the Centre will cover the lost revenue for states for five years, in case of a shortfall under the new GST regime compared to revenue projections for these years under the VAT regime. A similar plan can be charted out in this situation.

The Central Government could cover the difference in reduced projected revenues for the coming few years until the States could develop other mechanisms for revenue generation, as done at the time of the initial GST rollout in 2017.

Simultaneously, it is important for the States and the Centre this time, to innovate. Newer fuel technology and contribution to higher production based on alternate fuel sources could be a direction to look at. While FAME is a good start by the government to move towards the use of electric vehicles, the shift should be highly incentivised and speeded up and complemented by an equally if not higher increase in supplementary physical, social and policy infrastructure.

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The world order of oil prices is currently unstable and a possible recovery is not coming in before a few months and a worldwide recovery from the Covid-19. Supply cut measures are being made by producers, but prices getting back to their normal stage would take time. It is difficult to initiate talks of bringing fuel under GST at this point of time because there is already a lot at the hands of states.

Possibly, once we are back on the growth trajectory and industries start recovering; this could be the way forward for how India prices its fuel.

Needless to say, crude oil, however necessary, is not the future. The world has been digging new resources of oil, for example, production of oil from Shale Gas. But countries today need to start placing their bets of renewable energy sources and alternate sources of non-renewable sources.

India aims to reduce its crude oil consumption by 15% in the coming future with the help of alternate sources and local production. Railways is targeting meeting 25% of its energy requirements from renewable resources by 2025. A movement towards renewable energy is the only way countries will be able to become sustainable. Working with policies today to grow economically is undeniably of prime importance, but keeping an eye for the future never hurts.