As news of petroleum fuel retail prices hitting new highs every passing day hits the consumer, expectation builds up that the government would cushion the impact by paring the tax component in the final retail price.
The government should meet that expectation, but not yet. Crude prices are likely to remain range-bound, but the rupee could see some depreciation, if the US Fed proceeds with rate increases or the Donald Trump administration triggers events that lead to a flight to safety of funds from emerging markets to the US. Pump prices would go up again. And that would be the right moment for the government to show its concern.
The retail price of petrol includes nearly Rs 40 of central taxes, besides state-level VAT, per litre. The retail price of diesel includes nearly Rs 32 of central taxes, besides state level VAT. It is possible to lighten the tax burden on diesel and petrol, to make them less expensive for the consumer.
But that does not mean that such cheapening of petrofuels would hold inflation down. Taxes on petrol and diesel contribute a significant portion of the Centre’s taxes. If this tax revenue comes down, the fiscal deficit would widen.
In other words, the government would have to dig deeper into the non-government sector’s savings, to finance its expenditure. If the private sector does not have enough savings to spare after meeting its own investment requirements, such government borrowing would result in demand for goods and services from the government and non-government sectors that together exceed what is produced in the economy.
The result would be to increase prices and widen the current account deficit. Bringing fuel prices down could, in other words, raise the general price level, unless the government is able to raise the revenue lost from cutting taxes on fuel from some other source. Voters do not go by macroeconomic reason; they would want fuel prices to be under control. So, the government must cut taxes, but when prices threaten to rise yet again, on the rupee’s depreciation, which, on the plus side, could boost exports.