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Why The Modi Govt Was Smart To Not Lower Fuel Prices

09/02/2016 8:11 AM IST | Updated 15/07/2016 8:26 AM IST
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PRAKASH SINGH via Getty Images
A petrol fuel pump is pictured at a station in New Delhi on January 16, 2013. Petrol price was hiked late January 15 night by about 35 paise per litre in line with firming raw material cost. Petrol will cost Rs 67.56 per litre in Delhi with effect from midnight, as the state government withdrew VAT exemption on the fuel. AFP PHOTO/ Prakash SINGH (Photo credit should read PRAKASH SINGH/AFP/Getty Images)

India couldn't have been in a better position than it is today, thanks to the crash in crude oil prices. The crash has helped the Indian economy at a time when countries like Russia, Taiwan and Brazil are facing recession while China's growth is at a 25-year low. It has helped the Indian government revive three things which are critically important to the economy -- inflation, interest rates and fiscal deficit. Look back to about three years ago and it was these very factors that almost derailed the Indian economy.

The crude oil prices, which are at 12-year lows in dollar terms, have helped our economy to reach a better position than our peers. But the question that remains is -- if crude oil is 75% down from July 2014 levels in the international market why haven't we been benefited in the same ratio? Some critics have also pointed out that when the crude oil was $150 per barrel in 2012-13, petrol prices were ₹70 per litre, now that the crude prices are $33 a barrel, petrol prices are near ₹60. Why so?

When the crude oil prices crashed, lawmakers decided to give a fraction of the benefits to the Indian consumer, while the remaining was used to cover the fiscal deficit.

While this criticism seems sound on the face of it, it does not factor in that the inflation and interest rates during 2012-13 were alarmingly high. During the time when crude oil prices were $150 a barrel and petrol prices were ₹70, the inflation through 2009-14 was around 10% and fiscal deficit fluctuated in the range of 8-10%. Considering this, the Indian economics during the time seemed wrong because inflation and fiscal deficit are the main drivers of Indian economy.

Why isn't the crude oil crash reaching the end user?

When the crude oil prices crashed, lawmakers decided to give a fraction of the benefits to the Indian consumer, while the remaining was used to cover the fiscal deficit. Apart from this, it is oil marketing companies that keep the crude oil prices high and not the government. Since the crude oil prices crashed, excise duty on petrol has increased 34% while those on diesel increased by a whopping 140%. Hence, the end user ends up paying taxes and excise duty which is more than the actual cost of petrol or diesel. Of the ₹57 we pay for a litre of petrol, nearly 44% is diverted to the government. Similarly, of the ₹44 paid for diesel, 55% is in the form of government tax.

How has it benefited India?

In fiscal 2015, benefits of the crude oil crash to India stood at ₹2 lakh crore. This amount was predominantly utilised towards reducing the fiscal deficit. In fact the fiscal deficit hasn't gone south of 4.5% since 2014. Thanks to the fall in fiscal deficit the inflation levels also reduced to single digits, hovering near 6%. The RBI plans to bring this down to under 5% till FY17.

The crude oil crash also helped the RBI build $350 billion worth of reserves, usually used to stem a rupee fall during turbulent times.

The crude oil crash also helped the Reserve Bank of India build $350 billion worth of reserves, usually used to stem a rupee fall during turbulent times. The value of emerging currencies, including that of Russia, China, Brazil, Argentina and South Africa plunged over 3-5% during the Federal Reserve's interest rate hike and China's Yuan devaluation. The Indian rupee, however, fell 1%-2%, thanks to Reserve Banks of India's intervention. In fact, RBI governor Raghuram Rajan has committed about $20 billion towards anchoring the rupee to ₹65 against the dollar in FY17. Since the sell-off triggered in September 2015, RBI has already deployed about $15 billion to support the rupee.

Although the rupee is still on the higher side against the US dollar, macro-economic factors such as inflation and fiscal deficit are well within controllable levels. Hence, it is safe to say that the Modi government made a wise decision to not lower the petrol prices. Had they done so, it might have seriously damaged the Indian economy.

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