Amid mounting pressure and threat of high inflation, Centre finally cuts fuel price

Following the central government’s announcement, Maharashtra, Chhattisgarh and Gujarat also cut state tax on petrol and diesel.

READ | Fuel price cut by Rs 5 in some BJP-ruled states after Centre reduces excise duty

Why the government waited this long to cut prices

Taxes on petrol and diesel are a key revenue source for both the Centre and states and a cut will hit their budget sheets. The central government has used excise duty on fuel nine times between November 2014 and January 2016 to improve its finances thanks to the fall in global oil prices. The only time it cut excise duty was in October 2017.

Rates of state sales tax or Value Added Tax (VAT) vary from state to state. Unlike excise duty, VAT is dependent on the value of the fuels and is not set. So a higher price results in higher revenues for the state when rates move up.

Most states that impose the highest tax rates on petrol and diesel are struggling with high gross fiscal deficit and chose to keep prices high to improve their balance sheets.

What’s prompted a sudden change in mind?

Among other things, the threat of high inflation due to higher fuel prices and the anger over it.

Finance minister Arun Jaitley said that inflation is moderate — at less than 4 per cent — and higher direct tax collections give comfort with regard to fiscal deficit, despite the fuel hike. The Finance Minister has maintained that domestic macroeconomic indicators are strong and stable, except for current account deficit.

The Finance Minister blamed global oil prices, that have been on the rise as a result of which prices of diesel and petrol have risen dramatically over the last few months. But higher fuel prices would also mean higher inflation, which along with a weaker rupee, could prompt India’s central bank to raise interest rates, possibly more than expected. Higher interest rates will hit lending, which in turn could bring down growth.

ALSO READ | Oil firms stocks suffer after Centre’s excise cut, tank up to 12 per cent

With speculation growing for steeper interest rate rises, India’s benchmark 10-year bond yield rose as much as 10 basis points to 8.21 percent, not far from 8.23 percent hit in late September, which was the highest since November 2014.

This comes in addition to other macroeconomic problems the country is facing.

The rupee has been steadily depreciating against the dollar and hitting new lifetime lows. On Thursday, it hit 73.82 per dollar, which makes buying oil costlier. It also hasn’t helped that the US has raised interest rates, which has resulted in investors selling their investments in emerging markets like India.

The government has attempted multiple measures to calm markets. On Wednesday it allowed state oil marketing companies to raise $10 billion in overseas loans to help them cover the sharp rise in price for imported oil. The government had earlier raised import taxes on multiple imported goods.

Last week, the RBI’s eased banks’ liquidity coverage ratio norms last week and announced it would be buying 360 billion rupees of government bonds through open market bond purchases. However, these measures have only had limited impact so far.