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Fuel tax cuts will help ease price pressures, but inflation is likely to remain elevated

This is the second time in the recent past that the Centre has cut fuel taxes. In November last year, the Centre had lowered the excise duty on petrol by Rs 5 and by Rs 10 on diesel.

These decisions are driven by the desire to cool the surge in inflation — recent data showed that retail inflation had risen to an eight-year high of 7.9 per cent in April, while wholesale inflation has been in double digits for 13 consecutive months.

On Saturday, the Union government announced a reduction in the excise duty on petrol and diesel by Rs 8 per litre and Rs 6 per litre respectively. Alongside, the government also reduced the customs duty on raw materials and intermediaries for plastic products and iron and steel. Undoubtedly, these decisions are driven by the desire to cool the surge in inflation — recent data showed that retail inflation had risen to an eight-year high of 7.9 per cent in April, while wholesale inflation has been in double digits for 13 consecutive months. But, implicit in these decisions is also the acknowledgement that both fiscal and monetary policies are needed at this juncture to curb inflation. As per some analysts the cut in fuel taxes could help reduce inflation directly by around 20 basis points in June when its full impact will be visible. The second-round effects are likely to be equally strong.

This is the second time in the recent past that the Centre has cut fuel taxes. In November last year, the Centre had lowered the excise duty on petrol by Rs 5 and by Rs 10 on diesel. Back then, 21 states and some Union Territories had followed suit, cutting the VAT. If state governments follow suit this time also, the relief could be higher. Prior to this cut, taxes imposed by the Centre and states accounted for almost 43 per cent of the retail selling price of petrol. But with the latest cut, the government has brought the excise duty back to pre-pandemic levels. As per the finance minister, the reduction in excise duty will lower the government’s revenue by around Rs 1 lakh crore. However, it is possible that this loss in revenue is offset in part by higher collections through other sources. As per some analysts, the government’s tax revenues will exceed budget estimates by around Rs 1.3 lakh crore, even after this cut.

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While this decision will have a moderating influence on price pressures in the economy, the worry is that inflation has become entrenched. As per projections by analysts, inflation is likely to remain above the RBI’s inflation targeting framework. To tackle this surge in inflation, analysts had, prior to this move, expected the monetary policy committee (MPC) to raise rates aggressively over the course of the next few meetings. The MPC, in its next meeting which is scheduled a few weeks from now, must not only release an updated forecast for inflation, but also shed some clarity on the extent of monetary tightening it envisages, and over what duration to bring inflation in line with its target.

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First published on: 23-05-2022 at 03:54:47 am
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