4 Reasons The Government Cannot And Should Not Reduce Fuel Prices

There are three reasons why fuel in India moves higher or lower. The first is the impact of global crude prices. The second is the rupee movement against the dollar and the last is government levies, including excise and state levies like Value Added Tax (VAT).

The central government has direct control over excise, which it can reduce, but, the costs to the nation can be enormous. The other factors it has no control over.

Why it is a predicament for the government to reduce excise rates on fuel prices?

Let us examine some simple reasons why the government cannot reduce petrol and diesel prices, through a cut in excise, the only lever, directly under its control.

1) Under watch from rating agencies

Each time the government acts to reduce excise on petrol and diesel, they come under the glare of the global rating agencies. Take the case of the recent cut in excise on petrol and diesel by Re 1 per litre. One of the leading credit rating agencies was quick to point out that it is "credit negative" and could result in the fiscal deficit rising by 0.1 per cent.

No government would want a sovereign rating downgrade from the global rating agencies, which could result in an outflow of foreign capital. Least of all when the rupee is falling, as capital outflows could aggravate the fall.

2) Weakens the fiscal deficit

A cut in excise results in the fiscal deficit widening. A cut of Re 1 in petrol and diesel can result in an estimated loss of Rs 25,000 crores every year to the government. It can also widen the fiscal deficit. This is again not the best option, as a high fiscal deficit has its own ramifications.

For example, it is a keenly watched number not only by global rating agencies, but, also by analysts tracking the equity markets. A deterioration in the fiscal deficit number, can result in large amount of capital outflows from Foreign Portfolio Investors.

In the past, the nation has seen fiscal profligacy. At least the present dispensation, under the Narendra Modi government is showing the resolve to stick to fiscal prudence. In fact, Finance Minister, Arun Jaitley has gone on record saying that he would stick to the fiscal deficit of 3.3 per cent of GDP for FY 2018-19. This is not possible with frequent excise cuts on petrol and diesel.

Remember, the government has already to bear subsidy costs of Kerosene and LPG (for most), when global prices of crude move higher.

3) Hinders economic development

A reduction in revenues (like excise cut on fuel), means the planned expenditure of the government has to be curtailed. This can reduce the government's outlay in crucial areas, including infrastructure and healthcare. We do know that at a time when private investment is just not picking up, it is crucial for government expenditure to push growth, especially in infrastructure, that helps create jobs.

The government's highway development project - Bharatmala, entails an expenditure of a staggering Rs 5.35 lakh crore. Where will the money come from?

4) Reflects poorly

Petrol and diesel prices in the country are deregulated. This means they are linked to market prices. When you engage in constant intervention, it reflects poorly and a negative perception develops. Frequent policy changes is not welcome by investors and hinders easy flow of capital, whether through FDI or through capital inflows.

Remember, investors love governments that can take hard decisions, for economic prosperity in the more long-term. Hence, short cuts must be avoided.

Conclusion

It is likely that crude prices would fall in the more medium term. Taking a hasty decision to reduce prices, is not in the best interest of the nation.

In fact, as we we write, international crude prices have dropped sharply and the rupee has gained. We could see the benefits of both in the next few days, by way of lower petrol and diesel prices. It maybe time to be a little more patient and wait for things to cool off. As the old ad age goes: "patience is the mother of all virtues".