Why gas is the important thing to excessive inflation, and why that is dangerous information

In May 2021, inflation as measured by the Wholesale Price Index (WPI) was 12.94%. This is the highest value in the current series, which starts in April 2012. Inflation is the rate of price increase.

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Source: Center for Monitoring the Indian Economy.

One reason for this increase is the base effect. Prices in May 2020, as measured by the WPI, were down 3.37%.

The other reason is the surge in oil prices between May 2020 and May 2021. Data from the Petroleum Planning and Analysis Cell tells us that the average price of the Indian crude oil basket in May 2020 was $ 30.6 a barrel, averaging 66 in May 2021 .95 USD doubled a barrel. This drove up fuel prices over the past year.

Under WPI there is an entry entitled “Mineral Oils” which includes gasoline, diesel, household cooking gas, kerosene, jet fuel, and so on.

Mineral oils have a weighting of 7.95% in the WPI. Their prices rose 81.16% last year, responsible for much of the inflation. Almost half of the total inflation of 12.94%, that is 6.45% (7.95% from 81.16%) comes from the increase in fuel prices. Basically, to say it again, almost half of inflation is due to the rise in fuel prices.

But all of this is beneficial in hindsight. The question is what the future holds for us. Let’s look at that selectively.

1) Oil prices have risen because the global economy is expected to do better than last year as more people are vaccinated and economic activity recovers. In fact, the price of the Indian crude oil basket had risen to $ 72.98 a barrel on June 11th. As long as the global economic recovery remains intact, the oil price will remain higher than last year. In fact, the monthly average of the Indian crude oil basket hovered between $ 40 and $ 44 per barrel between June 2020 and November 2020. This means that if the price of oil does not fall in the months ahead, inflation as measured by the WPI will remain high.

2) Besides the high price of oil, there is something else at play. Since winning the Lok Sabha elections in 2014, one of the current government’s strategies for generating revenue has been to raise taxes on petroleum products. The original justification for the strategy was that oil prices are going down and we are therefore raising taxes. According to this logic, taxes on petroleum products should fall when oil prices rise. But that didn’t happen. The main reason for this is that tax collection has slowed down in recent years. Gross tax receipts amounted to 11.23% of GDP in 2017-2018. This fell to 10.25% of GDP in the period 2020-21.

Corporate tax collections fell from 3.34% of GDP to 2.32%. The main reason for this was a massive reduction in corporate tax rates in September 2019. The goods and services tax (GST) never turned out to be the expected money-thrower. The central GST surveys in 2018-19 (the first full year of the GST) had amounted to 2.42% of GDP. They fell to 2.31% in the period 2020-21. The central government has tried to compensate for the lower taxes by increasing excise duties on gasoline and diesel. In addition, much of these excise taxes are collected in the form of levies and surcharges that the government does not have to share with states.

Take a look at the table below which shows central government excise duties over the past few years.

Source: Petroleum Planning and Analysis Cell.  Between April and December 2020.

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Source: Petroleum Planning and Analysis Cell. Between April and December 2020.

As can be seen from the table above, the excise duty on petroleum products was from April to December 2020 2.36 trillion. In the nine months of the last financial year alone (2020-21), more excise taxes were earned than in previous years. It’s safe to say that the central government earned more than it earned 3 trillion through this route in the last fiscal year. At that point, the overall economy was shrinking and there were lockdowns in large parts of the country throughout the year, hampering movement.

As a result, the central government’s tax levies on petroleum products increased, although petroleum product sales fell by 9.1% over the course of the year. This happened mainly because the government massively increased excise taxes on petrol and diesel in the past fiscal year.

3) The high excise tax on petroleum products is expected to persist through 2021-22 as the low levies on the corporate tax front will continue and the government will have to compensate for this from somewhere. This will increase inflation as measured by the WPI. It will also affect private consumption in its own way. With incomes stagnating or not rising at all, the extra money people end up spending on petroleum products has to come from somewhere. And that means spending cuts in other areas.

Vivek Kaul is the author of Bad Money.

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