An inevitable decision: Duty hikes on oil are a practical move in the face of a tough external environment

With the rupee drifting to newer lows every other day on fears of a widening current account deficit (CAD) and no sign of a softening of crude oil prices, the government has chosen to restrict exports of auto and aviation fuels and imports of gold by imposing stiff levies. The objective is to arrest imported inflation, contain the CAD and stem the depreciation of the rupee, which has given up more than 2% against the dollar over the past week. A cess of $40 per barrel on crude oil production, aimed at cashing in on windfall profits, as also the export levies of Rs 6 each per litre of petrol and diesel and Rs 13 per litre on ATF will certainly hurt the businesses of oil producers and exporters. One could also argue such out-of-turn revisions in duties are generally undesirable in the interest of tax structure stability.

But these are extraordinary times, calling for difficult decisions, as finance minister Nirmala Sitharaman has said. After all, the government has to secure fuel supplies for the country at a time of rising global shortages. The government has mandated that exporters must supply 50% of the exported quantity in the home market in the current fiscal. India exported 42% of its diesel and 44% of its gasoline production in FY22 and similar amounts in 2022 so far. These are not insignificant amounts. The government thus cannot be faulted for wanting to retain some of this for local use. While it might seem unfair to tax the windfall gains made by oil producers who sell crude oil to domestic refineries at international parity prices, the government’s need to mop up resources to take care of both planned and additional expenses is understandable. Government spending is necessary to keep the growth momentum going. In any case, the government has already indicated that the additional levy will be a short-term measure and will be reviewed every 15 days for recalibration.

The strategy of preparing for what could be a prolonged period of unfavourable conditions in the global markets can’t be faulted. With no end in sight to the geopolitical tensions, crude oil prices continue to rule at above $110 per barrel. Moreover, it is now apparent that central banks will need to persist with hike rates and tighter monetary policies to be able to tame inflation. From India’s perspective, elevated crude oil prices will push up the import bill, the trade gap and, consequently, the current account deficit. India’s CAD is now expected to hit 3-3.5% in FY23. Moreover, the knowledge that the dollar will not just remain strong but could even get stronger has sent the rupee to new lows.

Reining in of imports by deterring exports of petroleum fuels could help contain both imported inflation and the trade deficit. To be sure, the rupee has performed better than several other currencies. But some of this outperformance has been the result of interventions by the Reserve Bank of India. As experts have pointed out, while RBI’s forex kitty is reasonably large at $590 billion, it cannot continue to supply dollars in these uncertain times. Foreign portfolio investors have pulled out some $29 billion since the start of the year. To be sure, the central bank isn’t required to support the currency each time it goes down, but a runaway depreciation will only exacerbate inflationary pressures, which in turn, would necessitate higher interest rates.

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