Why in News?

• If international crude rates stay stable, Indian Oil Marketing Companies (OMCs) will be able to take a call on reducing petrol and diesel prices, said Petroleum Minister Hardeep Singh Puri.

What’s in Today’s Article?

• Fuel Pricing Mechanism (Working, TPP, Taxes, Dealer’s commission, etc.)
• Limitations on Reducing Taxes on Fuel

Fuel Pricing Mechanism in India:

• Petrol prices were deregulated in 2010 and Diesel prices were deregulated in 2014e. now Oil Marketing Companies (OMCs) determine the prices of these products.
• These prices are not determined by the actual costs incurred by the OMCs such as Indian Oil, HPCL and BPCL on crude oil sourcing, refining and marketing.
• Rather, a formula — Trade Parity Price (TPP) — is used to price these products.
• TPP Formula:
  • TPP is based on the calculation that 80 per cent of petrol and diesel is imported into India and 20 per cent is exported.
  • So, petrol and diesel prices in India are determined based on prices of these fuels in the international market — and not on the basis of crude oil prices.
  • While international petrol and diesel prices generally move in line with crude oil prices, it need not always be the case, given that demand and supply dynamics could be different.
• From June 2017, the pricing of petrol and diesel is done through a daily pricing mechanism, based on a 15-day rolling average international rate.

Why are Fuel Prices Different in Each State:

• Apart from TPP, there are three other factors that determine the price of petrol and diesel in India:
  • Excise duty charged by the Central Government
  • Value-Added Tax (VAT) charged by the State Governments
  • Dealer commission to the gas stations
• In some states, fuel prices attract higher VAT compared to others, which further increases the price disparity.

Excise Duty Component:

• The excise duty levied on petrol and diesel consists of two broad components:
• Tax component (i.e., basic excise duty), and
• Cess and Surcharge component. 
• Of this, only the revenue generated from the tax component is devolved to states. 
• Revenue generated by the centre from any cess or surcharge is not devolved to states. 
• Currently, the Agriculture Infrastructure and Development Cess, and the Road and Infrastructure Cess are levied on the sale of petrol and diesel in addition to the surcharge.

Limitations on Tax Reduction on Fuel:

• Weakens the Fiscal Deficit:
  • A cut in excise results in the fiscal deficit widening.
  • A cut of Rs 1 in petrol and diesel can result in an estimated loss of Rs 25,000 crores every year to the government.
• 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.
• Reflects Poorly:
  • Frequent policy changes is not welcomed by investors and hinders easy flow of capital, whether through FDI or through capital inflows.
• Under watch from Credit 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 Rs 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.