Higher PL: Penny-wise, pound foolish?

The government has attracted criticism on deciding to make windfall on petroleum prices, as the steep slide in crude oil price offered a tempting chance to make some easy bucks. An average of 1.2 billion liters of diesel and petrol combined, there are Rs15 billion to be had over and above the previous month. That is quite a coup.

The government had set a rather modest target of Rs216 billion in lieu of Petroleum Levy (PL) for FY20. The official 1HFY20 fiscal numbers have the PL already pocketed at Rs138 billion, which makes nearly two-third of the target. While the government will struggle with all sorts of revenue targets, it will easily surpass this one.

By conservative estimates, another Rs80 billion are expected to be in the kitty in 3Q FY20 alone, which makes the government meet the PL target with a whole quarter to spare. Even if the PL rates are lowered from the current high of Rs20/ltr and Rs25/ltr on petrol and diesel respectively, the PL account is likely to be in surplus of Rs70-75 billion by the end of FY20.

From an accounting point of view, having more revenues from one avenue in a time where revenues are difficult to come by and the target is steep – this is a welcome move. Politically too, it is a much easier decision, when the retail price is actually being reduced while jacking up levy.

But accounting is a zero-sum game, with two sides to the equation. What is often ignored in the process of raising more revenues, is the implication a revenue measure could possibly have on expenditure. Any revenue measure is only as good as its net impact. BR Research had raised the question whether additional PL on petroleum products a net revenue item in the fiscal account (see: Petrol price: Opportunity (and) cost, published March 3, 2020).

So, what does a price increase or a partial pass-on of petroleum price do? It leads to higher prices or a lower reduction in prices. This has implication on the CPI inflation. Motor fuel has a weight of 2.9 in CPI inflation. For instance, the latest petroleum price decision, even though it resulted in reduced price, will lead to a contribution of 56 basis points to CPI.

For argument’s sake, let us assume that the PL on petroleum products was capped at FY19 levels – at an average of Rs14/ltr. This would be enough to achieve the FY20 PL target of Rs216 billion, at zero growth in product consumption. The PL in 9MFY20 has averaged Rs19/ltr. An additional Rs5/ltr for 15 billion liters of petrol and diesel combined, means Rs75 billion more in the PL account.

Had PL been capped at Rs14/ltr, the average motor fuel CPI would have contributed an average of 10 basis points for 9MFY20. In actual terms, it has contributed an average of 61 basis points to the headline CPI. This gives you a difference of 50 basis points. Now pause for a moment and think interest rates at 50 bps lower from current rates. Ignore the simplicity of the argument, but interest rates do move with inflation (expectations).

Now go to the expenditure account. Pick the biggest head of account, i.e. servicing of domestic debt. The country’s domestic debt stands at Rs22,000 billion. Every single basis point means Rs2.2 billion in domestic debt servicing. Plug in an interest rate scenario lower by 50 bps – and your domestic debt servicing goes down by Rs110 billion.

Go back to the equation. Additional revenues leading to 50 bps higher inflation impact are lower than the impact they have on domestic debt servicing by Rs30-40 billion. Very surely, an academic study with all the regressions would come up with a more nuanced finding.

But bear in mind, this scenario has not even touched the other benefits of a 50-bps reduction on overall economy, and the indirect impact of motor fuel price reduction on other elements of CPI. The research institutes of the country, with ample resources at disposal, must ask the question, even if the answer is totally different from the initial signs of this scenario analysis. From what it seems today, an additional rupee earned on PL today is not worth it, both in terms of accounting and politics.