Modi Has an Oil Problem – and Saudi Arabia Is Set to Make It Worse

Updated on
  • Pressure on government to curb rising gasoline, diesel prices
  • Strong case for Modi to take another excise duty cut: Nomura
Bloomberg’s Anirban Nag explains why Modi’s oil problem is set to worsen.

India’s Prime Minister Narendra Modi has an oil problem. And it’s set to worsen with Saudi Arabia rooting for the commodity to push through the $80 barrier.

Modi’s government made the most of cheap oil by substituting any fall in prices with taxes that kept retail fuel rates unchanged for consumers and boosted the federal revenue. Now, pressure is mounting to forego some of that windfall as pump prices of gasoline and diesel hit records, likely marring the ruling party’s prospects at the national ballot in 2019.

“There is a strong case for the central government to take another excise duty cut, and ask state governments to reduce value added tax,” Anil Sharma and Ravi Adukia, analysts at Nomura Financial Advisory and Securities India Pvt. wrote in a note Tuesday.

Federal Dominance

India federal govt's tax revenue from oil has nearly tripled in five years

Source: Petroleum Planning and Analysis Cell

* As per Bloomberg calculations

Fuel prices have started to pinch as Brent, the benchmark for more than half of the world’s oil, hit $80 a barrel last week. It’s still short of its all-time high of $147.50. But cutting local taxes, which account for more than half of the retail gasoline and diesel prices, would stretch government finances at a time when the subsidy burden on kerosene and cooking gas is climbing.

Assuming an average oil price of $70, the fiscal 2019 subsidy would total about 355 billion rupees, or 105 billion rupees higher than budgeted, according to Kotak Institutional Equities. Meanwhile, Moody’s Investors Service estimates that fuel subsidies could total 340-530 billion rupees in fiscal 2019, the highest since fiscal 2015, if Brent crude oil prices average $60-$80 per barrel.

While Saudi Arabia has avoided pinpointing an exact price target for oil, Bloomberg reported citing people familiar with development that it is aiming for $80 to support the valuation of Saudi Aramco before an initial public offering.

Read more: Rising Oil Risks Modi’s Reforms as Populism May Take Prominence

Tax or Oil

Central and states taxes eat up about half of pump prices

Source: India's Petroleum Planning and Analysis Cell

* Gasoline and diesel prices as on May 23 in New Delhi

Still, the political implications of cushioning the blow for motorists may be more compelling. State refiners that control more than 90 percent of the retail market, didn’t raise gasoline and diesel prices for nearly three weeks ahead of the elections in the southern Karnataka state. Elections for at least four more state assemblies are scheduled later this year.

For the Congress party, which trumped Modi’s BJP to form a coalition government in Karnataka, this is a political opportunity and the party is holding protests against rising fuel prices in the national capital and in Mumbai.

The federal government is said to be mulling a windfall-gains tax on oil producers like Oil and Natural Gas Corp. as a permanent solution for moderating retail fuel prices, the Press Trust of India reported Thursday, citing people familiar. Revenues from the tax may be used to compensate fuel retailers so that they absorb some rise in prices.

Holding prices even for days weighs on the finances of the state refiners Indian Oil Corp., Bharat Petroleum Corp. and Hindustan Petroleum Corp. They end up absorbing the losses since fuel prices have technically been deregulated and the government does not provide any subsidy. Not surprisingly, their shares have been among the worst performers on the NSE Nifty 50 Index this year.

Higher Subsidy Burden

Surging oil threatens India's budget

Source: CEIC, Union budget, Kotak Economics Research estimates

Financial year to March; FY 2019 is budget estimate; Kotak Estimate is for FY 2019 and based on average crude oil at $70 a barrel

— With assistance by Debjit Chakraborty, and Tuhin Kar

(Updates with report on likely government action in ninth paragraph.)
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