Opinion: Windfall taxes make sense

By Dr Manoranjan Sharma

The imposition of the windfall taxes and export duty evoked considerable debates across the development spectrum. The basic justification for the windfall taxes and export duty tax on petrol, diesel and Aviation Turbine Fuel (ATF) hikes imposed on July 1, 2022, stems from the fact that some oil refiners were raking in “phenomenal profits” while domestic supplies were bleeding. Small producers whose annual crude production in the previous fiscal year was less than 2 million barrels were excluded from this cess. Domestic petroleum product pricing remained unaltered by this cess.

Indian measures are similar to the Chinese action. Refinitiv Eikon reveals that Asian refining margins of diesel rose over 192% post the Ukraine war amid a global shortage and changes in trade flows, while the gasoline cracks have more than doubled on tight supplies and recovering demand. Given this asymmetric and uneven level playing field, the government rightly stepped in to remedy this completely unacceptable situation.

New Rules

The government also framed new rules requiring oil companies exporting petrol to sell in the domestic market, the equivalent of 50% of the amount sold to overseas customers, for the fiscal year ending March 31, 2023. For diesel, this requirement was 30% of the volume exported. These export restrictions were also aimed at enhancing domestic oil supplies while curbing diesel and gasoline exports.

Given the high price differential, it is no wonder that private refiners were increasingly taking the export route rather than doing local sales. These well-conceived measures would thus help boost domestic supplies of petrol, check abnormal profits of a few firms, reduce sectoral arbitrage and the inherent asymmetry in the system.

Given the severe fiscal crunch, which was exacerbated by the Central government’s slashing of fuel taxes, subsidised gas cylinders, capped sugar exports and permitted duty-free import of 20 lakh tonnes of crude soya-bean oil and sunflower oil in late May to check the inflationary spiral (estimated to cause a hit of over Rs 1 lakh crore to public finances), this measure is expected to generate close to $12 billion (Rs 94,800 crore) for the government in this financial year. Hence, it would almost offset the hit caused by reduced fuel taxes.

Correcting Anomaly

In sum, the government’s move was aimed at correcting an anomaly in the system, boosting tax collections and moderating the northward movement of prices (sticky CPI inflation, which rose for the seventh successive month from 7% in March 2022 to a 95-month high of 7.8% in April 2022; 15% WPI inflation, the highest in 3 decades, breached the MPC mandated threshold of 4% /-2%). This measure would thus have a wholesome effect on the twin current account deficits (record monthly trade deficit of $24.3 billion in May 2022) and fiscal deficit and achieve both the avowed objectives.

This would adversely impact global fuel supply modestly because global fuel supplies shrank in the aftermath of the Russia-Ukraine war. It would also disrupt the oil market and debilitate the incomes, profits and profitability of some Indian companies. But the credit quality of RIL, ONGC, Vedanta and Nayara Energy is unlikely to deteriorate significantly because their margins continue to be healthy.

The refiners or the downstream companies export oil products at high global prices and gain windfall profits. But this does not apply to state-owned upstream national oil companies like ONGC, which, in turn, have exclusive MoUs to sell their crude production in the domestic market only. Their prime buyers are the state-run refiners like IOC, BPCL and HPCL. There is, however, no such compulsion on private entities like Reliance to sell their crude only to state-owned refiners.

At the macro level, these innovative, out-of-box measures would reduce export receipts but higher Customs duties on gold imports would help contain the current account deficit within manageable proportions.

India’s foreign exchange reserves ($593.323 billion during the week ended 24 June 2022) are quite healthy in terms of accepted benchmarks. To be sure, India’s foreign exchange reserves could take a hit because of the rising repayment of external debt. But there is no reason for concern —much less alarm — in this sphere.

These windfall taxes certainly make sense because of the stark ground-level realities and the evolving macro-economic situation. What is contextually significant is the fact that the government will review these measures every two weeks based on international oil prices (Asia’s third-largest economy imports about 85% of its annual oil requirements), inflation, external balances and a currency depreciation (the rupee has depreciated 6% against the US dollar during FY23 because of the strength in the US dollar and investors pulling out an unprecedented $28 billion from the domestic share markets). This depreciation is, however, modest relative to other emerging market economies and even major Advanced Economies.
In the event of crude prices crashing because of a synchronised prolonged global slowdown, windfall gains will cease and there could conceivably be a rollback of these creative measures, just as it happened recently when the Centre reduced the windfall tax on diesel and aviation fuel shipments and scrapped the export tax on petrol.

 

(The author is Chief Economist, Infomerics Ratings, Delhi)