Here’s why the Indian government’s intervention to stop rising fuel prices may only be a temporary relief

• Fuel prices cut by ₹2.50 ($.034) a litre in several states across India.
  
• Govt cuts taxes on diesel and petrol by ₹1.50 per litre and asks state-run oil marketing companies to cut prices by ₹1 per litre.
  
• Global oil prices still a major factor on how petrol and diesel are ultimately priced.
  

After months of rising fuel prices with record high petrol and diesel prices in major Indian cities, the Indian government has finally intervened, cutting petrol and diesel prices by ₹2.50 ($.034) a litre in several states across India.

It has done so by slightly cutting the excise duty, a type of indirect tax, on imported diesel and petrol by ₹1.50 per litre and directing several state-run oil marketing companies to cut prices by a further ₹1 per litre on the sale of petrol and diesel. Government taxes are estimated to account for nearly 40% of retail prices of petrol and diesel.

As of Thursday, petrol prices in Delhi had climbed to ₹84 per litre and ₹91.34 in Mumbai; diesel was being sold at ₹75.45 and ₹80 in Mumbai. Overall, fuel prices had increased by at least 10% in the last month alone.

Uncertain global oil prices and fiscal situation

While the recent tax cut by the government resulting in the lower fuel price is great news for consumers, global oil prices are still a big determinant on how petrol and diesel are ultimately priced in India. Global fuel prices, however, have been on the rise with the international benchmark Brent crude nearing a four-year high of $86 per barrel earlier this week.

India currently mainly relies on oil imports, which make up about 80% of its current oil consumption. The price of crude oil, which makes up almost 90% of oil imports, is a major factor behind the final price of petrol and diesel in the country.

While it may seem the Indian government certainly has room for slashing taxes further on fuels, the recent cut is estimated to cost the government ₹2.7 trillion. According to analysts that amount will exert marginal pressure on the country’s fiscal deficit, which is being closely watched by international ratings agencies and the country’s capital markets. Any further revenue loss, however, could widen the fiscal deficit.

Meanwhile India’s finance minister Arun Jaitley has indicated that the government plans to draw on other indirect taxes like the GST to offset the additional burden on the government revenues, but in recent years the BJP government has relied heavily on taxes collected on petrol and diesel to prop up India’s fiscal deficit which had widened to 4.4% of GDP as of March 2014. When the global crude oil prices were at a historic low, the government continued to collect higher taxes on fuel, a strategy that in part helped it lower the fiscal deficit to 3.5% of GDP in the latest fiscal year. It aims to bring it down further to 3.3% of GDP in the current fiscal, an important year with the upcoming general elections in 2019. But with a weakening rupee, it will likely have fewer options in the form of import-related tax cuts.