Gradually rising inflation and the recent surge in crude oil prices pose a new concern for India's fiscal health, Barclays India said in a report.
The country's reliance on fuel taxes is posing questions for the government as higher crude prices feed inflation, said Rahul Bajoria, Chief India Economist at Barclays.
"Cutting excise duty would only delay inflation thanks to the wider fiscal deficit. That may buy some time for the recovery, however," he stated.
Although at current levels, international oil prices are unlikely to pose a major challenge to India's macro stability, the country will have to manage the inflation/fiscal deficit trade-off as oil prices climb, Bajoria noted.
Over the past one month, Brent crude oil prices rose sharply by around 18% to $50.34 a barrel now. As per Barclay's estimates, a "$10/barrel change (increase) in global crude oil prices will imply a Rs 5.8/litre rise in retail fuel prices" which would add "34 basis point to headline inflation over three-six months, assuming no change to petroleum taxes."
A Rs 5.8/litre cut in petrol and diesel taxes to offset rising crude oil prices, Barclays believes, would result in a loss of revenue of Rs 87,200 crore (around 0.39% of GDP), assuming normal fuel consumption.
Meanwhile, since 2014, petroleum taxes' share in total tax revenues has risen and, thanks to COVID-19, likely will reach 25% in FY21, Bajoria stated adding that "faced with plunging revenues in the initial weeks of the outbreak, the central government used the collapse in oil prices to hike fuel excises."
The government in this regard, as reports suggest, may allow the RBI some leeway as regards inflation, thereby allowing it to concentrate more on economic growth in the wake of the coronavirus pandemic.
On its part, the central bank expects inflation to be on the higher side, at 6.8% in Q3, pegging it to come down to 5.8% in Q4.
For the first half of financial year 2021-22 (H1FY22), RBI has projected the inflation rate to hover in the range of 4.6% to 5.2% with risks continuing to be broadly balanced.