Fuel for Thought: Tax cuts, subsidies reflect Asia’s belief expensive oil is here to stay

Desperate times call for desperate measures, and for Asian governments it's time to act rather than wait for oil prices to cool.

After shelling out more than $100/b for months, Asia's leading oil importing nations are running out of patience and are either slashing taxes or providing subsidies on fuels to ensure consumption does not suffer yet again.

Asian governments had hoped the sharp rise in crude prices following the start of the Russia-Ukraine conflict in March would be short-lived, but now they are convinced the price surge was not just a knee-jerk reaction. The recourse to various fiscal steps relay their strong belief that expensive oil is not going away anytime soon.

According to Platts Analytics, Dated Brent prices are expected to average $103/b in 2022, up from $71/b in 2021, before easing to $90/b in 2023. Now, Asian government are formulating policies to battle oil-led inflation in the hope that it's better late than never.

We estimate that every $10 per barrel rise in the price of Brent crude would raise the headline consumer price index by about 40 basis points.

— Dharmakirti Joshi, CRISIL chief economist

While some Asian countries, such as India, are reluctantly giving up some revenue by slashing taxes on fuels, other countries, such as South Korea, are shelling out subsidies to ensure the recovery in oil demand the region is witness after two painful years due to the pandemic stays intact.

"Oil prices are a big concern for the [Indian] government and the economy now because of its cascading effect," said Dharmakirti Joshi, chief economist at CRISIL, a unit of S&P Global.

Policy makers are spending sleepless nights in India, where inflation, based on CPI, has risen consistently for the past seven months, reaching an eight-year high of 7.8% in April.

India in late May slashed excise duties on gasoline and diesel by rupees 8/liter and rupees 6/l, respectively. It was the second duty cut in a little over six months.

"We estimate that every $10 per barrel rise in the price of Brent crude would raise the headline consumer price index by about 40 basis points," CRISIL's Joshi said.

As oil prices bite, governments in the region are desperate to play a balancing act and come up with polices that will ensure that the impact of high oil prices are minimized without letting the fiscal deficit shoot up or capital expenditure fall drastically.

The last time crude prices were this high between fiscal years 2011/12 (April-March) and 2013/14, CPI inflation had averaged 9.2%. This time around, CRISIL expects India's CPI inflation to be lower at 6.3% in fiscal 2023. This is because food and core inflation—together carrying 86% weight in the CPI basket—is expected to be lower.

The subsidy route

South Korea's surging retail diesel prices have surely dampened consumer sentiment. The government has decided to provide more diesel subsidies to cargo truck and taxi drivers, easing the fuel cost burden and reviving consumer confidence, according to the Ministry of Economy and Finance.

The threshold diesel price set for subsidy payments will be lowered from won 1,850/l ($1.45/l) to won 1,750/l($1.37/l) effective June 1. The government will compensate for half of the difference between the average retail price and the threshold base price through subsidy, the ministry said.

As diesel is the South Korean retail market is currently being sold at an average won 1,976/l ($1.55/l), truck and taxi drivers would be entitled to receive half of the gap between the new base price of 1,750/l, which equates to roughly won 113/l (8.8 cents/l), according to S&P Global Commodity Insights' calculation. This would be up from won 63/l (4.9 cents/l), based on the current threshold price of won 1,850/l.

The government has decided to extend the subsidy scheme by two months until the end of September, the ministry said. Diesel subsidies were first offered May 1 and were slated to originally expire July 31.

The move comes as retail diesel prices rose above gasoline prices May 11 for the first time since the global financial crisis amid tight supply of gasoil across Asia and the globe. Retail diesel price had long been priced at a discount of about won 200/l (15.7 cents/l) to gasoline.

More countries follow suit

Japan is also taking the subsidy route and has also pledged to increase fuel subsidies to refiners and oil product importers to Yen 37.3/l(29 cents/l) over May 26-June 1, from Yen 36.1/l a week earlier, due to strong crude oil markets. This is the fifth consecutive week that the subsidy has been increased.

In an effort to ease the pain arising out of high crude oil prices and mitigate the impact of rising oil prices on the economic recovery from the pandemic, the government started providing subsidies for gasoline, kerosene, gasoil and fuel oil at the end of January.

Without the subsidies, the gasoline retail price would have reached yen 205.2/l on May 23 but it was suppressed by yen 36.4/l to yen 168.8/l, the Ministry of Economy, Trade and Industry said in a statement May 25. Gasoil was also suppressed by yen 36.4/l and kerosene by yen 35.8/l, it said.

At the end of April, the government decided to expand the subsidy to include jet fuel and LPG, and to extend the subsidy payment period, which was due to run until the end of April, to the end of September.

In Japan, refiners use the subsidies to curb increases in the weekly wholesale prices of oil products, while trading houses deduct subsidies from the selling prices of imported oil products.

Whether more such measures by other Asian countries come into effect remains to be seen.