Oil Volatility Before Polls Exposes India’s Political Windfall Trap On Fuel Taxes

Few economic variables carry the political volatility of oil prices in India. When global crude rises, inflation anxieties spread quickly across households, transport costs ripple through supply chains, and governments scramble to contain the political fallout. Yet the latest oil shock — triggered by tensions involving the US-Israel-Iran war— has exposed a deeper contradiction in India’s fiscal architecture: a system that quietly profits from cheap oil but struggles politically whenever prices spike.

In early trading this week, Brent crude briefly surged to nearly $115 per barrel, a dramatic jump that reflected fears of disruption in the Persian Gulf. Within hours, prices retreated toward the $90–95 range, underscoring the extraordinary volatility now gripping global energy markets.

For India — which imports roughly 88 per cent of its crude requirements — such swings translate immediately into fiscal and political calculations. The dilemma confronting the government led by Narendra Modi arrives at a particularly sensitive moment: assembly elections in five states and one Union Territory are scheduled before May 2026, placing fuel prices squarely within the realm of electoral politics. What might otherwise be a technocratic debate about tax policy has therefore become a question of political strategy.

Over the past decade, petroleum taxation has quietly evolved into one of the most dependable pillars of India’s fiscal system. Petrol and diesel remain outside the Goods and Services Tax regime, allowing both the Union and state governments to impose separate levies.

As of March 2026, the Centre collects about ₹21.90 per litre in excise duty on petrol and ₹17.80 per litre on diesel, through a layered structure that includes basic excise duty, special additional excise duty, road and infrastructure cess, and the agriculture infrastructure development cess.

These levies generate enormous fiscal income. Central excise collections from petroleum products have averaged about ₹2.6–2.7 lakh crore annually in recent years, making fuel taxes one of the government’s largest non-GST revenue streams.

The roots of this dependence lie in the oil price collapse between 2014 and 2020. During that period, the government repeatedly increased excise duties to capture the windfall created by falling crude prices. By the time the pandemic struck, duties had climbed to nearly ₹33 per litre on petrol and ₹32 on diesel. At the time, the policy was widely viewed as fiscally prudent. In retrospect, it created a structural dependency that now constrains policy choices.

The problem lies in the asymmetric politics of fuel taxation. When crude prices fall, governments raise duties without provoking widespread public anger because retail prices remain stable or decline modestly. But when crude rises sharply, those same taxes suddenly become politically visible.

The result is what economists increasingly describe as a political windfall trap: governments capture revenue during oil price declines but face intense pressure to relinquish it during price spikes.

The current volatility illustrates the problem vividly. Brent’s surge to $115 — even though temporary — has rekindled fears of rising pump prices. In an election season, the optics of expensive fuel can quickly overshadow broader economic narratives.

With polls approaching in multiple states and one Union Territory, the government faces a familiar temptation: cut excise duties to soften retail prices and signal relief to voters. India has used this strategy before. During the oil price surge triggered by the Russia–Ukraine war, the Centre reduced duties by ₹13 per litre on petrol and ₹16 per litre on diesel cumulatively between late 2021 and 2022. A smaller reduction — perhaps ₹3–4 per litre — could again be deployed as a political instrument in the months leading up to elections.

But such relief is expensive. Each ₹1 reduction in excise duty costs the exchequer roughly ₹13,000–16,000 crore annually. Even a modest cut could therefore wipe out tens of thousands of crores in revenue at a time when the government is attempting to narrow the fiscal deficit while sustaining high infrastructure spending. In other words, the state would effectively be surrendering revenue gains accumulated when crude prices were lower.

Another strategy — one that has quietly defined fuel policy since 2022 — is to keep retail fuel prices stable and allow state-run oil marketing companies to absorb fluctuations in crude prices. Petrol and diesel prices across many Indian cities have remained largely unchanged despite volatility in global oil markets. This administrative stability helps dampen the transmission of oil shocks into consumer inflation. Yet the cost is simply shifted elsewhere.

Refiners such as Indian Oil, Bharat Petroleum and Hindustan Petroleum absorb the pressure through fluctuating refining margins. If crude prices remain elevated for an extended period, their profits shrink, reducing dividends paid to the government. Dividends from oil public sector undertakings contribute roughly 0.2 per cent of GDP to government revenues. In effect, the fiscal burden eventually returns to the state through a different channel.

Fuel taxation in India is also complicated by federal dynamics. State governments impose value-added tax on petrol and diesel, often forming the largest share of pump prices. Collectively, states earn roughly ₹3–4 lakh crore annually from fuel taxes — even more than the Centre’s collections. Persuading them to reduce VAT during an election cycle is politically improbable. Fuel taxes remain among the most lucrative revenue sources available to state governments, and past attempts at coordinated tax cuts have often devolved into partisan disputes.

The Iran crisis also highlights India’s structural vulnerability to disruptions in West Asian energy supplies. Nearly half of India’s crude imports pass through the Strait of Hormuz, one of the world’s most strategically sensitive shipping corridors. Around 85 per cent of LPG imports also transit through this route. India has attempted to mitigate these risks by diversifying crude imports — including significant purchases from Russia after Western sanctions reshaped global oil trade — and by building strategic petroleum reserves capable of covering several weeks of demand. But these buffers provide only temporary protection against sustained geopolitical shocks.

On paper, New Delhi has several policy options: reduce excise duties, pressure states to cut VAT, allow oil companies to absorb the shock, or accelerate structural reforms such as bringing fuels under GST. In practice, the choices are far narrower. Fuel taxes have become too important to government finances to be reduced significantly, yet fuel prices remain too politically sensitive to be left entirely to market forces — particularly in the run-up to elections.

This is the essence of India’s political windfall trap. The state harvests fiscal gains when oil prices fall but must share the pain when they rise. In an election year marked by volatile global energy markets, that contradiction becomes impossible to ignore.

The real question is not whether the government will cut duties if crude remains volatile. It is whether India’s fiscal model — built on the assumption of cheap oil — can survive in a world where geopolitical shocks increasingly define energy markets. (IPA Service)