Big cars, bigger troubles

An increase in the excise duty in India has caused car prices there to rise since the beginning of this year. India’s excise duty is based on vehicle size — specifically, length and engine displacement. The highest price increases have been on large utility vehicles, as the excise duty on these vehicles was restored to 30 percent from the 24 percent prevailing over the past six months. Prices for some of the utility vehicles have jumped by as much as 1.3 lakh ($3,683 U.S. dollars). 
As a share of the Indian vehicle market, large vehicles – mostly Multi-Purpose Vehicles (MPVs) and Sport Utility Vehicles (SUVs) – jumped 10 percent in Fiscal Year 2012–2013 to around 30 percent of total passenger cars. Most of those MPVs/SUVs are powered by diesel engines, and their cost of operation has increased lately due to the elimination of diesel subsidies. Nevertheless, consumer preference for these bigger and more comfortable utility vehicles still appears robust. Whether recent price increases begin to dampen the enthusiasm of Indian consumers for larger vehicles remains to be seen. If prices on utility vehicles remain high, that may begin to shift the market in favor of smaller, less pricey cars.
If the Indian market continues to trend towards more utility vehicles in the coming years, what sort of impact will it have on fuel demand?
A ten percent increase in market share of utility vehicles, from 30 percent in 2013 to 40 percent in 2020, would result in a cumulative increase in energy consumption of 1 million tons of oil equivalent (Mtoe), or 6.6 million barrels of oil. That increase would equal one-quarter of the fuel used by all passenger vehicles in 2000. As the Indian vehicle market continues to grow, the added energy demand attributable to MPV/SUV sales will total 8.5 Mtoe by 2030, or 62 million barrels of oil, equal to total fuel use by all passenger vehicles in 2009, as shown in the figure below.  Even at USD $48.8 a barrel, this increased fuel demand could cost India over 188 billion Rs ($3 billion U.S. dollars. Of course, in the longer term oil prices are likely to be considerably higher, and the resulting impact on India’s energy bill will be proportionally larger.  
If the increase in the excise duty nudges consumers towards purchasing smaller, more fuel-efficient vehicles, then India will end up saving a great deal in terms of energy consumption and carbon emissions. As the fact that most of those smaller, more fuel-efficient vehicles are gasoline-fueled, rather than diesel-fueled, India will gain a great deal more in terms of cleaner air; diesel cars currently sold in India pollute three times as much as comparable gasoline cars. Thus, the current rollback in excise duty on utility vehicles should receive at least two cheers.
I say two cheers since the existing excise taxes in India are linked to engine and vehicle size instead of fuel consumption.  It would be better if India were to base excise taxes on fuel consumption as opposed to vehicle size in order to reinforce incentives to cut both CO2 emissions and fuel use.  The purchase of MPVs/SUVs need not necessarily be discouraged, as long as their fuel efficiency is competitive. By linking the tax to fuel consumption, consumers and car manufacturers will receive a more direct signal to build and purchase more fuel-efficient vehicles, rather than shorter vehicles with smaller engines but not necessarily lower fuel consumption.
Fiscal incentives directly linked to fuel consumption will also help India meet or exceed its first passenger vehicle efficiency standards target. There is no reason why such a combination of fiscal incentives and standards could not be applied to the light-commercial vehicle (LCVs) segment as well. LCV fuel efficiency is normally regulated along with passenger vehicles (e.g. in Europe, China, US, and Japan) due to the similar gross vehicle weight and engine size. Absence of LCV fuel-efficiency standards may lead some manufacturers to categorize some models as LCVs to avoid the fuel-efficiency standards. The sooner India can close this potential loophole the better.