How Rising Oil Prices Impact The Indian Economy

India’s oil price headache is back.

After a gap of about three years, Brent crude oil prices are within striking distance of $80 per barrel. Prices rose after the OPEC+ group failed to reach a deal on increasing supplies.

In 2021 so far, Brent crude has turned expensive by over 46% to trade at near $75 per barrel. In the quarter ended June, prices have risen by over $10 per barrel or about 18%.

A crude price shock, or a sudden increase in the price of crude, impacts the Indian economy in a number of ways. A net importer, higher payments for crude impact the current account, while local inflation rises unless higher global prices are balanced by local tax cuts. Should oil prices remain high, the impact on growth is felt via consumption as disposable income in the hands of consumers drops after accounting for relatively inelastic demand for petroleum products.

The most direct impact of rising crude prices would be on the external sector balances, said Suvodeep Rakshit, senior economist at Kotak Institutional Equities. A $10 per barrel increase for the full year could increase the current account deficit by around $15 billion or 0.5% of GDP, according to Rakshit’s estimates.

The RBI, in 2019, in a paper titled, “The impact of crude price shock on India’s current account deficit, inflation and fiscal deficit”, said that as a rule of thumb, every $10 per barrel increase in crude prices leads to an additional $12.5 billion deficit, which is roughly 43 basis points of India’s GDP.

To be sure, India’s foreign exchange reserves of over $600 billion means greater comfort on the external front. Reserves are now adequate for more than about 15 months of imports based on the average monthly imports in a pre-pandemic year.

Every $10 per barrel increase in oil prices results in a 30-40 basis points rise in CPI inflation, both directly and indirectly, said Rakshit. For WPI inflation, the impact is even more, resulting in a rise of 65-75 basis points.

In an fledgling growth scenario it will create headwinds for monetary and fiscal policy, he added.

The RBI’s own estimates, based on the study cited earlier, suggest a $10 per barrel increase in crude oil prices could have a direct impact of 24 basis points and an indirect impact of 26 basis points. This was when only the transport component of CPI was used to measure the direct impact and where the pass-through to pump prices is only 66%.

The fuel and light index constitutes 6.8% of the CPI basket, while transport and communication makes up another 8.6%. Inflation in both groups was in double digits at 11.6% and 12.4% respectively in May.

With global oil prices rising at a time when local fuel prices are already elevated, the central and state governments will be faced with the difficult choice of risking inflation versus sacrificing revenue by cutting taxes.

“Excise duties, cess and taxes imposed by the centre and states need to be adjusted in a coordinated manner to contain input cost pressures emanating from petrol and diesel prices,” the monetary policy committee reaffirmed at it’s last resolution in June.

According to estimates by QuantEco Research, a reduction of Rs 5 in excise duty on petrol and diesel brings down inflation by about 8-10 basis points directly. The indirect or second order impact is of an equal magnitude. Potentially, a cumulative impact of 15-20 basis points of moderation on both retail and wholesale inflation can be effected with a Rs 5 excise duty cut, Yuvika Singhal, economist at QuantEco research, estimated.

The government’s accounts will be stretched to the extent that excise duty for the central government and VAT for states may have to be reduced to cushion the primary and secondary impact on consumers’ budgets, said Rakshit.

However, the government can absorb this loss.

The growth in fuel consumption will pick-up compared to a year ago, even amidst an unchanged structure of excise duties, will could mean a lower drop in collections even if taxes are cut.

But the decision is not easy, she added. “The government must decide on a quantum of reduction in excise duty which has trivial fiscal but not so trivial inflation implications.”

Dharmakirti Joshi, chief economist at Crisil, said it would have been a good practice to raise taxes when prices were low and cut them when prices rise, to bring down the shock element and smoothen prices. While that has not been done, even now, reducing tax would also be a way of stimulating the economy, Joshi said.

The current oil price rise hits you from two sides in this environment when growth is weak and commodity prices are generally rising, said Joshi. “This current bad mix of growth and inflation will be worsened further as a result of oil price rise,” he said.

Assessing the extent to damage to growth is difficult. In addition to consumers, higher oil prices will hit producers too.

A number of producers are facing margin pressure because input costs have risen, said Joshi, adding that, now the direct and indirect impact of rise in oil prices is also quite high and raises the cost of production further.

Rising oil prices are often a regular pattern in times of global expansionary fiscal policy, said NR Bhanumurthy, vice chancellor at BASE University. India remains vulnerable to oil price shocks due to its high import dependence, he said.

Most Related Links :
reporterwings Governmental News Finance News

Source link

Back to top button