Since FY05, consumption of oil and other energy products has increased significantly in line with generally strong economic growth and rising demand. This is reflected in the sustained increase in fuel consumption, particularly of diesel and liquefied petroleum gas (LPG, mainly used for cooking). Given current market fundamentals, characterized by low inventories and stretched spare capacity, our commodities analysts expect oil prices to remain high during 2012 (and beyond). Sustained elevated oil prices would create problems in many areas for the Indian policymakers.
The next impact would come via larger “under-recoveries” at oil firms, which sell fuel at administered prices. Our base case assumption for under-recoveries among the oil companies is nearly Rs 1.7 trillion in FY13 (equivalent to about 1.6% of the GDP), if oil averages $115 per bbl. In recent years, the government has reimbursed the oil companies about 50% of such shortfalls through cash subsidies.
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However, with the government planning to reduce its fuel subsidy burden in the latest budget, it appears increasingly likely that either oil companies will have to absorb larger losses or fuel prices will have to rise considerably.
Under various scenarios with the government providing subsidies in the range of 25-50% for under-recoveries, we estimate that likely hikes in fuel prices would lead to a rise in headline inflation.
We estimate that a rise in government fuel subsidies to cover about 50% of the under-recoveries (from its currently budgeted about 25%) would add about 0.4% to the fiscal deficit, assuming everything else remain unchanged.
Graphic by Sandeep Bhatnagar/Mint.
Edited excerpts from a report by Barclays India.
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