Oil price complications

Oil price complications

On Tuesday, crude oil prices in international markets briefly touched the $80-per-barrel mark before retreating to slightly lower levels. On Wednesday, the Prime Minister’s economic advisory council (EAC) in its Economic Outlook for 2009/10 projected the consolidated fiscal deficit of the Centre and the states for 2009-10 at 10.1% of gross domestic product (GDP). Both the numbers, oil prices and the fiscal deficit, tell a linked story.

In India, high crude oil prices are not transmitted to consumers of refined products such as petrol and diesel. While this helps tame inflation, it also adds to the Union government’s fiscal burden. This is not a happy trade-off, if it can be called one. But our politicians do see it in that light. The EAC report noted that this fiscal, the government proposes to issue bonds to oil marketing companies amounting to Rs10,306 crore. This will take the total debt liabilities to 10.3% of GDP. This may not offset the losses suffered by oil marketing companies. By one estimate, the under-recoveries of these companies by the July-September period amounted to Rs10,670 crore. If there are further increases in international crude oil prices, which are possible because oil producing nations may restrict production to secure attractive crude prices, the debt liability figure will certainly rise further.

This complicates policy choices. If domestic oil prices are aligned with international oil prices, inflation will be a certain outcome, even if they give some respite to oil companies. The other course is to bear higher oil prices and add to the fiscal deficit. There are dangers in that option, too. At 10.3% of GDP, the consolidated debt figure is in the high-risk zone. India risks sovereign rating downgrades and consequential difficulties in borrowing by our companies abroad. There are other macroeconomic risks as well.

The right choice in this situation would be to increase oil prices followed by a raising of policy rates by the Reserve Bank of India. At this moment, the Union government does not favour any of these steps, if the statements of assorted government officials and economists are anything to go by. If these measures are taken later, when the government musters some political will, they may not have the desired effect.

Is inflation a danger now? Tell us at views@livemint.com