Economy
How crude above $100 a barrel impacts India
Summary
- For the Centre, an oil price above $100 a barrel means a fine balancing act between protecting its revenues and keeping the economy going. For consumers, the question is not whether prices will increase but by how much
Crude oil prices have shot up over $100 a barrel, and reached even $130 as the Russia-Ukraine war intensifies and the West tries to choke Moscow with economic sanctions. The consequences for India will be dire. India is heavily dependent on oil imports for its domestic needs, and costlier oil will not only lift India’s import bill, but also have a trickledown effect on the prices paid by consumers of goods and services. And if the central government chooses to absorb the increased oil prices by reducing petroleum duties, it could also hurt tax revenues.
The impact of higher oil prices on India’s import bill will also be felt in its foreign exchange reserves and exchange rate. Fuel comprises about 32% of India’s imports, which is significantly more than the other top 10 economies, making the country more vulnerable to oil shocks.
As oil becomes pricier, Indian importers buy more dollars to purchase the same quantity of oil. This reduces the country’s foreign exchange reserves—a buffer against external shocks—and makes the Indian rupee less valuable. On 7 March, the rupee plummeted to an all-time low of 77 against the US dollar. India’s forex reserves have also slipped marginally from an all-time high of $642 billion in October 2021 to $632 billion in February 2022. This is still robust.
The last time oil prices crossed $100 a barrel, between 2011 and 2014, India’s forex remained stagnant, but the rupee depreciated about 35% against the dollar. Conversely, between March 2014 and March 2021, when oil prices remained low, forex reserves rose by nearly 90% and the rupee depreciation was 19%.
Consumer Costs
Domestic consumers, too, feel the impact of high oil prices. Milk prices, for example, have increased up to 5% during this oil spike. Between 2011 and 2014, the increase in wholesale prices—as measured by the monthly Wholesale Price Index (WPI)—was sizable. The annual WPI change moved in a band of 5% to 10%, which is considered high. Typically, the increase in prices for end-consumers is more than the increase in wholesale prices.
Post-2014, in a backdrop of a sustained fall in global oil prices, WPI inflation remained low till 2020, only rarely exceeding the 5% threshold. However, with oil prices rising from mid-2020 onwards, WPI inflation has increased sharply. For each of the 11 months till February 2022, annual WPI inflation has even exceeded 10%. Between March 2020 and February 2022, WPI has increased by 20%, led by a 40% increase in commodities under fuel and power. High crude prices will place an additional burden on household budgets, especially among the poor.
No More Subsidies
Moreover, between 2011 and 2014, petroleum was heavily subsidized in India. At its peak in 2012-13, India’s total petroleum subsidy payouts stood at ₹1.64 trillion. The government, therefore, shielded consumers from the blow of increasing crude prices by subsidizing the oil marketing companies (OMCs) to the extent of their under-recovery. The subsidy was funded by extra-budgetary means through the issuance of oil bonds to the tune of ₹1.34 trillion to contain the fiscal deficit.
However, petrol and diesel prices have been deregulated since 2014, and the quantum of this subsidy has decreased significantly. In 2019-20, petroleum subsidies stood at ₹266 billion, a mere 16% of their 2013-14 peak. The Centre is unlikely to reverse the hard-won gains on subsidies. In a deregulated environment, a sudden spike in crude prices is likely to be passed along to consumers, resulting in a massive spike.
Fiscal Management
To cushion the blow, the Centre has tax levers. Since 2014-15, the BJP-led government has benefited from low global crude oil prices. Even as petroleum subsidies reduced significantly, the Centre chose to keep petroleum prices high, by levying higher customs and excise duties. Its earnings from the petroleum sector, via tax revenues and dividends, jumped. Total earnings from petroleum in 2020-21 stood at ₹4.6 trillion, a 36% increase over 2019-20 and a three-fold increase over 2013-14.
This windfall has helped keep the fiscal deficit, and consequently interest rates, in check. High oil prices will compel the Centre to slash petroleum duties to tame inflation. But this will also have the undesirable effect of reducing its revenues, and leaving it with less to spend. One plank of the Centre’s strategy to rev up the economy is big spending to build new assets, especially in infrastructure sectors. Big shortfalls there can be costly.
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