India’s record-high petrol and diesel prices threaten road to recovery

India’s record pump prices of gasoline and diesel are the newest threat to the economy’s nascent recovery, as high local taxes on retail fuel risk fanning inflation and driving a wedge between the objectives of fiscal and monetary policymakers.

Gasoline prices were at an all-time high of 97.6 rupees ($1.3) a liter in Mumbai Tuesday, while diesel -- the bellwether of industrial activity -- sold for a record 88.6 rupees, data from state-run Indian Oil Corp. show. Taxes make up more than half of that cost and represent a sore point for the inflation-targeting Reserve Bank of India, which has vowed to keep borrowing costs low for as long as needed to support economic growth.

Also Read | Why Das should heed Buffett on bond yields

“Persistently higher prices could lead to a generalized inflationary environment, making it difficult for the RBI to hold on to its growth commitment,” said Priyanka Kishore, chief India and South-east Asia economist at Oxford Economics in Singapore. “Rising fuel taxes, alongside the pick-up in global oil prices, could threaten India’s recovery.”

While revenue gains from taxes on retail fuel are key for Prime Minister Narendra Modi and India’s states to boost spending in the economy that exited a rare recession last quarter, the RBI sees those levies, along with elevated crude prices, already pushing core inflation higher. Any withdrawal of the easy monetary policy to combat price-growth will lead to a spike in borrowing costs, in turn hurting consumption and business activity at a time when millions of Indians are still out of work due to the pandemic.

“Enabling a calibrated unwinding of high indirect taxes on petrol and diesel – in a co-ordinated manner by centre and states – are critical to contain the further build-up of cost-pressures in the economy,” Governor Shaktikanta Das said, according to the minutes of the latest monetary policy meeting.

Fuel taxes now make up nearly a fifth of New Delhi’s gross tax revenues, up from less than 10% nearly six years ago, according to calculations by economists at ICICI Securities and Primary Dealership.

While consumer price inflation is within the RBI’s 2%-6% target range, for now, economists see the second-round effects of higher pump prices on transportation and manufacturing sectors soon feeding into the headline print.

What Bloomberg Economics Says...

“Rising inflation could limit room for the Reserve Bank of India to inject liquidity to keep monetary conditions accommodative.”

-- Abhishek Gupta, India economist

Modi and his Oil Minister Dharmendra Pradhan have for now shifted the blame for high prices on previous governments and production cuts by some oil exporting nations.

Prices of Brent crude exceeded $60 a barrel last month, up from about $20 last April. India is the world’s third-biggest buyer of oil and higher prices inflate the import bill, and can cause the rupee to weaken. That in turn means higher input costs for other goods the country needs from overseas.

“With petrol and diesel prices at record levels and broad-based increases in the cost of industrial raw materials and intermediates, the risk of firms passing on input price increases to final goods and services remain, especially as the economic recovery gathers further traction and activity normalizes to pre-Covid levels,” the RBI said in its latest monthly bulletin.