Trouble in Ukraine is pain for RBI and finmin

The crisis will send cooking gas, petrol and other fuel bills soaring for Indian households and businesses. But that’s not the only worry for Indian economy’s crisis managers.

Depending on how long global oil prices remain elevated, the tensions could put a question mark on the RBI's credibility in making inflation projections and upset the government’s budget calculations. In particular, the fiscal deficit.

Rising steadily for the last several weeks as war clouds gathered over Ukraine, crude prices broke the $100 a barrel mark on Wednesday, as Russian President Vladimir Putin sent forces into Ukraine.

Crude prices could remain above $100 per barrel in the near to medium term unless the Opec decides to increase output materially, Crisil Research said in a note on Thursday, as the world watched Russian attacks on Ukraine. But over the past three months, Opec members haven’t been meeting their production targets, which has kept up the pressure on prices. Earlier in January, India's petroleum minister Hardeep Puri got on the phone with the Sultan Al Jaber, managing director and group chief executive officer (CEO) of the Abu Dhabi National Oil Company (ADNOC), the national oil company of oil rich United Arab Emirates (UAE), to nudge—without great success—crude oil producing countries to raise output and lower prices.

CLSA India estimates that a spike in oil prices to $150 a barrel for two months raises the average annual oil price forecast to $88 barrel.

Ahead of the Union budget on 1 February, the Indian basket of crude oil, an estimate of the average price at which domestic refiners buy crude oil, had edged up to $88.23 a barrel, up from average $80.64 a barrel during November 2021.

That ought to have had some measure of sobering effect on India’s official projections-making apparatus. And yet, the Economic Survey – prepared under Sanjeev Sanyal who has been promoted to secretary-level rank while shifting out of the finance ministry to the Prime Minister's Economic Advisory Council – released three weeks ago made GDP growth projections, relying on the assumption that oil prices will average $70-75 per barrel in FY23.

A few days after the budget was presented, governor Das defended the RBI’s projection of average retail inflation of 4.5% in FY23, saying it was robust and had taken into account all possible scenarios. He refused to say what are the crude price assumptions that went into preparing the projections. But there’s hardly an economist in the country willing to put their weight behind the RBI’s projections at the moment at least.

Retail inflation quickened to 6.01% in January, breaching the upper tolerance level set by New Delhi. And for the 10th straight month, wholesale inflation remained in double digits, coming in at 12.96% for January.

This when retail prices of fuel prices have remained unchanged for more than three months now since 4 November, 2021, despite a sharp uptick in crude prices, and are likely to be raised next month when the ongoing assembly elections will end in five states, including Uttar Pradesh that is being watched as an early signal of the political mood in the country with little over two years to go before the next Lok Sabha elections due in 2024.

Rather optimistically, Sitharaman's budget made no provision for a cut in excise duties in the event of crude oil prices remaining persistently high. If the government decides to absorb the oil price shock rather than passing it to the end users, the fiscal deficit will rise. For every $10 a barrel increase in crude prices absorbed into the budget, the fiscal deficit will go up by 43 bps as a percentage of GDP, CLSA estimates.

To hold prices at current levels, Sitharaman will have to slash taxes on fuels by ₹830 billion. This will widen the already-high fiscal deficit by additional 0.3 percentage points of GDP. The higher fiscal deficit, CLSA estimates, will push up government’s net borrowing by $11 billion and raise the excess supply of government bonds to $84 billion from $74 billion.

India’s gas requirements are thankfully taken care of with contracts with Qatar in place. Supplies from where are unlikely to be affected if the war doesn’t spill over. The impact of higher gas prices would be felt in India, though—just like elsewhere. Higher crude oil price also means more expensive LPG or cooking gas. Price of domestic LPG cylinders has also remained unchanged since October 6, 2021.

India’s vulnerability to price fluctuations arises out of its dependence on imports for 85% of its oil needs and domestic crude production declining steadily, slowing from 38.1 MMT in FY12 to 30.5 MMT in FY21.