Everyone is calling it: 2022 will be the year we see crude oil hit triple digits in dollar prices again.
Stock markets across the world have been on edge on rising worries over escalating Ukraine-Russia tensions. Political turmoil, reports of supply disruptions, and a seven-year high: crude oil has been off to a flying start in 2022 as the “up and up” of asset classes.
A jittery stock market, though, is the least of India’s worries around crude. In a scenario where triple digits on crude oil are staring us in the face, it was both odd and incongruous for the Reserve Bank of India (RBI) to say at its last meeting on Thursday that it sees retail inflation at 4.5% next fiscal year—lower than a 5% consensus estimate in a Bloomberg survey. Even more peculiar is its target for the second half: a markedly lower tick at 4% and 4.2% for the two quarters.
Back in Delhi, the finance minister’s budget speech earlier this month had no mention either of rising crude prices or the possible impact of that on the Centre’s widening deficit.
Of course, some of the silence could be the consequence of the complete freeze on fuel price hikes we have seen since state elections got underway. Increasing petrol and diesel prices at this point would be political harakiri for the Bharatiya Janata Party (BJP).
But no matter which party festoons their party offices with flowers and distributes sweets on Mar. 10, there’s one thing for certain. Petrol and diesel prices will start going up—and sharply at that.
Let us examine the strategy for the ruling government with regards to fuel prices so far. The last time we saw petrol prices frozen was before the five state elections (West Bengal, Tamil Nadu, Assam, Kerala, and Puducherry) in March and April 2021. They are on hold again for the ongoing polls in Uttar Pradesh, Punjab, Goa, Manipur, and Uttarakhand.
Indian Oil Corporation, Bharat Petroleum Corporation and Hindustan Petroleum Corporation, which together control more than 90% of the domestic market, have hit the pause button on price increases for over three months. This is clearly a violation of the agreed formula where the rule of thumb is that every one dollar increase in crude prices (pdf) leads to about an increase of 50 paise-60 paise per litre in retail fuel prices in India.
The stated position of the government and these oil marketing companies is that the freeze is being effected to protect consumers from the volatile global oil and refined fuel prices.
But that concern was not visible last year. In fact, the situation was quite the reverse. By June 2021, India had seen 43 price increases, only four cuts and a breach of the psychologically significant Rs100-per-litre mark on petrol in many states. May 2021 saw fresh hikes nearly every other day. After 16 fuel price hikes, the month ended with all-time high prices in several metros.
Let’s jump back another year to retrace this price hike journey. Retail petrol and diesel prices in India are in theory decontrolled—or linked to global crude oil prices. This means that if crude prices fall, retail prices should fall too. Through most of 2020, global crude prices did fall, very sharply too. In April of 2020, Brent crude, a global crude oil price benchmark, actually fell to $9.12 per barrel, its lowest daily price in decades.
However, when the pandemic hit last year, state-owned oil retailers stopped price revisions for a record 82 days. Consumers were hit by a double whammy—no benefit from the fall in crude prices in the first half of 2020 and then they were facing record-high prices in the second half of the year.
Why is this on-again, off-again situation with fuel prices a problem?
Even in the past, immediately after the elections, oil marketing companies have rushed in with price increases—and sharp ones at that, Sunil Kumar Sinha, principal economist and director of public finance with India Ratings and Research, said in an interview to the Economic Times. There is no reason to believe it will be different this time, he said.
He also drew attention to the cascading effect these increases have on the economy. If a 1% rise in global oil price is passed through into the domestic economy, it increases retail prices by about 7 basis points to 8 basis points (one basis point is equal to 0.01%) and wholesale prices by 13 basis points to 14 basis points. That’s just the first round effect.
In the second round, the impact is higher. Basically, whichever way you look at it, inflation is severely impacted. More so, when it is already at an elevated level.
In an interview with Bloomberg TV, Debasish Mishra, partner at Deloitte, said he expected companies to increase prices by Rs8 a litre-Rs9 a litre to make up for a shortfall in sale price by Mar. 10 when the election process winds down.
What kind of impact would such a sharp increase have on Indians? Relentless fuel price increases last year saw ordinary citizens hit hard. Reports from smaller cities and villages indicated two-wheeler users were trying to get by with bit-sized refills of as little as Rs60-Rs70. But that cannot be a long-term solution for those stepping out to work, to transport goods, to run a household.
Oil and the budget
For the state, there’s a much larger impact to bear. One, India is an oil-deficit country. The country’s import bill in December 2021 increased 38.55% to $59.48 billion. This was because of an increase in petroleum and crude oil imports, which soared 67.89% to $16.16 billion.
Two, a surge in crude oil prices could hurt India’s fiscal deficit—the budget’s revised deficit of 6.9% of GDP in 2022 and a planned 6.4% of GDP for the 2023 financial year are already higher than the estimates of global rating agencies.
Three, a rise in crude oil prices hits the rupee. In May 2018, for example, the rupee closed at 68.34 against the US dollar with crude seeing a surge to almost $77 to a barrel.
To raise then or not to raise. Former finance secretary Subhash Chandra Garg spoke to me about this seemingly unfixable conundrum.
“When the current government came to power in 2014, they inherited high crude prices [of around $109 a barrel] but they were going down,” By 2015, crude prices had dropped to $20 a barrel. “The government reaped that oil dividend for six or seven years,” he said.
But now, said Garg, the tide is turning. As a consequence, the government faces a very hard choice. “Crude is unlikely to abate because of geopolitical pressures,” he said. “They cannot keep avoiding increases. They will have to push through a hike.”
But he pointed to another complication. “Excise duty was revised massively in 2020,” he said. “Therefore on March 10 [the day the results of the state elections will be declared] when they undertake a price increase, either they allow the entire differential to be passed through or they also adjust excise duty partly or fully.”
In November, following a wave of public outrage at soaring prices, the finance ministry announced a sizeable Rs5 per litre cut in excise duty on petrol and an Rs10 per litre cut in excise duty on diesel, the first time in three years. Some states followed with a cut in VAT or Value Added Taxes. Now the government is faced with the hard choice of slapping on a sharp hike and pouring fuel all over retail inflation or biting the hand that feeds it and cutting excise duties further.
Excise duty revenues have been the finance minister’s golden goose. The centre’s revenue rose sharply in the 2021 financial year after the hike in excise duty on fuel. Collections will close at a robust Rs4 lakh crores excise collections this year. Projections for the next year have been marked down to Rs3.35 lakh crores.
There will be other consequences. Fertiliser prices will be affected by an increase in gas prices. This year, the government absorbed the entire fertiliser subsidy. Will it be able to do the same next year and what will that do it its finances? Dividend collections from oil marketing companies will drop. So will the mood around privatisation.
As Garg noted, “One of the reasons privatisation of BPCL (Bharat Petroleum Corporation Limited) has not happened is because a true free pricing mechanism has not been put in place—the cost will not be bearable for a buyer. It makes no sense.”
No free lunches
Because of its geographical location and keeping political relations in mind, India sources about 86% of crude oil, 75% of natural gas, and 95% of LPG from members of the Organisation of the Petroleum Exporting Countries. That oil comes at an additional price for countries like India and China: it is called the “Asian premium.”
In 2018, union petroleum minister Dharmendra Pradhan criticised the practice. “Why do we have to give Asian premium?” he asked. “There will be meetings, there will be consensus [with China and other Asian nations] to put a point of view in front of the oil-producing countries that we must get a reasonable and responsible price for our consumption.”
He even said that in the long term, India would opt for alternate fuels and alternate energy, conservation, and fuel-efficient technologies. Four years hence, there has not much to show on either count. There has neither been any change on the Asian premium that countries like India are charged, nor do we have a tangible option in place for our fuel needs.
As elections began across states such as Uttar Pradesh and Uttarkhand in the north and Goa in the south, “mehengai” or price rises have emerged as a bugbear for many prospective voters. The RBI’s seeming nonchalance about rising inflation raised many eyebrows in the economic community.
“We expect these benign inflation projections to be revised higher at subsequent meetings, as input price pressures are yet to be passed on to the economy,” Standard Chartered wrote. “Unless commodity prices correct significantly from here, achieving the FY23 inflation target of 4.5% will be challenging.”
Citigroup economists concurred; “With RBI MPC [monetary policy committee] sticking to its dovish stance, risks are mounting for assessment that policy is falling behind the curve. While the short tenor rates will likely struggle to recover from overwhelming RBI dovishness, long tenor rates are likely to price in fear of a larger quantum of cumulative hikes, the longer is the delay to get on with it.”
While there may be no one-to-one correlation to draw when crude oil prices cross the psychological $100-a-barrel mark, the ripples will be felt everywhere. Former finance secretary Garg recalled, “The last time crude crossed $100 to a barrel, that is what killed the then government. This is an essential item that cannot be reduced drastically. Transportation costs will go up, but you cannot scale back usage by too much. There are no good choices. Luck may be running out.”
As the finance ministry and RBI wait for a turn in events and prices, so is time.