Crude prices offer govt Diwali sparkle

The mood may be gloom and doom on Dalal Street this Diwali as the Indian economy braces itself for a ?cloudy? growth outlook and the finance ministry concedes that fiscal deficit targets for this year won?t be met. However, global oil prices?on a slide after touching nearly $150 a barrel this June?could offer the economy?s managers some happy options.

The cost of India?s oil imports fell to $56 a barrel on Monday, $5 less than $61-a-barrel threshold set by the Centre for considering a cut in domestic fuel prices. Though the government is unlikely to announce a fuel price cut before December 15 (see box), even if there is no downward revision, cheaper crude prices means the country?s massive oil import bill will be whittled down (India imports 70% of its crude). The fertiliser subsidy bill?which has already crossed the defence budget this fiscal?will also be lightened.

Furthermore, inflation is expected to ease further if commodity prices keep falling in line with crude, giving monetary authorities some elbow room to lower prime lending rates. ?As far as the fiscal deficit is concerned, the Centre?s fuel subsidy will be less. Also, the fertiliser subsidy in the second half of the year will be less. Fertiliser prices are linked to energy prices internationally as well as in India, where naphtha is used to manufacture fertiliser. But the overall fiscal deficit situation may not improve tremendously as the government?s expenditure has also risen,? said Saumitra Chaudhuri, member of the Prime Minister?s Economic Advisory Council.

India imported 121.672 million tonne of crude oil in 2007-08 and the oil import bill was $68 billion. The softening of crude prices in the past four months has reduced the monthly import bill of Indian refiners by nearly 40%.

When crude was at $145 a barrel, state-owned oil marketing companies? under-recoveries were estimated at Rs 2.4 lakh crore. At $75, under-recoveries will also come down substantially to Rs 52,800 crore. If oil prices stabilise at current levels resulting in an average price of $75 a barrel for 2008-09, a dip in fuel oil/naphtha prices alone would reduce the subsidy bill by around Rs 14,000 crore. A lower subsidy bill would mean the exchequer can focus its resources more aggressively on social sector programmes like the NREGS.

With the fall in fuel oil and naphtha prices, the cost of industrial production would come down, as would the diversion of subsidised diesel to industry, thereby bringing down the Centre?s oil subsidy bill further.

Moreover, the dipping import bill would ease pressure on the already-weakening rupee, as India?s demand for dollars will reduce to that extent.

?The fall in crude prices will have some impact on inflation to some extent. Prices of many commodities such as edible oil, rubber and plastics and man-made textiles may also come down as they are linked to crude oil prices. But it must be kept in mind that prices of other commodities are also decreasing in international markets,? Chaudhuri added.

?The fall in crude oil prices brings good news. It will help fight the growth deceleration. The fiscal deficit will come down, as the government will have to issue fewer bonds. Even if domestic prices are not cut, the fall in international prices will help control inflation as prices of aviation turbine fuel and other industrial fuels will come down,? said DK Joshi, chief economist at Crisil.

Decreased pressure on the inflation front would give the country?s monetary managers some leeway to cut interest rates, essential to ease up the credit squeeze that?s threatening to ?cloud? the real economy?s growth prospects.

?The cost of production for some industries will come down, which will help lower inflation. With inflationary expectations lowering, interest rates may also be gradually brought down,? said Joshi. ?But it must be kept in mind that the rupee has weakened significantly and so imports are not as cheap. About 40% of the fall in international crude prices will be offset by rupee depreciation,? he added.

The UPA had hiked domestic prices for petrol, diesel and cooking gas (LPG) by Rs 5 a litre, Rs 3 a litre and Rs 50 a cylinder, respectively, in June.

Reversing part of the hike soon would make immense political as well as economic sense, experts say. Back-of-the-envelope calculations suggest that cutting petrol and diesel prices by Rs 2 a litre each would bring inflation down by over 1%.

If prices for metals and other commodities remain stable, overall inflation could fall to a single digit from the current 11.04% sooner than the government expects.

Cheaper fuel only by Christmas?

The finance ministry has ordered a study to quantify the under-recoveries of state-owned oil marketing companies in 2008-09 in order to decide the extent of oil bonds to be issued to them and moot a fuel price cut, if feasible. ?Both these studies may be completed at the earliest and results made available to the department of expenditure not later than December 15,? an internal government communiqu? states. State oil companies have been asking for more bonds to be issued immediately, saying that they are running out of cash. Murli Deora assured the nation last week that his ministry would consider a downward revision in the prices of these fuels after last Friday?s Opec meeting. But considering that the government studies have been commissioned by the expenditure department on ?an urgent basis? and that the finance ministry will have a large say in any possible fuel price cut, Deora?s plans will have to wait until then.