With a resolution to the US-Iran tensions nowhere in sight and crude oil prices surging past $120 a barrel, India must brace for a prolonged period of strain. As the finance ministry has pragmatically observed, it makes little sense to bet on a best-case scenario. If global conditions improve, that will be a welcome reprieve. For now, policy must be anchored in realism: the economy faces not just a supply shock, but the risk of demand compression as inflation rises.
The damage is already visible. India’s crude basket averaged $113 per barrel in March and edged up to nearly $114 in April. Oil marketing companies (OMCs) have been absorbing much of the increase, even as the government has tried to soften the blow by cutting special excise duty on petrol and diesel by Rs 10 per litre. But this strategy has limits—and those limits are now in sight.
Beyond the Threshold
If crude prices remain elevated—well above the $85 per barrel threshold for any meaningful period—OMC losses will quickly become unsustainable. The government has no option but to bite the bullet and pass on at least a part of the increase to consumers. There is no credible alternative. Continuing to suppress retail fuel prices would either strain public sector balance sheets or widen the fiscal deficit, neither of which is tenable in the current macroeconomic environment.
The political economy of such a move is admittedly difficult. But with state elections behind it, the government has a window to act. Delaying the inevitable will only make the eventual adjustment more abrupt and more painful. A calibrated increase in petrol and diesel prices—however unpalatable—must be initiated sooner rather than later.
Fiscal Reality
The fiscal argument is compelling. As Union Expenditure Secretary V Vualnam has cautioned, fiscal stress is already a reality. A full-scale government bailout of OMCs would only exacerbate the pressure. At a time when macro-financial stability is paramount, the exchequer cannot be expected to absorb a sustained oil shock. Estimates suggest that, at $120 crude, pump prices would need to rise by over Rs 20 per litre to fully reflect costs.
In practice, the increase is likely to be more modest—but even partial pass-through will begin to curb demand and restore some balance. A sharper adjustment in petrol prices relative to diesel could help moderate the broader inflationary impact, given diesel’s role in logistics and agriculture.
None of this is without cost. Fuel price hikes will feed into inflation at a time when pressures are already building. The government’s own economic review has warned that higher energy costs will ripple across sectors. There are also emerging risks on the food front, with concerns that a weaker monsoon could push up prices. For the Reserve Bank of India, the challenge will become more complex.
Even if inflation remains within tolerance bands, a weakening rupee could force an earlier-than-expected rise in interest rates, which in turn would dampen credit growth and investment. Bond markets are already signalling stress, with sovereign yields crossing 7%. Yet, difficult as the trade-offs are, inaction is not an option. Artificially suppressing fuel prices only postpones the adjustment and magnifies the eventual shock. The government must act decisively—sharing the burden with consumers in a measured, transparent manner. There are no soft options left. The sooner policy aligns with reality, the better the chances of navigating what promises to be a turbulent phase for the economy.