With crude oil prices showing no signs of easing from the $100-a-barrel mark and under-recoveries at oil marketing companies (OMCs) continuing to mount, a hike in fuel prices had become inevitable. Friday’s increase of Rs 3 per litre in both petrol and diesel follows the Rs 10-per-litre cut in special excise duty announced in late March, a move aimed at partly offsetting the losses suffered by OMCs. Even these measures, however, fall well short of what is needed to compensate oil marketers for their under-recoveries.
The scale of the stress is evident from the fact that the average crude import price for refiners has climbed to about $105 a barrel from $69 before the US-Iran conflict began in late February. Oil Minister Hardeep Singh Puri has estimated that OMCs are losing nearly Rs 1,000 crore a day and that cumulative losses for the April-June quarter could touch Rs 1 lakh crore.
Higher Fuel Prices
Yet, raising fuel prices is politically and economically difficult because of the inflationary pressures such increases trigger. One cannot, therefore, expect very sharp hikes in one go. That said, these are likely only the first steps as the government weighs further options to curb fuel demand, and additional increases cannot be ruled out. With the West Asia conflict stretching into its third month, much longer than initially expected, there are clearly no easy choices for an economy that imports more than 80% of its crude oil requirements.
The scale of the fallout is already becoming visible. Rising prices of crude derivatives have pushed up costs for manufacturers across sectors including plastics, synthetic textiles, paints, and tyres. Gas shortages have increased operating costs for restaurants, eateries, and several manufacturing units. User industries — from makers of white goods to fast-moving consumer goods players — have started passing on higher input costs to consumers, and more price increases are likely in the coming months.
Policy Challenges
To be sure, the impact was not yet visible in April’s inflation data. Retail inflation edged up marginally to 3.48% in April from 3.40% in March, coming in lower than expected as the government absorbed a significant part of the crude price shock. But the latest increase in petrol and diesel prices — fuels that carry a combined weight of 4.8% in the consumer price index basket — will have a far broader effect. Diesel, in particular, has economy-wide implications since trucks transporting nearly 70% of the country’s goods run on it.
Economists estimate the fuel price hike could raise annualised inflation by around 25 basis points. In reality, however, the impact is often much larger once second-order effects begin to play out. Even so, the government must, as far as possible, align domestic fuel prices with market realities. The sooner the economy adjusts, the better. Containing fuel demand, reducing the oil import bill, and preventing the current account deficit from widening further are all critical policy objectives.
The relatively high trade deficit, combined with sustained dollar outflows from equity and bond markets, is already exerting pressure on the currency. The rupee hit a fresh low of 96.14 against the dollar on Friday. The government has itself flagged mounting fiscal stress, and there is little merit in further burdening the exchequer through large-scale bailouts for OMCs. For the Reserve Bank of India, the simultaneous challenge of rising inflation, elevated bond yields, and a weakening currency will complicate policymaking. But sustaining growth momentum at a time when aggregate demand is beginning to soften may prove the toughest task of all.