The recent rise in crude oil prices is a cause of serious worry for our finances and may have wider implications than changes in oil prices in the last few years.
After the rise in early 2014, prices have fallen continuously. In early 2016 these reached a level of about $30 per barrel. Since June this year, these prices have shown a regular upward trend.
A few days ago, prices touched $64 per barrel. This is a nearly 40 per cent rise in a period of less than six months.
Let me briefly analyse the implications of this trend for the Indian economy.
India imports nearly 200 million tonnes (mt) of crude oil to meet its needs. In addition, it also imports about 23 million tonnes of petroleum products. After accounting for the export of about 55 million tonnes of oil products, the net domestic need met by imported crude is about 170 million tonnes.
We also have domestic crude oil production as well. After accounting for it, we are able to meet the needs of the domestic market of about 210 to 215 million tonnes of products.
Every one dollar increase in crude oil price leads to about Rs 8,000 crore of extra out go by way of purchase cost. An increase in oil prices of about $18 in a span of less than six months will imply extra burden on the economy of more than Rs 1.5 lakh crore if the trend persists. This is about one per cent of our GDP.
There are strong indications that this price trend may not be reversed easily. Several global factors contribute to this process.
Global growth is continuing. The demand from China and India, two of the largest economies growing at about seven per cent or more, has put upward pressure on oil demand.
A recent assessment by the International Energy Agency (IEA) indicates a demand increase of about 1.3 million barrels per day in 2017 and 1.5 million barrels per day in 2018. The Opec projections are quite similar. So despite the increasing demands, both Opec and non-Opec countries have decided to cut back production.
In fact Russia and Mexico have slashed their production fully in accordance with their announced cuts. Saudi Arabia also has cut back production, as per their plans. The availability of shale oil from the USA and its export to different countries has been an important window in recent years. The pace of its growth in recent times is good.
But will it be enough to offset the decline from other sources? This is still not clear from assessment made by all the expert agencies. Present indications suggest that may not be the case.
Further, there are other dark clouds on the production front, which can push up prices. The geo-political conditions in Saudi Arabia are a cause of concern.
First, there was the face off with the Qataris. Since Qatar is not an important oil producer, this had little impact on oil availability. But now the conditions within the Kingdom of Saudi Arabia are changing fast. Many members of the royal household and royal princes have been arrested and put behind bars, ostensibly on charges of corruption.
There is worry that it is a power struggle in the kingdom. In such a situation, even a slight disruption in oil production, given that Saudis are the largest oil exporters in the world, could be difficult to meet in the short term framework.
After the assumption of office, the new government had a huge advantage in terms of low oil prices. The prices declined to as low as $29 from a high of more than $100 per barrel. This enabled it to balance their budget more effectively, have a lower fiscal deficit and raise revenue by raising excise duties on oil products.
Duties on diesel were sharply hiked to Rs 17.33 per litre in April 2017 as against Rs 3.56 per litre just three years ago.
Similarly for petrol, these were increased to Rs 21.48 per litre from Rs 9.48 per litre in the above period. This huge jump in excise duties, coupled with increased consumption of domestic oil products by an annual 7-11 per cent, resulted in huge jump in revenues from petroleum products.
Recently, as prices of crude oil started rising and prices of oil products increased, the government had to revise the duties downwards by Rs 2 per litre.
With massive increase in the price of crude oil of more than 40 per cent in a five-month period, the prices of oil products have risen and may continue to do so. This will bring in consumer resistance. With elections to eight assemblies, including Madhya Pradesh, Rajasthan, Karnataka and Chhattisgarh slated next year, the clamour for providing relief and reducing excise duties so that prices of petrol and diesel do not rise will go up.
The government may find it difficult to continue with high prices of oil products and could roll back increased excise duties further. This will result in lower revenues.
In the current half year, fiscal deficit has reached 90 per cent of its annual target. Lowering of revenue receipts from the petroleum sector, which provides nearly 50 per cent of its excise tax revenues, will put further pressure on fiscal deficit.
In the last few years, growth has been driven primarily by government investment. Private investment in the last three years has declined sharply and as a percentage of GDP, has been far less than what it once was.
If the level of expenditure budgeted in the current year is to be maintained, the government may not have enough tax receipts and resort to increased borrowing.
This would result in the government exceeding its fiscal responsibility and budget management (FRBM) limits. With already most of it being exhausted in the initial few months, it may find it difficult to adhere to the budgeted figures. This could be seen negatively by the rating agencies and may ultimately impact the borrowing cost of our companies in the international market.
Increased oil prices will also adversely impact efforts to check consumer inflation. The transportation industry is primarily driven by petrol and diesel products.
High prices of petrol and diesel would result in high transport cost, which will add to the prices of all goods. The problem will be compounded by the fact that the government may have to borrow more from the market to meet its scheduled capital expenditure needs.
This will restrict space for borrowing by the private sector. Higher inflationary expectation may also make the RBI reluctant to change the repo rate.
To stimulate growth, the industry and the market have been talking about it for some time as an essential step.
Many economists have advocated this. In the context of rising inflation, this may be difficult for the RBI. GDP growth could be adversely effected in view of the high oil prices.
The sharp increase in oil prices poses a challenge for the economy. This level of prices may imply a higher outgo of foreign exchange by about $5 to 30 billion. If the government continues with its current policy, prices of transportation fuel will rise sharply, leading to inflation and consumer resistance.
If the government rolls back its excise duties on petroleum products to moderate impact of high oil prices, it will have to borrow more from the market to meet its expenditure needs.
This will restrict private borrowing space and increase fiscal deficit. The government needs to carefully adopt a middle path, but keep inflation in check.
If prices rise rapidly, it may be difficult to contain widespread public criticism. No government would like that when elections are round the corner.
(The writer is a former cabinet secretary and ex-member of Planning Commission)