Crude oil prices have been on the boil for some time now due to the escalating Russia-Ukraine conflict. It soared past $100 a barrel this week for the first time in over seven years. If the oil prices remain at this level, it will considerably upset India's Budget math.
While the Union Budget 2022-23 has not made any explicit assumption about oil prices, the Economic Survey has made its projections assuming that crude oil prices will be in the range of $70 to $75 per barrel. Brent crude oil price jumped to $105 a barrel on February 24 after Russian President Vladimir Putin authorised military troops to carry out attacks against Ukraine. Brent crude, also known as London Brent, makes up more than half of the world's globally traded supply of crude oil.
Crude price over $100 per barrel
The crude oil price has almost doubled in 14 months. Brent crude oil price was less than $50 a barrel in December 2020. At over $100 per barrel, the crude oil price currently is around 40 per cent higher than the government's assumptions of $70 to $75 per barrel.
Such a large gap in price will have a considerable impact on the macro-economic projections. The high crude oil prices pose inflationary, fiscal and external sector risks. The government has projected 8 to 8.5 per cent real GDP growth for the financial year 2022-23.
"This projection is based on the assumption that there will be no further debilitating pandemic related economic disruption, monsoon will be normal, withdrawal of global liquidity by major central banks will be broadly orderly, oil prices will be in the range of $70-$75/bbl, and global supply chain disruptions will steadily ease over the course of the year," the Economic Survey 2021-22 noted. In the Union Budget 2022-23 Finance Minister Nirmala Sitharaman has projected the economic growth for the financial year ending March 2022 at 9.2 per cent.
GDP growth projected at 11.1% in 2022-23
The nominal GDP growth is projected at 11.1 percent in the financial year 2022-23. As per the first revised estimates, the nominal GDP growth in 2021-22 is pegged at 17.6 percent. Clearly, the government has pegged the real GDP growth for 2022-23 at 8 to 8.5 percent assuming a significant drop in inflation. If the oil price does not come down to the average of $70 to $75 a barrel, inflation, as well as the GDP growth numbers, will get upset. The country's current account deficit would widen.
India is heavily dependent on imports to meet its energy requirements. Around 86 percent of the country's crude oil requirements are met through imports.
According to a State Bank of India's research report, the average price of the Indian basket of crude oil rose from $63.4 per barrel in April 2021 to $84.67 a barrel in January 2022, an increase of 33.5 per cent.
If the crude oil price rises to an average of $100 per barrel, from the current average, inflation is likely to increase by 52-65 basis points. One basis point is a hundredth of a percentage point.
Two possibilities
There are two possibilities. One, the rise in crude oil and gas prices is passed on to the consumers by a corresponding increase in retail prices of petrol, diesel, and other petroleum products. It will have cascading inflationary impact.
The second possibility is that the government absorbs the entire oil price shock rather than passing it to the end-user. This will lead to an increase in deficits. If the government decides to maintain its fiscal and other deficits commitments, then it would be required to lower the spending on the areas like social welfare and infrastructure development.
$10 per barrel increase in oil price will raise inflation
According to a Mint Street memo published by the Reserve Bank of India (RBI) in January 2019, a $10 per barrel increase in oil price will raise inflation by roughly 49 basis points (bps) or increase the fiscal deficit by 43 bps (as a percentage of GDP) if the government decides to absorb the entire oil price shock.
Though there has been a sharp increase in crude oil prices in the international markets, petrol and diesel prices have not changed in India since November 2021.
Based on the existing VAT structure and taking Brent crude price of $100 to $110 per barrel, diesel and petrol prices should have been higher by Rs 9-14 each as of now, SBI said in a research report.
Will govt reduce excise on petroleum products?
If the Government, however, reduces the excise duty on petroleum products and prevents the prices of petrol and diesel from rising, then the Government will incur excise duty loss of Rs 8,000 crore for a month.
"And if we assume that the reduced excise duty continues in the next fiscal and assuming petrol and diesel consumption grow around 8-10 per cent in FY23, then the revenue loss of the Government would be around Rs 95,000 crore to Rs 1 lakh crore for FY23. In this context, the FY23 budget numbers that are pegged conservatively would act as a clear counter cyclical buffer for such revenue loss," Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India, said in the research note.
Ghosh noted, "There appears to be an upside risk of 90-100 bps to RBI's inflation of 4.5 per cent for FY23 if oil price averages to $90 per barrel. And 100-130 bps upside if oil price averages to $100 per barrel."
Retail inflation crosses upper limit of RBI tolerance band
The headline inflation, as measured by the Consumer Price Index (CPI), rose to 6.01 per cent in January 2022 from 5.66 per cent in the previous month, according to data released by the National Statistical Office (NSO) earlier this month. The retail inflation crossed the upper limit of the RBI's tolerance band of 6 percent for the first time in seven months. Wholesale Price Index (WPI) based inflation stood at 12.96 per cent in January.
The headline inflation has crossed the tolerance limit of the RBI and any further increase would force the central bank to tighten the monetary policy.
The monetary policy tightening, like an increase in policy interest rate, would negatively impact economic recovery. The sharp rise in crude oil prices due to the Russia-Ukraine crisis has brought India's finances into a precarious situation.
Going ahead, the economic policymakers will have a tough time managing these challenges.
