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This is not the last upswing in oil prices; India has to make its demand for oil more elastic. Here’s why.

Effective October 1, fuels have become dearer. Indraprastha Gas Ltd raised the price of CNG and of domestic piped gas. Petrol prices were hiked by 24 paise per litre and diesel by 30 paise. The price of non-subsidised LPG was up by Rs 59 per cylinder and subsidised LPG cylinder became costlier by Rs 2.89. All this is an outcome of higher global oil prices and a weak rupee. The media and analysts these days are speculating increasingly on the possibility of crude oil prices reaching $100. This has gained traction ever since Brent crude breached the $80 mark and has sustained itself at those levels.

Brent crude has averaged $75 in the fiscal so far. Much of the rise in prices is attributable to increased conformity (led by fall in output from Venezuela) towards the output deal by the OPEC and other cooperating nations, and the sentiments around US sanctions on Iran oil exports that come into force starting November. At its latest JMMC (Joint OPEC-non-OPEC Ministerial Monitoring Committee) meeting in September, the OPEC and other cooperating nations seemed to have paid little heed to the US President’s rhetoric to bring down oil prices. The group of nations expressed satisfaction regarding current oil market outlook, with an overall healthy balance between supply and demand. There are no signs telling the OPEC would increase output—its next meet is scheduled for December 3. The future course of output cooperation deal will become known then. But, in recent months, Russia and OPEC have hinted multiple times at a long-term output cooperation. Pipeline constraints in the US prevent US shale industry to pump out more oil and make it available to the market. With excess oil inventories gone, prices have become very sensitive to any supply-side news. On the demand side, oil demand remains strong and is yet to show any signs of weakening.

So what will be the impact of $100-barrel oil on India? India’s trade deficit was $161 billion in FY18. Around 44% of this was on account of oil. India imported 1.7 billion barrels of crude in the last fiscal, worth $88 billion, when the average price of Indian basket of crude was about $52 a barrel. In the last fiscal, trade deficit on account of oil was $71 billion. In the event oil prices reach $100 a barrel, India would be importing around $14 billion worth of crude every month. If oil prices were to reach $100 and sustain themselves at elevated levels till the end of the fiscal, India’s oil trade deficit would swell by almost 58% in FY19. While higher crude oil prices would also increase the value of our refined product exports, given the high base of imports versus exports, the overall impact on trade deficit would be negative.

Increase in crude oil prices leads to increase in prices of fuels at the pump. Prices of diesel and petrol are now deregulated and change on a daily basis. Diesel and petrol together have 2.19% weightage in the CPI basket. LPG accounts for 1.29% of the basket. Other components of the CPI basket too get impacted by higher fuel prices via second round effects. Crude at $100 could add 1-1.5% to the headline inflation number. Higher crude oil prices will also increase the cost of petrochemical inputs which make their way into various items, and may in turn lead to an increase in retail price of goods. Increased outlay on fuel could lead to decreased discretionary spending. This might lead to inflation easing in some of the categories like clothing & footwear and some miscellaneous items. RBI, too, has sighted high oil prices as risk to its inflation outlook.

On the fiscal front, increase in oil prices will increase the subsidy outlay—kerosene and LPG are still subsidised. The budget for FY19 has budgeted petroleum subsidies at Rs 24,933 crore—Rs 20,377.8 crore for LPG and Rs 4,555 crore for kerosene. An LPG cylinder costs the consumer Rs 502.4 after a subsidy of Rs 376.6. OMCs lose around Rs 19.09 per litre on kerosene. Subsidy on account of LPG will also increase as more and more people are brought under the Pradhan Mantri Ujjwala Yojana. As of August, the government has already used up Rs 18,468.76 crore under petroleum subsidies—74% of the budgeted amount. The government will have to shell out more on account of subsidies unless prices of kerosene and LPG are raised, or OMCs are asked to absorb more and more burden. A cut in taxes on any of the fuels might lead to lower retail prices and in turn inflation, but at the same time will result in lower government revenues and increased fiscal burden. The petroleum sector contributed Rs 5.5 lakh crore to the government kitty last fiscal.

A higher trade deficit and high inflation don’t really bode well for the already weak rupee. An increase in fiscal burden might also lead to an increase in government borrowings and may push up yields. The stress on government finances has reduced considerably since subsidies have been done away with. Petrol and diesel account for around 50% of the consumption of petroleum products in India. India will improve its resilience to movement in oil prices only if we are able to make our demand for oil somewhat elastic—reduce our dependence on oil imports, increase use of alternate fuels, greater use of public transport, increased adoption of carpooling, etc. Small steps in the right direction at a micro level will go a long way in yielding greater benefits at a macro level.

The swing in oil prices and its impact on the economy is nothing new. Over the years, oil prices have moved in a broad range on account of various reasons, and this current upswing might not be the last one. Given the inelastic nature of our demand for crude, India tends to benefit every time oil prices fall and faces a tough time when oil prices rise.

-The author is a corporate economist. Views are personal