Wednesday , 26 September 2018

Spiraling oil prices pose a formidable challenge

Dr D M Deshpande

Global crude oil prices are on the boil, once again. The Government shielded the retail oil users for a short period before elections in the state of Karnataka. With elections done, though not dusted yet in that state, the state run oil PSU’s have hiked the retail prices continuously for the last seven days. There seems to be no respite as the oil scenario presents a bleak picture. The U.S waking out of the nuclear deal with Iran and placing sanctions against it is only worsening the matters as far as crude oil prices are concerned.

Between 2013 and 2015 when the oil prices were falling, India was a key beneficiary. Though the economy is seventh largest in the world, India is excessively dependent on imported oil. The principal reason why India was able to keep twin deficits down during the period between FY 2014 and FY2016 was due to low oil prices and consequent saving in the oil import bill. Since the oil price was falling quite steeply, it gave an opportunity to the Government to shore up it’s revenues. During this period, excise duty on petrol was hiked nine times and benefit of only a smaller proportion of the fall in price was passed on to the consumer. Yes the Centre did reduce the duty by Rs 2 a litre in October last but it was neither here nor there. States did not pay heed to reduce VAT and more rise in oil price was in the offing.  Now, as a corollary, common man expects that the Government reduce it›s taxes as the oil prices have escalated and are presently hovering at around $80 a barrel.

What is driving oil prices up is something which is seen with a lot of interest internationally. If it is demand side of economics that is responsible for spike, it isn›t much of a problem. In that case, it could be due to the world economy growing and the west coming out of recession. It would of course mean higher oil import bill; but it will be offset to a great extent by higher non oil exports and remittances. More than 50 per cent of our remittances come from Gulf countries and fortunes there are linked to global oil prices. Moreover, higher domestic activity will translate in to higher growth rate. However, if it is supply side that is driving up oil prices, countries such as India will certainly be worried. There are two reports to go by; unfortunately they almost contradict each other in a way that leaves no answer to the question of rising oil prices.

One is the report by World Economic Output  of the IMF; around 80 per cent of the rise in price is owing to supply side constraints, especially the much faster than expected decline in production in Venezuela. The second one is the report ‹Oil Price Dynamics› by the US Federal Reserve which says that less than two-fifth of the recent increase in oil prices in 2018 is due to supply side factors! Oil has always been a volatile commodity in international trade. The last time when the oil touched almost $150 per barrel was during the boom period before the global financial crisis of 2008. Interestingly, even then, the demand-supply mismatch was no more than 2 per cent; yet the financial intermediaries and hedging institutions took the price sky high.

Taxes and levies have also contributed in a big way for higher petrol and diesel prices at the pumps. Nearly half the price paid by the user goes to the governments-states and central. Central tax on diesel has increased by three-fold. Petrol too attracts a similar levy. Last time when the prices of oil went up, tax rates were moderate. But this time around, since the Government has already hiked excise and other duties on petrol, it is hurting the ultimate consumer.  As the duty is ad valorem, that is, a certain percentage of the value, every time there is a revision of price upwards, the duty also goes up.

There is a case for lowering the taxes. It is doable especially because the government has the headroom to maneuver the same. It should give some relief to the common man. It will also help the Government and the RBI to manage the inflation better. Sudden and huge rise in transport costs of men and materials will only abet inflationary forces. If Government remains a silent spectator as it has been for a while, it will strengthen inflationary expectations, which is like adding fuel to the fire. It is important to douse the fire of anger in people before it is too late. Not doing so now may result in a situation where the Government is forced to go back on reforms and return to administered prices in oil. That will be unfortunate, if it happens.

All major forecasts for oil predict a price in the range of $65 to $70 a barrel, no more. It means that the current high price is not sustainable; any further rise will bring US shale into play. A lot of other alternative sources of energy, too become viable. So, the Government is now in a position to provide a cushion, it should do so, without any further delay.

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