In the coming months, crude, crops and currency will determine the country’s inflation outlook
The benign inflation situation for several quarters seems to be under threat. India is currently facing a double whammy of rising crude oil prices and a rapidly depreciating rupee. This is a potent, indeed lethal, combination that raises inflation risks. If the trend continues, it has the potential to inflict on the government quite a bit of political damage.
At close to $80 a barrel, crude prices today stand is sharp contrast to $30 a barrel two years ago. Escalating geopolitical tensions have propelled crude oil prices to multi-year highs. Analysts forecast that prices may rise even higher. If that happens, the global economic growth momentum that we currently witness may be lost.
There is positive correlation between economic growth and energy consumption. At the moment, global consumption growth for energy products such as crude and natural gas is robust. But at continued high price levels, demand growth risks a slowdown. In the event, economic growth itself may be affected and growth in world merchandise trade will take a hit, leading to negative spin-off effects on jobs, incomes and capacity utilisation. We need to recognise the danger.
On the currency front, the rupee has depreciated from around 63 to a dollar in January to the current level of close to 68. A weaker rupee translates to higher landed cost of imported goods. Our imports have become so much more expensive.
It is well known that our dependence on crude oil imports is already at an unconscionable level of about 80 per cent. Every increase in international oil price translates to higher cost of import and thereby contributes to inflation. As a rule of the thumb, a $1/barrel rise in crude oil price sets us back by $1 billion.
After crude and currency, we need to look at crops. In different parts of the country, farmers are angry. They have not received even the minimum support price announced by the government. Pulses, cotton and oilseeds are examples. The upcoming kharif planting season may witness loss of acreage in some crops.
Forecast of a ‘normal’ south-west monsoon is of course a consolation. But as yet we do not have any clue as to the temporal and spatial distribution of rains so crucial for advancing crop prospects. In other words, we have to wait and watch.
So, in the coming months, three ‘C’s — crude, crops and currency — will determine the inflation outlook. As the nation moves towards general elections less than a year from now, inflation would come under sharper focus and will swing the mood of the electorate.
Be that as it may, when international crude prices traded at less than half the current levels, the government did nothing to pass on the benefit of low prices to the consumers. Indeed, taxes on mineral oil and products were raised from time to time to generate additional revenue. The constant refrain from New Delhi was that huge revenue was needed to fund a variety of welfare programmes. Now that international oil prices are rising, consumers are squeezed. They are forced to pay higher prices for petrol and diesel. The anger among urban consumers is palpable.
It is clear that New Delhi’s idea of generating revenue from crude oil and products (import duty, excise duty, sales tax and many more levies) was facile and unintelligent for the simple reason that global energy markets by their very nature are highly volatile and prices are subject to wide swings.
It was naïve on the part of the government to have decided to fund ambitious welfare programmes based on revenues generated from fickle markets such as that of crude oil. Now that prices have risen — and it was inevitable — New Delhi finds itself in an indefensible position. The government needs to respond to the blunder. There is tremendous popular pressure to reduce taxes and in turn reduce the high retail prices of petrol and diesel, so as to pass on the benefit to consumers. The sooner it is done the better. One recalls a similar blunder committed by the government way back in 2002 based on low international price of palm oil. For long years, palm oil used to be sold through the public distribution system to needy consumers. In 2002, palm oil went through a prolonged bear market phase and prices fell as low as $200 a tonne.
Without an understanding of the market dynamics and naively assuming that low palm oil prices were here to stay, the then government withdrew supply of palm oil through PDS. In less than two years, palm oil prices doubled, and needy consumers were left to fend for themselves.
The lesson: do not plan long-term welfare programmes based on revenue generated from short-term market price movements of highly volatile commodities.
The author is a policy commentator and commodity market specialist. Views are personal