The general concern over price increases is valid. The pressure of higher prices is the hardest on the poorest sections of society
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State-run oil-marketing companies (OMCs) last week raised the prices of non-branded petrol and diesel by ₹3 per litre. This was the first price increase in four years. Gas-distribution companies also raised the price of compressed natural gas by about ₹2 per kg. Global crude-oil prices have increased by about 50 per cent over the past few months owing to the war in West Asia and the blockade of the Strait of Hormuz by Iran and the United States. The government resisted increasing the prices for various reasons, but the proposition became more unsustainable with each passing day. It has also taken a hit with the reduction in special excise duty on petrol and diesel. Nevertheless, the OMCs were reported to be facing underrecoveries worth ₹1,000 crore per day. The price increase will lessen some pressure but is unlikely to be sufficient. Pump prices need to increase further in the coming days and weeks.
The general concern over price increases is valid. The pressure of higher prices is the hardest on the poorest sections of society. However, it is not possible for the government or oil companies to absorb losses for an extended period. Even though demand for fuel is considered less elastic, price increases will likely encourage more conservation than appeals. While passing on the price increase to the end consumer is the most prudent policy choice, it will have other macroeconomic consequences, which need to be managed. An oil price shock tends to have stagflationary effects. In other words, it reduces the growth rate and increases the inflation rate. The current shock may potentially have a bigger impact because, apart from higher prices, availability — in the case of gas, for instance — has also been an issue.
The wholesale price index-based inflation rate increased to 8.3 per cent in April compared to 3.9 per cent the previous month, largely because of higher fuel prices. The consumer price index-based inflation rate for April was a modest 3.5 per cent, primarily because of the limited passthrough of higher oil prices. After the increase in fuel prices, economists expect the retail inflation rate to inch towards 4 per cent. It is a relief that the inflation rates were at lower levels at the beginning of the conflict. Since there are no clear signs of an early resolution to the conflict, a further passthrough of fuel prices will push up the inflation rate. In the context of monetary policy, central banks usually look through spikes in energy prices. However, sustained higher prices could lead to second-round effects, which can increase policy challenges.
Things could get more complicated for the Reserve Bank of India in the coming months because the monsoon this year is expected to be below normal. If left unaddressed, a significant increase in food and fuel prices could affect inflation expectations. The Monetary Policy Committee (MPC), therefore, needs to be extremely alert. It is also worth noting that inflation rates in many parts of the developed world are running well above target, and they may be forced to raise interest rates sooner than India does. The Reserve Bank of Australia, for instance, raised the policy rate earlier this month for a third consecutive time. The inflation rate in the US is running close to double the target. Potential rate increases in the developed world could further affect capital flows and put pressure on the currency. The June meeting of the MPC will have to deal with several moving parts.
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