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Union Budget 2017: How volatility in oil prices can spoil the math

After the Economic Survey, chief economic advisor Arvind Subramanian cautioned that oil prices, trade tensions and protectionism are challenges to his outlook. These three things, especially crude oil can spoil the budget math, built on expenditures on subsidies and revenue earned from taxes on petro products, among other things.

union budget Updated: Feb 02, 2017 06:44 IST
Suchetana Ray
IEA has assumed that there will be deficit supply of oil in the first half of 2017.
IEA has assumed that there will be deficit supply of oil in the first half of 2017.(File Photo)

After the Economic Survey, chief economic advisor Arvind Subramanian cautioned that oil prices, trade tensions and protectionism are challenges to his outlook.

These three things, especially crude oil can spoil the budget math, built on expenditures on subsidies and revenue earned from taxes on petro products, among other things.

From plunging to $26 in February 2016 before climbing back to $52.7 in December, oil prices defined volatility. But the decision by the Organization of the Petroleum Exporting Countries or OPEC to cut oil production has led to the commodity piece firming. Led by Saudi Arabia, OPEC has decided to produce less oil, by nearly 1.8 million barrels per day.

Analysing the OPEC decision and Russia’s keenness to join the production cut, the International Energy Agency (IEA) assumes that there will be deficit supply in the first half of 2017, itself. Experts expect prices to be upwards of $60.

Simply put, this means oil prices will zoom, which does not bode well for the Indian economy.

“The uncertainty around commodity prices, especially that of crude oil, has implications for the fiscal situation of emerging economies. It is however expected that increase, if any, in oil prices would get tempered by quick response from producers of shale gas and oil,” said Arun Jaitley while presenting the budget on Wednesday.

The downward spiral of crude since the end of 2014 had also reduced India’s oil import bill from $112 billion in 2014-15 to $64 billion in the last fiscal. This in turn helped the government trim current account deficit. Despite two previous years of drought, low crude prices has also helped the government to keep inflation under check.

Read | Crude oil producers pin tax-relief hopes on budget

India, which depends on imports to meet 80% of its oil needs, will have to spend Rs 9,126 crore more every year for every one dollar per barrel increase in crude prices.

Every rupee per litre increase in fuel leads to 0.02-0.07% rise in WPI inflation.

Oil prices impact the twin deficits; current as well as fiscal.

The Union Budget 2016 had projected a 3% cut in the subsidy bill. And this cut was aided by a 10.2% cut in oil subsidy. The calculation was done, assuming an average import price of crude at $48 per barrel for this financial year.

The government has also increased its revenue by increasing duties on petro products nine times since the crude oil plunge in 2014. This combined with higher dividends from public oil companies in dividends amount to a 50% increase in government revenues. From Rs 1.72 lakh crore in 2014-2015 the earnings went up to Rs 2.58 lakh crore in 2015-2016.

Reportedly, Budget 2017 has assumed an average crude price of $50-$55 per barrel. But the fiscal math will go awry if the IEA’s prediction comes true.

One of the economic advisers to the finance minister said: “We have elbow room till crude hits $65 per barrel. One spurt does not change the math and increase fiscal deficit.” But a sustained spike in crude prices would hurt the math, unless the government refuses to lower the duties on petro products. But that would hurt the common man in a year when nine Indian states will go to polls.

“The target of 3.2% fiscal deficit will be difficult to achieve if crude breaches and sustains at over $60. This will force the government to roll back the duties hurting its revenue collection,” said Debasish Mishra, partner at Deloitte India.

The only hope for India could be that OPEC’s track record in sticking to production cut resolutions is poor.

Another important component for the government to maintain the sanctity of the fiscal deficit target would capital receipts especially from disinvestment.

Read | Budget 2017: Foreign investors reassured but will be watching

Government Wednesday said it will raise Rs 72,500 crore through disinvestment of PSUs, including listing of three railway PSUs IRCTC, IRFC and IRCON, and proposed merger and consolidation to create globally competitive public sector units.

But the government does not boast of a stellar track record in meeting its stake sale targets. Fiscal 2016-17 is the seventh year in a row when the government would not be meeting the disinvestment target fixed in the Budget.

As much as Rs 56,500 crore was budgeted to be raised through PSU disinvestment in 2016-17.

In 2014-2015, the Modi-government missed the target by 44%, it got worse in the next year at 41.5%. Till November 2016, 59% of the disinvestment target has been met.

Sluggish market conditions has been the biggest dampener for the government’s stake sale programmes for the past few years. And a 60% increase in the target doesn’t look very smart, given forecasts that Asian markets are likely to continue their choppy run given uncertain crude prices, trade tensions and Fed rate hikes will exert pressure.