Number Theory: Can lower fuel prices ease inflation pain from cereals?

There is good reason to believe that fiscal policy can play a positive role in controlling inflation via an intervention on the fuel prices front.

The prospect of a continued tightness in cereal markets -- over concerns of rain-related adversity to the rice crop and global tail winds to wheat prices -- have generated upside risks to India’s inflation prospects. When it comes to food prices, there is very little inflation targeting that monetary policy can achieve. Inflation targeting works on the premise of higher interest rates deflating demand, and deflating food demand is not a palatable option at all in democracies. There is, however, good reason to believe that fiscal policy can play a positive role in controlling inflation via an intervention on the fuel prices front. Here are three charts which explain this in detail.

The petrol pump attendant said the car driver first asked him to fill up the tank and then also got several plastic cans filled, leading to a total bill of ₹26,500. (Reuters)

The charts that matter

• 
  Energy prices have fallen faster than grain prices after the Ukraine war surge

  Primary data from the World Bank’s Pink Sheet commodity price database shows this clearly. World Bank’s energy price index had crashed to 31.6 in April 2020. While the index was gradually recovering, it saw a sharp surge after Russia invaded Ukraine in February 2022. The grain price index saw a similar spike after the beginning of the war in Europe. While the energy price index is significantly below pre-war levels, the same cannot be said about grain prices. It needs to be kept in mind that the latest data in World Bank’s database is only for June and grain prices in July could see a further surge after India banning non-basmati rice exports and Russia disrupting the Black Sea grain trade deal.
• 
  India’s crude oil basket prices have fallen in keeping with global prices, but petrol-diesel prices have not

  On a de jure basis, petrol and diesel prices are market-aligned in India. However, there is good reason to believe that this principle is not being followed in de facto terms. Data from the Centre for Monitoring Indian Economy (CMIE) shows that petrol-diesel prices have been constant since June 2022. While CMIE’s monthly average data is available till June 2023, prices have not changed in July as well. The price of India’s crude oil basket (COB) was $115.3 per barrel in June 2022 and it has fallen to $74.9 per barrel in June 2023. While the exact math of the link between COB and retail prices of petrol/diesel is not straightforward – exchange rate and taxes are crucial variables here – a case can definitely be made for the reduction in petrol/diesel prices. Because bulk of the fuel sales in India are done by government-owned companies, a large part of the extraordinary profits from keeping prices high provide a fiscal cushion to the government, especially the central government, via the dividend route.
• 
  And fuel prices are still feeding into inflation

  A disaggregated analysis of Consumer Price Index (CPI) data – it is India’s benchmark inflation measure – shows that while the contribution of fuel prices to the headline inflation number has come down, it is still in the positive territory. This could change if fuel prices were reduced in keeping with the fall in crude oil prices, and could definitely ease the task of inflation management. As is obvious, this is a call of the government (which controls the oil companies), and the Reserve Bank of India.
• Why is this route not being explored?

  The reason can be that the government is hoping to deploy the savings from this route somewhere else. It could be aimed at medium-term fiscal consolidation — overall fiscal deficit levels are still quite high — and saving the fiscal ballast for the interim budget before the 2024 elections or the state elections cycle later this year. The fact that there is no political pressure to bring down prices in keeping with crude prices has clearly helped the government in continuing with this policy.