Rising fuel prices and the prospects of economic recovery

A rise in prices of petrol and diesel also feeds into the prices of other commodities via a cascading effect. Businesses that are unable to pass on these costs will have to take a hit to their profits.
The Union government has maintained that it does not plan to bring down taxes on petrol-diesel immediately. This has fed into expectations that prices may not come down anytime soon.(HT Photo )
The Union government has maintained that it does not plan to bring down taxes on petrol-diesel immediately. This has fed into expectations that prices may not come down anytime soon.(HT Photo )
Updated on Sep 30, 2021 04:53 AM IST
Copy Link
ByRoshan Kishore and Vineet Sachdev, Hindustan Times, New Delhi

India is a week away from the effective start of its festive season, which will likely see a much-needed consumer spending boom. But the country’s economy faces a serious threat -- inflation, especially via the fuel route. A rising trend in international crude prices is only one part of the fuel inflation story as taxes are a big reason behind the current levels of fuel prices. While the situation is already very difficult, any further increase in international crude prices will only make it more precarious. Here are five charts which explain this.

Petrol-diesel prices are disproportionately high compared to crude prices

While Brent crude prices reached the $80 per barrel after three years, they have been higher in the past. But petrol-diesel prices were not as high back then. For example, Brent crude price was above $100 between February 2011 and September 2014. But petrol-diesel prices were significantly lower than what they are today. The reason why prices are higher at the moment is the increase in tax component of fuel prices after the Covid-19 pandemic. A comparison of price build-up of petrol-diesel brings this out clearly. The tax component of fuel prices was 37.83 and 28.06 per litre on 14 March 2020, before the Covid-19 pandemic hit. This is now 56.26 and 44.77 for petrol and diesel.

This has led to a sharp rise in fuel inflation and inflation expectations

The fuel component of both retail and wholesale inflation has been rising rapidly in the past few months. A rise in fuel prices also feeds into the prices of other commodities via a cascading effect. Businesses that are unable to pass on these costs will have to take a hit to their profits. Smaller businesses are more vulnerable to this pressure than larger ones, as was pointed out a research note dated August 2, by Pranjul Bhandari from HSBC Securities. This means a squeeze on their earnings.

The bulk of the tax component of petrol-diesel prices is on account of Union government taxes. The Union government has maintained that it does not plan to bring down taxes on petrol-diesel immediately. This has fed into expectations that prices may not come down anytime soon.

This, when read with the fact that retail inflation has stayed closer to RBI’s upper tolerance limit of 6% since June (although it hit a three-month low of 5.3% in August), and inflation expectations of households have been rising consistently in RBI’s latest survey (July 2021), underlines the threat of hardening inflation expectations feeding into an already volatile inflation scenario.

Oil is not the only imminent inflation threat on the horizon

Crude oil is not the only tailwind to inflation in the world at the moment. “Consumers are most likely to feel the pinch in the supermarket, where inclement weather in one of the biggest crop growers (Brazil) is also contributing to higher prices”, a September 29 Bloomberg column by Mark Gilbert said. “Annual inflation is running at 5.3% in the US and 3.2% in the UK . and is forecast to have reached 3.3% in the euro zone. In all three regions, prices are rising at a pace way faster than the 2% central banks are supposed to target”, he added. Bloomberg’s News Trends function, which can tally the occurrence of keywords from more than 1,500 sources, shows monthly usage of the term Stagflation (low growth high inflation) is at a record high, Gilbert said in the column.

And commodity prices are surging.

The Bloomberg Commodity Index, which tracks prices of energy, grains, industrial metals, precious metals, livestock and sugar, coffee and cotton, crossed 100 on September 27 for the first time since March 2015.

The problem for India this time is that while global inflation is arising from high demand in advanced economies, high inflation will generate headwinds for demand and future growth in countries such as India.

Festive demand could sidetrack policy focus from the problem at hand

Thanks to its entrenched inequalities, the Indian economy is facing two kinds of inflationary problems at the moment. There is a small section of the economy (still large in absolute numbers) which is seeing the same supply crisis present in the advanced countries for commodities such as cars, high-end electronic gadgets etc. due to factors such as microchip shortages. With demand booming during the festive season, the supply crunch is likely to give the impression that the inflation problem is transient. The situation is likely to be very different for the non-rich, whose incomes and purchasing power has perhaps still not recovered from the pandemic’s shock. Indicators such as the RBI’s Consumer Confidence Survey capture this grim reality. If inflation does not come down, inflation expectations of this group will harden at higher levels.

If economic policy makers are swayed by the economic story of the top 10% in the country, and ignore the economic reality of the majority, the situation might be even more dire by the time it is acknowledged. While the larger project of boosting poor people’s incomes will take a concerted policy effort, putting an end to the negative fiscal stimulus via high levels of taxes on petrol and diesel can be the first concrete step in this direction.

SHARE THIS ARTICLE ON
Topics
Close Story
SHARE
Story Saved
OPEN APP
×
Saved Articles
Following
My Reads
Sign out
New Delhi 0C
Monday, November 29, 2021