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War and oil: India faces trying times as global risks pile up

India, like most net importers, has a history with oil. The rise in crude oil prices poses inflationary, fiscal and external sector risks for India.

February 24, 2022 / 04:31 PM IST
A man sits outside his destroyed building after bombings on the eastern Ukraine town of Chuguiv on February 24. (Image: AFP)

A man sits outside his destroyed building after bombings on the eastern Ukraine town of Chuguiv on February 24. (Image: AFP)

At a time when Ukrainians are fleeing their homes in the face of a Russian assault, it might be a tad unsavoury to discuss the consequences for India from what are blithely called 'geopolitical tensions'. But, as the last two years have shown, the economic fallout of a humanitarian crisis can be severely debilitating.

Earlier today (February 24), Brent crude futures went past the $100/barrel mark for the first time in over seven years as Russia attacked several parts of Ukraine after President Vladimir Putin approved a military operation to "demilitarise" its neighbor.

India, like most net importers, has a history with oil. After months of record-high local pump prices, an excise duty cut in November 2021 provided some relief to consumers. However, that tax break feels like a lifetime ago.

"Russia accounts for one in every 10 barrels of oil consumed globally, so it is a major player when it comes to the price of oil and it's really going to hurt consumers at the petrol pumps," Navneet Damani, Senior Vice President, Commodity and Currency Research, Motilal Oswal Financial Services, said in a note on February 23.

According to Damani, the rise in crude oil prices poses inflationary, fiscal and external sector risks for India.


"Crude oil-related products have a direct share of over 9 percent in the Wholesale Price Index (WPI) basket. The rise in crude oil prices is also expected to increase the subsidy on LPG and kerosene, pushing up the subsidy bill. India is Ukraine's largest export destination in the Asia-Pacific and the fifth largest overall," Damani added.

When will fuel prices be hiked?

When it comes to inflation, what matters is the pump prices. And data from the Petroleum Planning & Analysis Cell shows that the retail price of petrol and diesel in Mumbai has not moved at all since November 4 – the first day of the post-excise duty cut era. But it is seemingly a question of when, and not if, oil marketing companies will start raising fuel prices.

That when may be as early as the second week of March.

"A sustained bout of high oil prices is a risk to the economy's inflation (once fuel prices are adjusted post State polls), fiscal and current account math," noted DBS Bank's economists on February 23.

The seventh and final phase of voting for the Uttar Pradesh assembly elections takes place on March 7.

Governments are loathe to see higher fuel prices during elections given their politically-sensitive nature. And while it may make political sense to announce another round of excise duty cuts, the government has refused to be drawn into such a discussion, with at least one eye on its coffers, whose dependence on excise collections have grown over the years.

The RBI's conundrum

But if domestic fuel prices are raised once voting is complete, it would make the Reserve Bank of India's (RBI) inflation forecasts even more untenable. The central bank has already come under fire for saying average Consumer Price Index (CPI) inflation will decline to 4.5 percent in FY23 from 5.3 percent in FY22. While the underlying assumptions, particularly those relating to fuel prices, are not known, Governor Shaktikanta Das has defended the expected inflation trajectory set out by his staff and called it "robust".

One only has to go back to the RBI's forecasts from October 2021 to see how reality doesn't always pan out as calculated. The RBI had then assumed $75 per barrel as the price of India's crude oil basket for the second half of FY22. Instead, the price of the basket was 7 percent higher during the October 2021-January 2022 period itself. Global crude oil prices have only increased since then.

As per the RBI's own calculations, a 10 percent increase in crude oil prices can result in a 30-basis-point rise in domestic inflation and 20-basis-point fall in growth. While these numbers may seem small, Morgan Stanley expressed concern in a report on February 23 that if oil prices rose by another $20 per barrel "in a sharp and sustained manner", macro-stability risks would rise, with India being one of the more exposed economies.

The policy implications are not pretty.

Monetary policy pressure

According to Morgan Stanley, the Centre could consider cutting fuel excise duty by Rs 5-10 per litre, although this would have to be balanced by reduced fiscal stimuli in other areas to assuage fears of a fiscal slippage. On the monetary policy side, the RBI could be forced into taking action as early as April 2022, with the risk that it might have to take up "front loaded rate increases".

But before the Monetary Policy Committee meets on April 6-8, there is the small matter of the US Federal Reserve's interest rate decision, due on March 16. According to former RBI governor Raghuram Rajan, Russia's aggressions and the resultant energy price shocks may give the US Central bank some food for thought, but not completely dissuade it from raising interest rates.

"If inflation in industrial countries had been low – if inflation in the US was low – the Fed would have a clear sense of what to do. And that would be: don't tighten into a supply shock, allow the supply shock to play out and even perhaps increase accommodation," Rajan told CNBC-TV18 on February 24.

"With inflation where it is, that becomes harder. And I think the Fed will have to perhaps balance out the risks of overtightening. So, my sense is, what this does is it takes some of the more outlandish moves off the table. The Fed will start the process of tightening in its March meeting but maybe it will signal a steady pace rather than an abrupt pace," the former central banker added.

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Siddharth Upasani
first published: Feb 24, 2022 04:31 pm
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