Petrol prices in India are deregulated and aligned to market rates. Though crude prices have risen in the last month, there has been no increase in prices at the retail level on account of the ongoing elections in Uttar Pradesh. This means, that oil marketing companies are facing huge under recoveries, which the government would have to make good through oil bonds or cash.
Even if petrol prices are hiked after the assembly elections in Uttar Pradesh, it would stoke inflation. Now inflation has been a cause of serious worry, which has prompted the RBI to hike rates by 13 times in the last two years. Rising interest rates in turn has had an effect on India’s economic growth rates, which is expected to dip to 6.9% in 2011-2012, from 8.1% in the previous year.
Rising fiscal and current account deficit
Rising crude prices also affect’s India’s fiscal deficit. Diesel, which has not yet been deregulated is a big worry for the government. The government currently subsidises diesel prices, which means that it loses large amounts by way of subsidies. This is expected to increase the fiscal deficit, which is now expected to be way beyond the 4.6% projected in the Union Budget of 2011-2012, thanks in a big measure to crude.
Under recoveries on fuels is now expected to cross a staggering Rs 130,000 crores, making it the worst fuel subsidy figure in history.
The government can of course deregulate diesel and thus reduce the fiscal deficit. However, doing so will cause a political storm, since diesel is used in vehicles for transportation and also by farmers. Even if the government were to bite the bullet and deregulate diesel and align it to market prices, considering the prevailing international prices of crude, we could see inflation spiral out of control.
Rising energy prices are also having a telling effect on the current account deficit. The RBI had already warned in December that the current account deficit would widen due to high energy prices. This is exactly what has happened, with the nation staring at a current account deficit of 3.5% of GDP for 2011-2012, which is by no means a comfortable level. In fact, it has been several years since the current account deficit has reached such a high level.
Clearly, rising crude prices are capable of playing “spoilsport” to sustained economic growth. In the present context two things must happen to favour India: either crude prices must start falling, or the rupee must appreciate faster than crude, which will negate the effect of rising crude.
The Finance Minister rightly remarked recently, when he said “he was having sleepless nights on account of the subsidy bill”. If crude continues to rise, without an appreciation in the rupee, the fuel subsidy might well cause nightmares.