The Fuel Price Hike and Inflation - Atasi Das

Revenue compulsions and fiscal prudence have apparently prompted the Congress led UPA government to go in for fuel price hike in petrol and diesel, in face of rising public discontent and strong political opposition (even from its allies), in the backdrop of rising prices; especially food inflation.

Fuel Price Hike: The Government Stand
The Indian government administers retail prices of items like petrol, diesel, cooking gas and kerosene, with an eye to control inflation, to protect the economic interests of the poor consumers, from the ill effects of the highly volatile global energy prices.

However, the central government is now seemingly in favour of abandoning the fuel price control system in a bid to downsize its subsidy burden (to help contain the fiscal deficit)-apparently supporting the views of the Parikh committee recommendations (submitted in February 2010), on a viable and sustainable system of petroleum pricing.

In the recently announced Union Budget for 2010-11, the Union government has raised customs duty on crude oil to 5 percent and that on petrol and diesel to 7.5 percent from 2.5 percent. The excise duty on non-branded petrol and diesel has been increased by Re1 per litre to Rs14.35 and Rs4.60 per litre respectively. The government expects to raise around USD 5.7 billion worth revenue from its increased taxes on motor fuel; and it hopes to contain the fiscal deficit (which has touched a 16-year-high) at 5.5 percent of GDP in 2010-11. The 13th Finance Commission report advocates fiscal deficit figures to stay pegged at 4.2 per cent in 2012-13 and 3 per cent in 2013-14; fiscal deficit had swelled to 8 percent of GDP in the Interim budget 2009.

The Prime Minister, Mr. Manmohan Singh has defended the recent fuel price hike and opined that blindly following populist policies will only erode the country’s investment climate, hamper job creation and also curtail the government’s ability to fund social sector schemes. He holds that the government decision to hike petrol and diesel prices by about 6 percent and 7.75 percent respectively (to augment government revenues) will only add 0.40 percent to the wholesale price inflation (a figure contested by the political opposition). Mr. Singh hopes that, the economy, forecasted to grow at 7.2 percent in 2010-2011, can well absorb the effects of the fuel price hike, without creating much inflationary pressure in the long run.

In the face of the political hue and cry over the fuel price hike, the government has released data to show that the previous NDA government had raised the price of kerosene (the common man’s fuel) by 258 per cent in 1996 -2004, while the UPA government has gone for a mere 2 per cent hike in 2004-2010; the corresponding fluctuation in global crude oil prices was between $36 - $73 per barrel, during the UPA’s term, compared with a $18 -$36 variation during the NDA regime.

World crude oil prices (in dollars per barrel) climbed to 81 (as per a report dated 3rd March, 2010) from 75.98 on the 26th of February, 2010.  The latest rally in crude oil prices has been on the back of a weak dollar - as the euro and the yen drove up against the dollar, oil, which is priced in dollars became relatively cheap, leading to a surge in its demand and hence its price. Investor sentiments about a quick global economic recovery are also driving up demand for petroleum products; prices are expected to climb to $90 per barrel in 2011. 

So it seems that, given the situation, the fuel price hike was inevitable but what remains to be seen is how the government takes into consideration the distributional aspects of growth, to protect the marginalized population from the singes of inflation, particularly food inflation.

All eyes are now set on the RBI policy review, coming up in April 2010, to see how it calibrates monetary policy, to ensure an optimum balance between the apparently opposing goals of robust GDP growth and low inflation. Private sector banks like HDFC, ICICI and Kotak Mahindra have already hardened auto loan rates by 25-50 basis points and scrapped their low rate home loan schemes. 

The Aftermath
The fuel price hike has reportedly pushed up transportation costs by 10-15 percent, which in turn will stoke food inflation, as about 65% of Indian goods are transported by trucks; the effects of the fuel price hike will gradually get transmitted to both food and non-food items, leading to heightened generalized inflation.

The key challenge before the government clearly lies in the containment of inflation, particularly food inflation. Food price index has risen to 17.87 percent in the 12 months up to 20th February 2010, and the fuel price index to 9.59 percent. The country is expected to see double digit ‘headline inflation’ figures by March end, from 8.56 percent in January 2010; mostly due to high food prices, manufacturing prices (which picked up to 6.55percent in January 2010 from about 5percent in December 2009) and fuel prices.

The government holds that the current food inflation is more of a supply and distribution related issue - a cost push inflation, due to high procurement prices (and not due to monetary expansion), which will lessen once the crops sown in winter reach the markets, by April 2010.

Air fares are also set to go up, courtesy the fuel hike (10 per cent service tax on the airline industry and 5 per cent customs duty on crude oil).

The Indian benchmark indices have however, rallied after the 26 February 2010 budget declarations, reflecting positive investor confidence. The gains continued till 5th March 2010 (buoyed by positive global cues); the 30-share BSE index closed 22.79 points higher at 16,994.49, posting a 3.4 per cent gain, in the concerned week.

Analyst Opinion
Since fossil fuels form a major input base of an economy, end products become dearer with rising input costs. The impact of the increased fuel prices will reportedly have a skewed effect on the industry; sectors less dependent on it, such as financial services, education, insurance, utility enterprises, health care and government are likely to experience lesser cost inflation due to the price hike in comparison to those at the other end of the spectrum, for example transportation, construction, retail, wholesale, agriculture, and manufacturing; needless to say that the ultimate cost burden will be shifted to the end consumer.

Conclusion
Fossil fuel subsidy is an issue of global economic importance, as fossil fuels meet the lion’s share of the world’s fuel consumption needs and is also a major source of GHG pollution. A 2008 IMF study advocates the linking international prices to domestic prices, to promulgate economic efficiency (as subsidies affect the consumption, production and distribution pattern of resources, by altering their pricing mechanism).

In practice, governments need to follow a policy of gradual hike in prices of goods consumed by the poor, such as kerosene; also, some of the money garnered from the subsidy reform ought to be targeted for social sector spending for the poor. Successful subsidy reform is difficult to implement in the absence of political consensus, public awareness, and presence of vested interests, conditions widely prevalent in the Indian system.