What does soaring crude oil price mean for the Indian economy?

The Economic Survey tabled recently has projected a real GDP growth of 8-8.5% in FY23 assuming that oil prices will average $70-$75 per barrel in the next financial year.  

But that doesn’t seem to be happening. The price of Brent crude oil crossed 96 dollars per barrel on Monday amid fears of a possible Russian invasion of Ukraine, with the US saying such an invasion could be imminent. 

However, it dropped to $94 a barrel on Tuesday after Russia’s announcement that it is withdrawing some of its troops from the border with Ukraine in a possible de-escalation of tensions between the two countries. 

Amid all this, India’s retail inflation rate accelerated to 6.01% in January, breaching the upper tolerance limit of the Reserve Bank of India (RBI) after a gap of seven months. And for the 10th month in a row, the wholesale inflation is in double digits, coming in at 12.96% for January.

The rural belt was worst hit as the pace of price rise touched 6.12% from 5.36% in December. While in urban areas, it was 5.91% in January, marginally up from 5.90% a month earlier.
 

According to experts, higher edible oils component pushed food inflation. While clothing and footwear inflation also soared to 8.84% in January, up from 8.3% in December.

“When you do inflation projection, you assume a crude price for the whole year, a particular price and a range of prices. If you take $95 a barrel and make a projection for the entire year you will definitely go wrong. It may go up further and come down steeply,” said RBI Governor Shaktikanta Das.

Economists have warned that rising oil and food prices pose a risk to inflation. But RBI Governor Shaktikanta Das said the central bank’s retail inflation outlook for FY23 was quite “robust”. The RBI has projected average retail inflation of 4.5% in FY23. 

Das reiterated that inflation momentum was on a downward slope since and the central bank had taken into account all scenarios.

India is vulnerable to fluctuations in oil prices as it depends on imports for more than 80% of its oil needs. Market watchers expect oil marketing companies to effect a sharp hike in petrol and diesel prices in March, once state Assembly elections come to an end.

 Fuel prices have remained unchanged for more than three months now despite a sharp uptick in crude prices. 

 An RBI paper from January said that if a crude price shock hits the Indian economy the Current Account Deficit to GDP ratio will rise sharply irrespective of a higher GDP growth.

 And a $10/barrel increase in oil price will raise the inflation by roughly 49 basis points or increase the fiscal deficit by 43 bps as a percentage of GDP if the government decides to absorb the entire oil price shock rather than passing it to the end users.

The government is hoping that crude oil prices will come down over the next few months so it won’t be forced to cut excise duties to rein in inflation when oil companies pass on higher costs to customers. 

Given the Budget has not made any provision for a cut in excise duties in case crude oil prices remain persistently high, both the RBI and the government will find themselves in a tricky situation.