Advani worried about the falling rupee
Why curbs on overseas investment will boost domestic realty

Economy Aug 19, 2013

Rupee woes: More trouble ahead as oil prices touch all time high

By Vivek Kaul

My father takes the Delhi Metro to work. Of late it takes him nearly 25 minutes to get into the Metro station in the evening. This is because the line for the security check is very long.

Basically the high price of petrol and diesel is forcing more and more people to take the Delhi Metro. And things will only get worse on this front in the days to come.

On August 15, 2013, the price of the Indian basket for crude oil touched an all time high of Rs 6680.46 per barrel (around 159 litres). In dollar terms the Indian basket for crude was priced at $108.59 per barrel. One dollar was worth Rs 61.52 on August 15, 2013. And this led to a price of Indian basket of Rs 6680.46 per barrel.

This number would have gone up even further today, given that the rupee has depreciated further against the dollar. It touched an all time low of 62.76 to the dollar today. Even if we assume the same price of the Indian basket in dollar terms (i.e. $108.59), at Rs 62.5 to a dollar, this works out to Rs 6786.88 per barrel. This is higher than the price on August 15, 2013.

In a press release dated August 16, 2013, the Ministry of Petroleum and Natural Gas, talks about the increasing under-recoveries on diesel. The under-recovery on diesel has gone up to Rs 10.22 per litre for the fifteen day period ending August 15, 2013. Before this, the under-recovery was at Rs 9.29 per litre. This leads to a daily under-recovery of Rs 389 crore or Rs 11,670 crore for the month. That's the under-recovery just on diesel. Other than this there are under-recoveries on cooking gas as well as kerosene. The under-recoveries for the first quarter of 2013-2014 (i.e. period between April 1, 2013 and June 30, 2013) stood at Rs 25,579 crore.

This is likely to go up during this quarter, given the depreciation of the rupee and the increasing price of oil. Oil prices have been going up internationally because of the uncertainty that prevails in Egypt. The "fear premium" is getting built into the price of oil.

As a report in the Daily News and Analysis points out "Egypt controls the Suez Canal and the 320 km Suez-Mediterranean (Sumed) crude oil pipeline, which together account for around 2.5% of the global crude oil supply. Logically, any threat to these two major infrastructural landmarks could lead to a disruption in supply from the Middle East to customers in the United States and Europe."

Reuters

Reuters

And this is driving up the price of oil in dollar terms. Along with this the depreciating rupee has led to a "double whammy" for the price of oil in rupee terms.
Based on the recommendations of the Kirit Parikh Committee, on June 25, 2010, the government of India announced full deregulation of the prices of petrol and at the same time announced that diesel prices would soon follow suit.

This meant that the international price of oil would determine the price of petrol and diesel in rupee terms.

Till then, the government used to force the oil marketing companies(OMCs) to sell oil at a price which did not make commercial sense for them. The government subsequently compensated the OMCs for these under-recoveries.

While petrol prices were deregulated, the same did not happen in case of diesel prices. As A Citizen's Guide to Energy Subsidies in India points out "The Government of India (GOI) on 25 June, 2010 announced the full deregulation of the prices of two crucial petroleum products: petrol and diesel. Henceforth, prices of these two products will be determined by the unfettered play of market forces and government "subsidies" on these products...Petrol prices were liberalized from June 2010 and it was reported that diesel prices would soon follow suit."

But the diesel prices did not follow suit. "The government announced on November 24, 2011 that diesel price deregulation had been put on hold owing to the rise in the level of food inflation. a rise in diesel prices would result in an increase in freight charges levied by transport companies. This would, in turn, feed into higher prices of food commodities," the report points out.

Only very recently, the government started to increase the price of diesel, to reduce the under-recoveries. But with the international price of oil going up and the rupee depreciating against the dollar, even at higher prices, the under-recoveries on diesel haven't come down. The under-recovery on diesel was at Rs 9.29 per litre in January. It is now at Rs 10.22, despite diesel prices going up.

It remains to be seen how the government deals with the situation. If it increases the price of diesel it will translate into higher inflation. If it doesn't pass on the higher prices to the consumers, then the fiscal deficit of the government will shoot up because it will have to compensate OMCs for the under-recoveries. Fiscal deficit is the difference between what a government earns and what it spends.

Elections in five states are to be held in December 2013/January 2014. These states are Delhi, Mizoram, Madhya Pradesh, Rajasthan and Chattisgarh. The Congress is not in power in three out of the five states.

Prices of diesel were not raised before the Karnataka elections. Given this, it is likely that the price will not raised in line with the 'real' price of diesel. Hence, the fiscal deficit of the government is likely to go up. "We are concerned with the government's ability to stick to its budgeted fiscal deficit target," wrote analysts of Nomura in a recent report titled India: turbulent times ahead.

A higher fiscal deficit will lead to higher borrowings by the government. This will lead to higher interest rates as a higher government borrowing will crowd out others. This will slowdown economic growth even further.

If the government tries to maintain the fiscal deficit and at the same time not pass on the higher price of diesel to end consumers, then it will have to slash spending. As the Nomura report points out "If the government wants to stick to its budgeted fiscal deficit target (of 4.8% of GDP in FY14), it will have to either slash spending or substantially hike diesel prices - either way, it will hurt growth."

Whatever the government does on the diesel price front, the short point is that we are screwed.

(Vivek Kaul is a writer. He tweets @kaul_vivek)

by Vivek Kaul

Related Stories.