The macroeconomic environment has changed significantly since Finance Minister Nirmala Sitharaman presented the Union budget and the RBI released its inflation forecast for the coming financial year. On Thursday, crude oil prices hovered around $120 a barrel for the first time in years. While prices moderated slightly thereafter, for the Indian economy, which imports around 80% of its needs, the rise in crude oil prices will have adverse consequences. Higher prices will impact growth, be inflationary and put upward pressure on the current account and fiscal deficit. Given that crude oil prices are currently significantly higher than those factored into the Union budget and RBI calculations, navigating this uncertain economic environment will require skillful management from monetary and fiscal authorities.
Since November last year, when the price of India’s crude oil basket stood at $80.64, oil marketing companies have refrained from revising prices at the pump, even as global prices have risen. . But once assembly elections are over, fuel prices at the pump are likely to rise. However, steep hikes will be needed – according to a report by ICICI Securities, a hike of Rs 12 per liter will be needed just to break even. It will be inflationary. Needless to say, fuel price hikes will upset the central bank’s optimistic assessment of the path of inflation. According to the recent RBI assessment, inflation is expected to decline from 5.7% in the fourth quarter of 2021-22 to just under 5% in the first half of 2022-23. This will complicate the choices before the monetary policy committee. Higher prices will also reduce household discretionary spending. Governments can respond by lowering fuel taxes to absorb some of the burden. However, it will weigh on their income and expenses. So growth will take a hit. Higher oil prices will also lead to higher imports, increasing the current account deficit at a time when global financial conditions are tightening. Recent data shows that the merchandise trade deficit has already widened to $21.2 billion in February from $17.9 billion, with much of the rise driven by oil. The rupee is already under pressure. This will only add to inflationary pressures.
The indirect consequences of the deterioration of the economic environment are also beginning to be felt. There are reports that LIC’s IPO may be delayed to next fiscal year due to the prevailing market uncertainty. While the full effects of the oil price shock will be visible with a lag, when taken together with the third wave of the pandemic, they suggest further downside risks to economic growth in the fourth quarter, which according to the latest estimate from the National Statistics Office, was already expected to slow to 4.8%, from 5.4% in the previous quarter.
This editorial first appeared in the print edition of March 5, 2022 under the title “Cost of War”.