The fall in the global price of crude oil augurs well for us as it is a continuation of the positive developments that have taken place for the Indian economy, starting with higher GDP and IIP growth, and lower CAD and inflation. Higher output from North Dakota and West Texas has contributed to this downward trend, which is expected to continue till January, notwithstanding the higher demand likely to emanate in the winter.
To begin with, it must be put on record that the price of crude has actually reverted to the January situation when the West Texas Intermediate (WTI) stood at $95.14 (was $94.53 at September-end). Brent is the one which has declined sharply from $107.94 to $95.7/barrel during this period. The arbitrage on this spread has now come down with supplies increasing in the market. The ISIS threat has now taken a backseat and a stronger dollar has steadied the price at a lower level. The Indian basket price has tended to follow Brent and has now come down from $108.76 on January 2 to $95.34/barrel by September-end. The decline really started from August onwards. What does this mean for India?
First, the fact that we have moved towards marking-to-market the price of petrol and now diesel is good, as any reduction in price of crude oil actually gives us the option to either lower the consumer price and hence soothe inflation, or retain market price and use this benefit to support the subsidy on other products such as LPG and kerosene. The choice is really with the government.
Second, the trade balance is to get some support from the price movement. India's basket is different and priced higher based on the quality. Last year, the price averaged $105.52/barrel. Depending on the decline in price of our basket, the benefits can be evaluated. Demand for oil is typically fairly inelastic, and in the last two years imports of crude oil were approximately 1.354 billion and 1.390 billion barrels, respectively. Assuming this number to remain almost unchanged at, say, 1.40 billion barrels, the total savings for a dollar reduction in price will be no more than $1.4 billion or $14 billion on an annualised basis in case there is an average reduction of $10 per barrel in price. The latter looks probable if this trend continues.
Given that imports were around $450 billion last year, the savings would be just around 3% of total for FY14, and with a higher base in FY15 would be even lower at 2.8%, assuming total imports to be $500 billion. However, in terms of CAD, there will be an improvement. Last year, CAD was $32 billion and savings of, say, $14 billion on an annualised basis would reflect in a lower CAD amount and ratio. Trade deficit was $147 billion, which will improve by 10% with such savings. Therefore, the picture on the external front is positive.
Third, from the point of view of tax collections for the government, it would be a mixed picture. For the central government, the customs duty is denominated by a specific duty rate per tonne, while the excise rate is also in similar terms. Hence, a lower price will not affect the central government under ceteris paribus conditions. State governments, however, do charge sales tax, which varies between 20-28% ad valorem. A lower price would translate into a decline in revenue as the ad valorem rate is unchanged.
Fourth, the inflationary impact would depend on how we choose to regulate prices. Currently, in the WPI index, the weight of fuel products is 9.36%, of which 7.56% (including 5.87% for petrol and diesel) is marked-to-market anyway. This will lower the primary impact of inflation and 10% decline in price, which is broadly speaking $10/barrel decline in prices, will lower inflation by roughly 0.75-0.8%, provided there is 100% pass-through. However, the secondary impact is uncertain as the pass-through may not be free flowing. In case of the regulated prices under kerosene and LPG, the implied under-recovery will come down with the cost of the product coming down.
Fifth, the impact on CPI, however, looks to be more restrictive as crude oil enters the index indirectly in two forms: fuel & light and transport & communications. While the weights in the index are 10.4% and 5.83%, respectively, for the sub groups, the tendency would be that with the exception of direct consumption of petroleum for vehicles used by households, the other items are unlikely to change as transport charges never come down because taxi and bus charges move up but never down as they are adjusted to generalised inflation or subsidised. Therefore, the impact on retail inflation would be relatively muted.
Last, the government can see benefits at the margin in terms of the fuel subsidy bill, which has been an area of concern. The policy of increasing the price of diesel gradually to make it market-oriented has worked well, and with the subsidy on the other two products being lowered, the government can decide on whether or not it should let the prices of deregulated products move downwards or hold them to cross-subsidise the regulated products.
The situation of declining crude prices would also offer an opportunity to the government to start calibrating the prices of kerosene and LPG to the market gradually in a meaningful manner. The success of the diesel story should be replicated where the prices are allowed to creep upwards in a non-obtrusive manner. The current system of limiting the number of cylinders is quite inefficient and open to gaming. A more straightforward approach would be pragmatic.
A thought worth pursuing is that since one is never sure of how the crude oil prices will behave, it may be worth creating an oil stabilising fund, which can be used in times of an upward swing in global prices. This will be possible if we transfer the price advantage on account of lower current prices either fully or partly to this fund.
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