Over the last 2 years, the price of petrol in Delhi has gone up from Rs.62.19/litre to Rs.76.57/litre. During the same period, the price of diesel has gone up from Rs.50.95/litre to Rs.67.82/litre. Remember, Delhi has the lowest price of petrol among the metros and in cities like Mumbai the price of petrol has already crossed Rs.84/litre. Why are fuel prices rising and what are the challenges that it creates for you?
Why is the price of petrol and diesel going up sharply?
Chart Source: Bloomberg
As can be seen from the above chart, the price of Brent Crude has gone up from $46/bbl last year to $79/bbl in the current year. India imports nearly 75% of its daily oil requirement and therefore the domestic price of petrol and diesel is largely determined by the landed cost of crude oil. Additionally, the government had also increased the excise duty on petrol and diesel on 8 occasions in 2015 but has cut the duty only once since then. With the pricing of petrol and diesel being largely deregulated, most of the price hikes in the landed cost of crude oil are passed on to the end customer. That explains why the price of petrol and diesel is going up.
How it impacts the economy and the household budget?
Higher oil prices not only impact the overall Indian economy but also the household budgets. Here are four major implications of higher petrol and diesel prices in India.
Remember that fuel costs constitute a key component of the household budget. The average Indian family with a single car drives nearly 2,000 km on an average per month including weekend drives. Assuming that the average car gives around 12 km/litre in city roads, you are looking at an average consumption of around 170 litres per month. An increase of around Rs15 in the last 2 years would take the fuel budget up by nearly Rs2,550 per month. Assuming a monthly spending budget of Rs50,000, that is a 5% increase in the total budget purely on account of fuel cost.
Let us now turn to the impact of higher petrol and diesel prices on CPI inflation (retail inflation). Over the last 4 months, the CPI inflation has been rising due to a mix of higher food prices and higher fuel prices. Higher fuel prices also have a secondary impact on inflation as it increases the cost of transportation and therefore impacts a lot of other products that are in the inflation basket.
Higher inflation has an impact on the RBI interest rate policy. The interest rates in India are set by the Monetary Policy Committee (MPC) and one of the key determinants of the rate of interest is the rate of CPI inflation. When inflation goes higher, the RBI will be under pressure to hike the repo rates in the economy. This can have two broad implications. Firstly, it will raise the cost of capital when you value companies and that will put pressure on equity valuations. Secondly, the cost of funding goes up for Indian companies and that is already evident in recent borrowings. Higher cost of funding poses financial risk to Indian companies. The 10-year bond yields are already hinting at a hike in interest rates by the RBI.
Last, but not the least, higher oil prices leads to a rise in the import bill and that increases the trade deficit. The average monthly trade deficit is getting closer to the $15 billion mark and the Current Account Deficit is now above 2% of GDP. This puts pressure on the value of the Indian rupee. Look at the chart below:
Chart Source: Bloomberg
As the chart shows, the INR has weakened from 63.50/$ in Jan-18 to 68.33/$ in May-18. This has been largely driven by higher trade deficit and current account deficit. When the rupee weakens, imports become more expensive and this impacts the cost of production of import-intensive industries. There is another challenge for companies that have Foreign Currency Borrowings in their books. Since the repayment is in dollars, the actual payable is much higher in rupee terms when the rupee weakens versus the US dollar.
When oil prices go up, the impact on the price of petrol and diesel are just the most visible and immediate repercussions. There are larger implications for macros like inflation, interest rates, trade deficit, exchange rate of the rupee and the forex reserves. It is this strong downstream impact of oil that makes it a big challenge for the economy and also for the individual household budgets.