Why is the price of petrol and diesel going up sharply?
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:
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.