Petrol, diesel prices play havoc: Effect on economy, stock markets

However, surging fuel prices have the potential to destabilize the economy. Further, it may also affect the stock markets negatively, especially those shares that are dependent on oil and gas in some way or the other.

Sep 07, 2018 12:09 IST India Infoline News Service

Petrol Pump
Retail fuel prices have risen consecutively for the last 10 days. This upswing is the result of a deadly cocktail of the international geopolitical situation, a diving rupee, and the government’s unrelenting tax regime.
 
Despite petrol’s price being in the range of Rs79-86 and diesel in the range of Rs71-75 as per the price in various metro cities, the government has refused to intervene or cut down on the taxes levied on fuel. Union petroleum minister Dharmendra Pradhan has blamed external factors and the depreciating rupee for this price upsurge, claiming that the increase is merely “temporary.”
 
However, surging fuel prices have the potential to destabilize the economy. Further, it may also affect the stock markets negatively, especially those shares that are dependent on oil and gas in some way or the other.
 
But then again, why are petrol and diesel prices soaring, reaching new heights every day? Why is the government in a precarious situation? How can this impact the economy and the stock markets? Let’s dive deeper.
 
Why are fuel prices rising?
 
  • Volatile global scenario: First, the volatile international scenario has led to a surge in oil prices. Global crude oil prices have been hovering near $80 for quite some time. The cut down of crude production by OPEC countries and Russia and the massive supply meltdown in Venezuela further pushed up the prices. Further, US President Donald Trump’s threats about sanctions on Iran continued to pressurize the prices. Even though Saudi Arabia and other OPEC members have lifted up supply, markets are wary that they won’t be able to meet the requirements of the shortfall from Iran, Libya, and Venezuela, which are grappling with crises. Apart from this, India is one of the largest importers of Iranian oil; thus, Trump’s warning that “anyone doing business with Iran will not be doing business with the US” will be a blow to the Indian economy, as it might have to look for an alternative or face a fuel crunch.
  • Weakening rupee: Second, the rupee has nosedived and is currently at a record low of Rs71.75 against the US dollar. Here, the country is entangled in a vicious cycle. India relies on oil imports for its fuel requirements and imports about 80% of its needs. Thus, rising oil prices leads to a much bigger import bill in dollars, which in turn, weakens the rupee. Incidentally, the rupee’s value has plummeted 10% since the beginning of the year. Hence, a blow to the twin deficits. Moreover, the economic crisis in emerging markets like Venezuela and Turkey has also lead to a contagion effect, adversely impacting the rupee.
  • High domestic taxes: Third, some other market analysts argue that the reason for the high domestic prices is the high taxes, that is, excise levied by the Centre and VAT imposed by the states. It is normally argued that petrol and diesel are considered milch cows to make revenue for the government. Interestingly, as per the Finance Ministry’s revenue collection estimates, the government expects to earn over Rs2.58lakh cr by imposing taxes on petroleum products by the end of this fiscal. This is a humungous jump from the gross revenue collection of ~Rs88,600cr in 2013/14 when it took office.
Impact on the economy
 
The macro effect: The obvious effect of rising crude oil prices is the effect it has on the country’s import bill. An exorbitant import bill increases the country’s current account deficit, which means that the value of the goods and services it imports exceeds the value of the goods and services it exports.
 
Oil Marketing companies (OMCs) take the hit: Further, high taxes on crude oil discourage producers from pumping enough supply to the retail market, making fuel pricey. High prices also puts pressure on the profit margin of oil marketing companies.
 
Inflation rising: The Economic Survey of the Government of India has estimated that a $10/barrel rise in crude oil price can increase WPI inflation by 1.7%, widen CAD by $9-10bn, and reduce economic growth by 0.2-0.3%.
 
Costlier manufacturing: Apart from increasing the cost of transportation, rising crude prices also makes manufacturing of certain products costlier due to great input costs, driving up prices.
 
Capital inflow: A rising trade deficit due to higher import bills weakens the rupee and may also cause FIIs to pull back owing to a weakening rupee vis-à-vis the strengthening dollar.
 
Burden on the middle class: The price rise mainly affects the middle class, which is not exactly a huge voter base, but notably, the saffron party’s maximum cadre comes from this segment. After demonetization and GST, rising crude prices could be a sore point for them. Moreover, though BJP believes that their voter bank has shifted to poor and dalits, inflation induced by rising prices will hit them as well.
 
How are the stock markets affected?
 
Rising crude oil prices puts downward pressure on profits, which hurts the stock market.
 
Stocks of oil marketing companies like HPCL, BPCL etc. are predictably affected. Such companies buy raw material, that is, crude oil at a steep price. Meanwhile, the prices of their refined products like petrol and diesel does not usually increase in the same proportion as that of crude oil prices. Thus, such companies end up losing money.
 
Further, airline companies like IndiGo, SpiceJet, and Jet Airways are also negatively impacted as fuel cost rises. Considering the fact that most of these companies suffer from a cash crunch, their shares might not do well owing to the risk.
 
As fuel prices increase, logistics costs will increase for companies dealing in FMCG products, cement, consumer goods, and agriculture, which in turn, might affect their profits and stock prices.
 
So, are there any possible solutions in sight?
 
The government can only pray that the international crude scenario settles down soon. Any cut in tax will increase the fiscal deficit, leading to a reduction in the capital expenditure during election year. If the price rise continues, the government may have to force OMCs to incur losses and sell fuel at a lower price.
 
For the long term, the country can move towards fulfilling its longstanding ambition of reducing its dependence on oil and moving to alternative sources such as electricity and biofuels.

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