Oil Prices to rise in India?

Fueling the economy?

The Union Cabinet, headed by Prime Minister Manmohan Singh, was scheduled to meet today to announce a decision on raising petrol prices by Rs2 a litre and diesel prices by Re1 a litre, combined with some cut in excise duty on the two fuels. The Group of Ministers on fuel prices, headed by External Affairs Minister Pranab Mukherjee, had met last week and decided to leave this matter in the hands of the Union Cabinet. While the Finance Minister P Chidambaram is in favour of a fuel price hike, the Petroleum Minister Murli Deora is backing a cut in duties.

The meeting has been triggered by the recent global price trends. Global oil prices have been surging and crossed the $100 per barrel mark in early January. Concerns over inadequate refining capacity, political tensions and soaring demand from the emerging markets of China and India have kept oil prices at elevated levels. Of course the sizable downturn in the US dollar had a dampening effect on oil futures, which offer a hedge against a weak dollar. Despite the jump in global oil prices, the Indian government has capped the prices of widely consumed fuels in the country.

Recent indicators have been pointing towards a continuing slowdown in the US economy (with the latest data showing a 17,000 cut in US non-farm payrolls). This has cooled global oil prices to some extent, down to around $90 per barrel. Industry experts and economists are expecting oil prices to decline further due to the possibility of an increase in output by the OPEC and declining demand from the US.

However, this still does not solve the problem for the Indian Cabinet. State-run refiners have not been allowed to raise prices since mid-2006. According to recent reports, the three main government owned companies, Indian Oil, Bharat Petroleum and Hindustan Petroleum, are together expected to report more than Rs71,000 crore on the sale of petrol, diesel, LPG and PDS kerosene this fiscal due to the government’s ceiling on retail prices. Private oil companies, like Reliance Industries, Essar Oil and Shell India, are suffering the most. While state oil firms are receiving crores of rupees in subsidies, the price capping prevents private companies from significantly hiking their prices, since they would lose consumers.

Inflation, which had slid to a five-year low of 2.97% in the last week of October 2007, is now at a five-month high, at 3.93%. This acceleration is prior to any increase in oil prices. “The inflation rate will be higher by 1.5 percentage points if the entire increase in oil prices is allowed to be passed through into the economy,” said HSBC economist Robert Prior-Wandesforde.

The Indian economy has proved its mettle in the face of uncertainty and has continued to grow. The IMF expects the economy to expand by 8.75% this fiscal year “as a result of rising productivity and investment.” The Indian economy may be able to sustain 9-9.5% growth. A hike in fuel prices has the potential to dampen growth. However, it is to be seen if the government announces any significant hike before the national polls in May 2009.