Insights into Editorial: Global stagflation risk: On the need to cut fuel taxes

Context:

As Russia’s invasion of Ukraine is set to enter the third week, the economic costs of the conflict in Eastern Europe threatens to stall the shaky global recovery from the COVID-19 pandemic.

Oil prices surged after Russia invaded Ukraine on February 24, with Brent rising above $116 a barrel, while supply disruptions have hit global prices of wheat, soybean, fertiliser and metals like copper, steel and aluminium – raising worries about prices and economic recovery.

State oil companies have told the government that they need a price increase of 10-12 rupees per litre for petrol and diesel.

While the expansive financial sanctions imposed on Russia by the U.S. and its western allies have sent the value of the rouble plunging by more than 60% against the dollar since the start of the conflict, the war-led disruptions to supply.

The sanctions have sent the prices of several key commodities soaring: from wheat and corn, to metals including nickel and aluminium, and, most crucially, crude oil and gas.

Russian supply of Natural gas to Western countries:

1. Brent crude futures surged to a high not seen since July 2008, and are currently about 29% higher than before the invasion began on February 24.
2. The price of natural gas has also risen sharply in Europe amid concerns that supplies from Russia could be hit either on account of European nations agreeing to a U.S. proposal to shut the tap on Russian energy exports or by retaliatory sanctions by Moscow.
3. Russia supplies Europe about 40% of its gas requirements, roughly a quarter of its oil and almost half its coal needs, and an embargo on energy supplies from Russia could send already high electricity costs in the countries comprising the eurozone skyrocketing.
4. That in turn would hit consumers, as well as businesses and factories, forcing them to either raise prices or possibly even temporarily shut operations.

Higher gas prices begin to trickle in:

1. Some of the recent spike in gasoline prices should be included in the data, but more of the run-up should appear in March and April.
2. Economists had expected inflation to peak in March, but now they say it could be later in the spring before it tops out.
3. The national average price for a gallon of unleaded gasoline was a record $4.25, up 60 cents in a week and up nearly 80 cents over the past month, according to AAA.
4. Gasoline prices moved somewhat higher in the last days of February, enough to nudge my headline CPI forecast up by a tenth to +0.8%, but the bulk of the pain will be felt in March and April.
5. Stanley forecasts February’s headline CPI will be up 7.9% year over year. They expect March’s CPI will be at least a percentage point higher, just under 9%.
6. Forecasting institutes expect the energy price spike to prove mostly temporary, so that we may see some relief by midyear, depending on how long it takes for the war in Ukraine to be resolved and how long it takes other oil and gas suppliers to step in and backfill Russia’s sanctioned exports.
7. Oil has been on a tear, topping $130 per barrel earlier this week. West Texas Intermediate crude futures were trading at about $109 per barrel.
8. Oil prices were sharply lower Wednesday on a report that the United Arab Emirates, an OPEC member, was open to production increases.
9. But even so, as long as the Ukraine conflict continues, Russian oil will be impaired and that is likely to keep prices high, according to oil analysts.

Fiscal Health of India will affects:

1. If oil prices continue to increase, the government shall be forced to cut taxes on petroleum and diesel which may cause loss of revenue and deteriorate its fiscal balance.
2. The growth slowdown in the last two years has already resulted in a precarious fiscal situation because of tax revenue shortfalls.
3. The revenue lost will erode the government’s ability to spend or meet its fiscal commitments in the form of budgetary transfers to states, payment of dues and compensation for revenue shortfalls to state governments under the Goods and Services Tax (GST) framework.
4. Natural Gas Price: The increase in gas prices has put upward pressure on the price of both Compressed Natural Gas (CNG) used as a transport fuel and Piped Natural Gas (PNG) used as a cooking fuel.

India’s policymakers face a tough choice:

In a 2019 paper on ‘The Impact of Crude Price Shock on India’s Current Account Deficit, Inflation and Fiscal Deficit’, two senior RBI researchers posited that a $10 increase in the price of oil from a $65 level would raise headline inflation by about 49 basis points (bps) or widen the Government’s fiscal deficit if it decided to absorb the entire oil price shock.

India’s policymakers face a tough choice: bear the cost of lower revenue by cutting fuel taxes or risk both faster inflation and slower growth.

India will raise petrol and diesel prices next week for the first time in more than four months as global crude prices soar after Russia’s invasion of Ukraine last week, three government officials said, amid growing concern about inflation.

Asia’s third-largest economy, which imports 80 per cent of its oil needs, faces retail inflation staying above the central bank’s tolerance limit of 6 per cent as companies pass on a nearly 40 per cent rise in crude prices since November, as well as rises in prices for other imported raw materials.

Impact on India:

1. Current Account Deficit: The increase in oil prices will increase the country’s import bill, and further disturb its current account deficit (excess of imports of goods and services over exports).
2. Inflation: The increase in crude prices could also further increase inflationary pressures that have been building up over the past few months.
3. Economic Recovery: Although the rising prices have impacted the world, India is particularly at a disadvantage as any increase in global prices can affect its import bill, stoke inflation and increase its trade deficit, which in turn will slow its economic recovery.
4. India and other oil importing nations have called on OPEC+ to boost oil supply faster, arguing that elevated crude oil prices could undermine the recovery of the global economy.

Conclusion:

India’s leading state-owned oil refiners are also looking to club their demand to secure better deals on oil procurement.

Experts noted however that while bunching of demand may help secure a better deal, an attempt to diversify consumption could conversely lead to lower discounts from individual countries.